Yukos Expropriation
For Yukos, the path from success, to expropriation and destruction, began with tax. In essence, the Russian authorities took tax liabilities away from various Yukos subsidiaries and associated companies, which were tax payers in their own right (based in different regions throughout Russia), and reassigned those companies’ incomes to Yukos. This section will explain this process in detail.
From owing no further tax, to owing billions
In September 2003, after a three month audit completed in March 2003, which generated some tax discrepancies that were resolved in July that year, the Russian tax authorities certified that Yukos had no tax debts for the years 2000 and 2001. The same indication was given in October and November 2003.
Nevertheless, in December 2003, the tax authorities informed Yukos that a ‘re-audit’ would be carried out.
Unlike the first audit, which had gone on for months, the re-audit took a mere 15 days. It comprised of some 70 pages and 284 supporting documents in its annex. Its conclusions were stunning and unprecedented, and would set the stage for the battle between Yukos and the Russian authorities.
The audit report claimed Yukos had underpaid its 2000 taxes due by RUB 79.6 billion, (EUR 2.27 billion). In addition Yukos was ordered to pay fines of 40% of the tax arrears and penalty interest, to arrive at a final, additional tax debt of RUB 99.4 billion (EUR 2.9 billion).
Analysis of the tax liabilities assigned to Yukos in the reassessment
Between 2000 and 2003 inclusive Yukos had, like most operations of its size in Russia, carried out parts of its business through subsidiaries and associated trading companies. The trading companies were registered as separate tax payers based in Russian Special Economic Zones (SEZs) and other investment areas. These are economically stagnant areas, often in geographically difficult locations, or where military or nuclear activities were conducted in the Soviet period. Under Russian Federal legislation, such areas were permitted to adopt local tax regulations, whereby local corporate profit tax was applied at a lower rate so as to attract companies to register as tax payers in these areas.
In other words, companies registered for tax purposes in these investment zones were expressly permitted by the Russian Federal legislation to pay less local corporate profit tax because they were registered there. The level of corporate profit tax payable to the Federal (as opposed to the local) tax budget was unaffected by place of tax payer registration.
The economic sleight-of-hand played by the Russian tax authorities against Yukos was to suddenly, and without precedent or justification, retrospectively treat the subsidiaries and trading companies as non-existent, rather than as separate tax payers, and treat their income as that of Yukos itself.
The fundamental flaw of this approach is that there is no provision in Russian law allowing the tax authorities to ‘pierce the corporate veil’ and attribute the income of one company to another, even if it is a subsidiary, dependent or affiliate entity. Neither is there any provision for consolidated tax assessment of company groups, or centralised collection of a group’s aggregate tax liabilities from a parent or holding company. Each company is required to register as a separate tax payer and to declare and pay its own individual taxes.
In short, the decision to disregard the tax status of the third parties to Yukos, and then assess Yukos to be taxed on that income, lacked any legal basis and was entirely without precedent.
The justification put forward by the tax authorities was that the Yukos group exported oil through various trading companies registered in regions with favourable tax rates. The tax authorities alleged this amounted to unlawful tax avoidance because the use of trading companies registered in the special investment zones served no viable economic purpose other than the reduction of tax.
Three immediate contradictions arise in respect of the stated justification for the reassessments:
- Most of the reassessed liabilities were unrelated to the special investment zones: they concerned VAT, which was uniform in all parts of Russia;
- Reduction of one’s tax burden in this way was not prohibited, but positively and expressly allowed by Russian law;
- The purpose of the favourable tax rates in the special investment zones was to attract tax registration to regions that were otherwise economically inexpedient.
These contradictions become even more evident in the context of the individual taxes. Although Yukos was reassessed to seven different taxes over the relevant period, 95.5% of the total reassessed tax liabilities were in respect of two taxes: VAT and corporation profit tax (CPT). These are therefore covered below in some depth.
VAT
Of the reassessed tax liabilities, 56% were in respect of VAT levied on turnover from the oil exports of the trading companies during the relevant period. These liabilities arose as follows.
The trading companies exported oil and claimed the exemption from VAT to which they were entitled. The tax authorities however decided to treat Yukos as the exporter of the oil. They then levied VAT on those export sales, and charged this to Yukos, because the trading companies, rather than Yukos, had claimed VAT exemption. When Yukos later claimed VAT exemption (applying the tax authorities’ "logic"), VAT exemption was still refused.
VAT is a purely federal tax, levied at uniform rates throughout Russia. Thus, whilst different types of operations are taxable at different rates, no VAT economy can be gained by the use of companies in special investment zones. Therefore the justification given by the tax ministry for its assignment of income, and therefore of the reassessed tax liabilities to Yukos, did not apply to VAT at all.
Throughout the relevant period, turnover from oil exports was either exempt from VAT (2000) or levied at a 0% rate (2001 – 2004), subject only to a requirement that the taxpayer provide specified documentation confirming that the oil was indeed exported. Accordingly, the reassessed VAT liabilities assigned to Yukos were in respect of turnover that incurred no tax liability at all.
The tax authorities held that the exemption/0% rate did not apply to the trading companies’ turnover because Yukos had ‘not submitted’ the supporting export documentation necessary to claim the rate under Article 165 of the Tax Code. The company was therefore held liable for VAT on the trading companies’ turnover at the maximum rate, which was 20% in 2003-2004 and 18% in 2004.
The tax authorities did not dispute that the turnover in question arose from export operations qualifying for the 0% rate. Nor did it dispute that all the necessary documentation had been submitted by the trading companies themselves and was accepted by the tax authorities at the relevant time. The supporting documentation was moreover available to the tax authorities during the audits that gave rise to the reassessments and was, as a matter of practice, not merely sent to the relevant tax inspectorate on a monthly basis. It was also information supplied by Yukos directly to the tax authorities, also monthly.
Thus, the reassessed VAT liabilities arose not from any economic activity incurring tax liabilities, but from the tax authorities’ own unprecedented and selective approach to ‘piercing the corporate veil’. The export turnover received and declared by the trading companies was attributed to Yukos, whereas their actions claiming the 0% export rate were not.
Corporate Profit Tax
Thirty-seven percent of the reassessed tax liabilities were in respect of Corporate Tax Profit (CTP).
There are two types of special investment area that levy lower local tax rates; the various Yukos trading companies were registered in both types. Tax payers registered in these areas paid a lower rate of local CTP than elsewhere. However, they paid the same level of federal CTP as everybody else in the country.
In each of the relevant years, the tax authorities effectively ’disapplied’ the lower rates in respect of the trading companies and reassessed their CPT at the maximum rate. These resulting tax liabilities were then assigned to Yukos.
The tax authorities justified this approach on the grounds that the Yukos group’s use of trading companies registered in special investment zones amounted to unlawful tax avoidance because it served no viable economic purpose other than the reduction of tax. Conceptually this approach posed three problems.
First, although the ‘commercial purpose’ requirement for a tax reduction scheme may be familiar to tax systems of other countries, it was (until Yukos) wholly alien to the Russian legal culture, which relied on strict formal rules and had no concept of legally compliant but nevertheless ‘abusive’ tax schemes. A tax reduction scheme either complied with the formal rules, or it did not.
Second, the special investment areas were not offshore jurisdictions competing with Russia for tax revenue. The relevant Federal tax legislation expressly allowed them to determine their own local tax rates and the rules for claiming them, a policy tool that positively encouraged tax competition within Russia. Moreover, the very purpose of the favourable tax rates in the special investment zones was to attract tax payers to register in regions that were otherwise economically unattractive.
Thirdly, and most importantly, the allegations provided no lawful basis to assign the trading companies’ tax liabilities to Yukos, regardless of whether they were entitled to rely upon the lower tax rates.
The tax authorities therefore devised three legal theories in support of its decision to assign the trading companies’ tax liabilities to Yukos:
- Yukos was the ‘actual owner’ of the trading companies’ assets;
- The trading companies’ transactions were fictitious transactions; and
- The entire complex of tax reduction mechanisms had been devised in bad faith.
None of these theories as applied by the tax authorities had any legal precedent. As far as is known by Yukos, none has been applied in equivalent circumstances to another tax payer.
Yukos’ objections ignored – and two days to pay
In January 2004, Yukos filed a detailed thirty-page objection to the tax reassessment with the tax authorities. This was, however, simply ignored – an early example of the countless times that, over the course of the Yukos legal proceedings in Russia, judicial due process and the rule of law was set aside.
(It is worth noting that, even at this initial stage, international agencies were expressing concern over the lack of transparency and fairness in the Yukos tax proceedings. The OECD’s Annual Economic Survey of Russia, for example, noted in 2004 that the Yukos cases amount to "highly selective law enforcement" reflecting "judicial subservience to the executive, as well as the high degree of politicisation of the security services, prosecutors and police").
Matters came to a head when, on 14 April 2004, the Russian authorities served the tax re-assessment for 2000 on Yukos. This stated that the company only had until 16 April – that is, just two days – to pay the amount allegedly due in full. The timeframe was notable not only for its brevity, but also for its subtext. The 14th was in fact a company-wide holiday, celebrating the anniversary of the founding of Yukos.
Despite the vast amounts in question, and the extraordinarily short time allowed to pay, the tax authorities did not even allow this short time to pass. Instead, they claimed it was unnecessary to wait until the end of the ‘grace period’ if there was evidence that the dispute between the tax authority and the taxpayer was insoluble. They accordingly sought an injunction to freeze all of Yukos’ assets, and started the enforcement and de facto expropriation process immediately.