Business Fragmentation: Tax Authorities' Viewpoint

Business fragmentation has recently become a frequent topic in the news [1]. One of the reasons for this are Russian Tax Code amendments which provide for an amnesty for taxpayers who attempt to save on taxes in this way [2].

Recently, the Federal Tax Service of Russia intervened in the discussion between taxpayers and tax authorities with Letter No.SD-4-7/9113 dated 9 August 2024, which set out criteria based on which tax authorities interpret entrepreneurial activity as "business fragmentation", i.e. an attempt to illegally save on taxes.

The Federal Tax Service of Russia explicitly says that it is impossible to develop a universal standard of proof (i.e., a closed list of formal signs of "business fragmentation"). It is difficult to disagree with this: entrepreneurial activity implies a wide range of ways of doing business, depending on many parameters (field of activity, end consumers, etc.). And the tax savings options that inventive entrepreneurs resort to seem almost endless. The Federal Tax Service itself notes that any definition of formal parameters of acceptable or unacceptable business structuring creates new opportunities for unscrupulous taxpayers to bypass the law.

According to the Letter from the Federal Tax Service, when qualifying a taxpayer's actions as "fragmentation", the tax authorities are guided by:

• general approaches to proving the fact of "fragmentation", which can be found in previous explanations of the Federal Tax Service of Russia;
• the current position of the Supreme Court of the Russian Federation;
• the judicial practice of resolving tax disputes by arbitration courts that develops on their basis.

Evidence of the existence of a "single centre" for several companies may include, in particular:

• common founders and/or managers of organisations;
• common employees;
• common HR policies;
• accounting records maintained by the same person;
• identical IP addresses;
• common access to cash management and control;
• identical location addresses;
• common means of communication and identification (phones, email, signs, website);
• common counterparties, representatives, material and technical resources, participants sharing expenses, signs of formal document flow, etc.

Naturally, this list is not exhaustive and each case will be considered separately by the tax authority to identify "fragmentation".

In its letter, the Federal Tax Service emphasised specifically that the recently introduced concept of "business fragmentation" [3] is not intended to establish a standard of proof in tax disputes, among other things, through the introduction of new legal institutions or the initiation of tax audits using new approaches to proof. That is, the entry into force of amendments to the RF Tax Code should not become an additional reason for heightened attention of tax authorities to business activities conducted by taxpayers.

[1] Business fragmentation: a new letter from the Federal Tax Service of Russia — Unicon (unicon.ru)

[2] An expert has revealed who will be affected by the business fragmentation amnesty— Unicon (unicon.ru)

[3] Federal Law of 12 July 2024 No. 176-FZ "On Amendments to Parts One and Two of the RF Tax Code, Certain Legislative Acts of the Russian Federation, and Recognition of Certain Provisions of Legislative Acts of the Russian Federation as Invalid”

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