Legislative amendment affecting Article 54.1: Russian Supreme Court practice review: what foreign parties should note

Following the Russian Supreme Court's practice review addressing the application of Article 54.1 of the Tax Code, the framework governing unjustified tax benefit claims against foreign-owned Russian entities has shifted in ways that in-house counsel cannot afford to overlook. The review does not introduce a new statute, but it systematises how courts across Russia are expected to interpret and apply the existing provision — and in several respects it narrows the grounds on which taxpayers have historically relied to resist Federal Tax Service audit assessments. For multinationals with Russian subsidiaries, joint ventures, or operating entities, understanding the scope of that shift is now a practical priority.

Article 54.1 of the Russian Tax Code, which came into force in 2017, displaced the earlier judicial doctrine of unjustified tax benefit as the primary legal basis for denying deductions and input VAT credits where the Federal Tax Service concluded that a transaction lacked genuine commercial substance. The provision establishes two cumulative conditions under which a taxpayer may rely on a transaction for tax purposes: the transaction must have a genuine purpose other than tax reduction, and it must have been performed by the counterparty stated in the contract. Where either condition is not met, the tax authority may disallow the corresponding deduction or credit.

In practice, the application of those conditions generated divergent outcomes across Russian arbitrazh courts. Different circuits applied varying evidentiary standards, particularly on the question of how much a taxpayer is required to verify about its counterparties' tax status and operational capacity before entering a transaction. The Supreme Court's practice review addresses that divergence directly. Its central function is to set a uniform interpretive benchmark — one that courts in all circuits are expected to follow when evaluating taxpayer conduct under Article 54.1.

The most consequential element of the review, from a foreign parent company's perspective, is the crystallisation of the "due diligence" standard applied to counterparty selection. Under the prevailing approach now endorsed by the review, a taxpayer cannot rely on the formal regularity of its contracts to rebut an FTS allegation of substance failure. Courts have generally held that a taxpayer must demonstrate that it conducted affirmative verification of its counterparty's resources, registration status, and capacity to perform — not merely that the counterparty appeared legitimate at the point of contracting. The review confirms and sharpens this standard.

A second significant element concerns the reconstruction of the tax liability when a disallowance is made. Earlier interpretations sometimes left open whether the tax authority was obliged to calculate the taxpayer's actual economic position — allowing for costs genuinely incurred even where the stated counterparty could not be confirmed — or whether a full disallowance was permissible. The review addresses this in a manner broadly favourable to the FTS, affirming that reconstruction of the genuine liability is required only where the taxpayer has cooperated in identifying the actual supplier or performer of the service. In the absence of that cooperation, a full disallowance remains the default position.

The practice review's practical reach is broader than its formal scope might suggest. It applies, in principle, to any Russian taxpayer. But certain categories of foreign-owned entities are disproportionately exposed.

Entities operating in supply-intensive sectors — manufacturing, logistics, construction, retail distribution — routinely transact with multiple tiers of Russian counterparties, some of which may have features the FTS characterises as low-substance: short operating histories, minimal fixed assets, or concentrated turnover. These are precisely the characteristics that FTS audit teams target when building an Article 54.1 case. A foreign parent whose Russian subsidiary has not maintained documented counterparty due diligence — procurement records, capacity assessments, performance confirmations — faces a material increase in audit vulnerability.

Entities that have historically treated intercompany arrangements as self-evidently substantiated are also at elevated risk. The review reinforces the position that intragroup transactions are not exempt from the Article 54.1 analysis. Where services are provided by a related entity — shared services, management fees, IP licences — the same genuine-purpose and genuine-performance tests apply. FTS audit practice for foreign subsidiaries has, in the experience of the firm, increasingly focused on exactly these arrangements.

A third category of affected entity is the Russian operating company whose foreign parent has provided guarantees, capital contributions, or financing instruments that were subsequently used to fund transactions now under scrutiny. Where the FTS is able to characterise a transaction chain as having been structured to produce a tax outcome rather than a genuine commercial one, the financing structure may become part of the evidentiary picture. In-house counsel managing Russian subsidiaries should be aware that document preservation obligations run to the full transaction chain, not merely to the immediate counterparty relationship.

"The review does not expand the statute — but it closes interpretive gaps that Russian subsidiaries of foreign companies have, in practice, relied upon. The evidentiary bar for counterparty due diligence is now materially higher." — Kristina Kornouhova, Senior Lawyer, Practice Lead — Tax & Antitrust, Vetrov & Partners

For in-house counsel managing a Russian subsidiary facing a pending FTS audit or pre-audit information request, the timeline between that initial contact and the formal start of audit proceedings is often shorter than companies anticipate.

If your Russian entity is facing an FTS audit or information request, early engagement with Russian tax counsel is material to outcome — make an enquiry: info@vetrovpartners.com | WhatsApp/Telegram: +7 (983) 510-38-76

The practical steps available to a foreign parent or its in-house counsel depend on where the entity currently sits in the audit cycle — or whether it is not yet under audit at all.

For entities not currently under audit, the most useful immediate action is a structured review of existing counterparty files. The question is not whether the underlying transactions were genuine — in most cases they were — but whether the documentation that existed at the time of contracting is sufficient to satisfy the evidentiary standard now confirmed by the review. That standard is retrospective in its application: an FTS auditor reviewing 2024 or 2025 transactions will apply the framework as clarified by the Supreme Court, not as it may have been understood at the point of contracting. Gaps in counterparty verification records are best addressed before an audit request arrives, not after.

For entities already under audit or receiving requests for documents under Russia's pre-audit information-gathering procedures, the immediate priority is ensuring that responses are legally coherent and do not inadvertently narrow the taxpayer's subsequent procedural options. A response that concedes a particular characterisation of a transaction, even implicitly, can limit the arguments available at the formal audit stage and in subsequent appeal proceedings before the Federal Tax Service and the courts.

For foreign parents reviewing the consolidation of their Russian operations — including entities considering divestiture, restructuring, or the simplification of supply chains — the Article 54.1 landscape is now a relevant factor in the tax risk assessment that should accompany any such review. Latent audit exposure for prior periods does not extinguish automatically on disposal; in certain structures it may follow the former parent through indemnity provisions or warranty claims arising post-completion. An accurate picture of the Russian entity's Article 54.1 exposure is a necessary input to that assessment.

The firm's Tax Controversy practice has advised foreign-owned Russian entities in pre-audit preparation, FTS audit defence, and appeal proceedings before arbitrazh courts across several circuits. A related analysis of how Article 54.1 operates as a matter of substantive doctrine is available at Anatomy of Article 54.1: Russian Supreme Court practice review.

For a structured review of your Russian entity's Article 54.1 exposure, request our practice review: info@vetrovpartners.com | WhatsApp/Telegram: +7 (983) 510-38-76

The Supreme Court's practice review, as with any instrument of this type, addresses the questions brought before it through the cases reviewed. It does not exhaustively resolve every contested point in the Article 54.1 landscape. Several areas of interpretive uncertainty remain.

The treatment of transactions with counterparties that are members of the Eurasian Economic Union — entities established in Belarus, Kazakhstan, Armenia, or Kyrgyzstan — is not squarely addressed. EAEU-based counterparties occupy an ambiguous position: they are subject to a distinct regulatory regime under the EAEU Treaty framework, yet Russian tax authorities have not consistently applied a lighter evidentiary standard when scrutinising them. It remains to be seen whether post-review audit practice will treat EAEU-domiciled counterparties differently from their non-EAEU equivalents.

The standard for digital-service transactions — where the "performance" of a service may leave a different documentary footprint than a physical goods or construction contract — is another area where the review's guidance, while directionally helpful, leaves room for further calibration by the courts. Entities whose Russian subsidiaries rely heavily on software licences, platform-based services, or data-provision arrangements from foreign or related-party counterparties should monitor developing court practice in this area closely.

Guidance on both of these open questions is tracked in the firm's ongoing review of Article 54.1 case law, summarised at Article 54.1: Russian Supreme Court practice review. Foreign companies seeking local tax counsel in connection with FTS proceedings may also wish to review the firm's matters record for representative mandates.

• Article 54.1: Russian Supreme Court practice review
• Anatomy of Article 54.1: Russian Supreme Court practice review
• Tax Controversy practice overview

Q: What specifically changed under the Russian Supreme Court's Article 54.1 practice review?

A: The practice review does not amend the statute itself — Article 54.1 of the Tax Code remains unchanged in its text. What the review does is set a binding interpretive benchmark for arbitrazh courts across all Russian circuits. The most significant clarifications concern the counterparty due diligence standard and the conditions under which the FTS may apply a full disallowance rather than a reconstructed liability. Under the prevailing approach confirmed by the review, a taxpayer must demonstrate affirmative verification of a counterparty's operational capacity — not merely formal contractual regularity. Where the taxpayer cannot or does not cooperate in identifying the actual performer of a service, a full disallowance of the associated deduction or VAT credit is the default outcome.

Q: Which foreign-owned Russian entities are most exposed to the new FTS audit standard?

A: The entities most directly exposed are those operating in supply-intensive sectors — manufacturing, logistics, distribution — where multiple tiers of Russian counterparties are involved and where counterparty due diligence records may not have been maintained to the standard now confirmed by the review. Entities with significant intragroup arrangements — management fees, shared services, IP licences — are also at elevated risk, as the review confirms that intragroup transactions are subject to the same genuine-purpose and genuine-performance analysis as third-party dealings. Foreign parents reviewing Russian subsidiaries ahead of divestiture or restructuring should treat Article 54.1 exposure as a material input to the pre-transaction tax risk assessment.

Q: What should a foreign company do if its Russian subsidiary has already received an FTS information request?

A: The immediate priority is ensuring that any response to an FTS information request is legally coherent and does not inadvertently limit the taxpayer's subsequent procedural options. Responses that implicitly concede a characterisation of a transaction can narrow the arguments available at the formal audit stage and in appeal proceedings. Foreign companies in this position should seek Russian tax counsel before providing substantive responses. Early engagement is material to outcome: the period between an initial information request and the formal commencement of audit proceedings is typically shorter than companies expect, and procedural choices made at that stage are difficult to reverse.

Vetrov & Partners is a Russian boutique law firm established in 2009. The firm is recognised by Pravo-300 — Russia's principal legal directory — for eight consecutive years, and is listed as a trusted adviser by the German Consulate General in Novosibirsk.

The firm's Tax Controversy practice advises foreign-owned Russian entities — including subsidiaries of multinationals, joint ventures, and holding structures — on Federal Tax Service audits, transfer-pricing disputes, and appeal proceedings before Russian arbitrazh courts. With over 1,000 matters handled since inception, the team combines detailed knowledge of Russian tax procedure with direct partner involvement on every engagement.

Enquiries: info@vetrovpartners.com | WhatsApp / Telegram: +7 (983) 510-38-76 | t.me/vitvetcom

This publication is provided for informational purposes only and does not constitute legal advice under Russian or any other applicable law. The information herein should not be relied upon as a substitute for professional legal counsel tailored to your specific circumstances. Vetrov & Partners is a Russian-qualified law firm. For matters governed by foreign law or requiring local admission in another jurisdiction, we collaborate with trusted counsel in the relevant jurisdiction. For advice regarding your particular situation, please contact info@vetrovpartners.com.

— Kristina Kornouhova Senior Lawyer, Practice Lead — Tax & Antitrust, Vetrov & Partners vetrovpartners.com/kornouhova/