Contributions to this article were also made by Meldir Erbulekova, Student-at-Law at the Gowlings Moscow office.

Foreign companies setting up sales networks in Russia should be aware of the decision summarized below, which creates a potential increased tax exposure.

In the Astellas Pharma Europe B.V v. Inter-District Inspectorate of Federal Tax Service #47 in 2004, the Arbitration Court ruled in favor of tax authorities and created a precedent which will likely impact the business practices of other international companies operating in Russia.

In this case, a foreign pharmaceutical company had a representative office in Russia. Its sales network involved a third part exclusive distributor who imported Astellas pharmaceutical products for resale in Russia. All advertising and promotional activities relating to the imported goods were carried out by the representative office of Astellas while the distributor was responsible for making sales.

In 2012, the Tax Service conducted an audit for the years 2009 and 2010 and noted that the representative office had handled not only the registration of the essential drugs but also all advertising and promotion activity. They concluded that Astellas had acted not only in the interests of the head office, but also for the benefit of the exclusive distributor in Russia. As a result, the tax authorities considered such activities as formation of permanent representation and required Astellas to pay combined back taxes and fines in excess of $1 million.

The company paid the tax and appealed the decision but was unsuccessful all the way to the Supreme Court where their request for leave to appeal was denied in May 2015.

Under Article 246 of the Tax Code, foreign companies are deemed to be tax residents, and therefore liable to pay tax, if they are found to be operating in Russia through "permanent representation", or if they receive profit from sources in Russia.

The term "permanent representation" of a foreign company under Russian tax law should not be confused with the term "representative office".

Under par. 2 of Article 306 of the Tax Code, the term "permanent representation" of a foreign company means an affiliate, representative office, department or bureau, an office, agency or any other set-apart subdivision or other place of activity of a company (hereinafter 'the department') through which the company regularly performs its business activity in Russia, connected with performing work, rendering services, or conducting other activity save for the case of the exception in par. 4 of Article 306 of the Tax Code.

Under par. 4 of Article 306, the performance by a foreign company in Russia of an activity of preparatory or auxiliary character in the absence of any sign of a permanent representation is not considered to be permanent representation. In other words, any preparatory or auxiliary activities conducted by foreign company in Russia is an exception to the general rule of permanent representation and consequent tax liability.

However, the exception to this deemed exception is if these activities are conducted for the benefit of third parties: par. 3 of Art. 307 of the Tax Code states that,

"if the foreign company performs on the territory of the Russian Federation an activity of a preparatory and (or) an auxiliary character in the interest of third persons which is leading to the formation of a permanent representation, and if with respect to such an activity no receipt of any remuneration is envisaged, the tax base shall be defined in the amount of 20 per cent from the sum of the outlays of this permanent representation involved in such activity."

It was the Federal Tax Service's position that since the foreign manufacturing company bore the actual costs for the product promotional activities, while the distributor benefited from this free promotion, this activity fell within the exception to the exception above, and thus the promotional activities were construed to be a deemed revenue to the foreign company. The marketing activities that were carried out were activities for which a resident company would normally have charged a fee and thus have derived a revenue. Tax was imposed upon this deemed revenue.

The Commercial Court of Moscow affirmed the Tax Service's position. The court concluded that the activities conducted by the representative office of the foreign company could not be considered as preparatory or auxiliary and consequently as leading to formation of permanent representation since such activities must be conducted exclusively to the benefit of the head company, not to the benefit of third parties.

The court stated that marketing and promotional activities carried out by the representative office were not only beneficial to the head company, but also to its official distributor.

This decision is noteworthy for foreign companies setting up sales networks in Russia. It created a negative precedent as regards an additional tax base to which foreign entities may be exposed.