06.08.08

The following is a slightly simplified English translation of a more detailed Russian article. The Russian contains more references and citations to the applicable Russian legislation. The English contains more in-text description of the relevant processes of Russian accounting and law. To view the Russian original, click here.

Buying And Selling Real Estate In Russia:
VAT And Profit Tax Concerns
Yulia Mazur, Partner and Head of Accounting, Alinga Consulting Group

Although Russian real estate is becoming an increasingly popular target for investors and businesses alike, Russian legislation is still unclear on how transactions involving real estate should be taxed.

This article will examine the basic issues connected with the purchase and sale of property in Russia and how such transactions should best be considered in calculating VAT and profit tax.

The fundamental issues include the following:

• Given that the transfer of a property and payment for it usually occur in advance of the formal transfer of property rights, when should the proceeds from a property sale enter into the VAT and profit tax bases?
• When can amortization on a property be accounted for and when is it possible to use that amortization as a VAT deduction?

The difficulty in answering these questions comes with the fact that there is conflicting information within the Russian Tax Code, especially when that information is considered in light of the Russian Civil Code.

Point 2 of Article 8 of the Russian Civil Code states that "the rights to the property… are realized at the moment those rights are registered (with the state), unless otherwise stipulated by law."

Point 1 of Article 131 of that same code further states that the creation, transfer, and cessation of rights to immovable property are subject to registration with the Unified State Register.

In short, the rights to a property are not legally transferred until the sale of a property is registered by the buyer with the state.

Real Estate Sales in Russia

1. VAT

Point 1 of Article 167 of the Russian Tax Code (TC) states that, as a general rule, sums should be included into the VAT tax base on the earliest of the following dates: 1) the day that goods, services, labor, or property rights are delivered or transferred; or 2) the day that payment or partial payment is made (or the day that the amount is entered into receivables). If goods have not been delivered or transported, but property rights given, then the goods (and their value) should be treated as though they have already been received.

On the basis of this rule, the sum should be entered on the day the deed to the property is drawn up. This event usually occurs first and can be considered the date on which the property itself is effectively "delivered" to the buyer.

However, Point 1 of Article 146 of the TC says that VAT is taxed at the moment that goods or services are realized in Russia and property rights are transferred. At the same time, Point 1 of Article 39 states that realization occurs when the property rights are transferred.

In this case, "realization" occurs not when the deed is drawn up, but when property rights are formally transferred – that is – when they are registered.

So when is the VAT tax base calculated and when should be a tax invoice be issued?

The tax base should be calculated on the earliest of two dates: 1) when the property rights are registered or 2) on the date payment is made. The invoice should issued, in our opinion, no later than five days after the registration of property rights.

While this system has worked in practice, there is still the possibility of disputes arising with the Tax Authorities, who are often of the opinion that VAT should be charged at the moment a good is physically transferred (i.e. when the deed is drawn up).

There is another, related issue. Often in real estate deals, a down payment is made to guarantee the conclusion of the contract. Should this down payment be considered as partial payment upon its receipt (and thus be included into the VAT tax base)?

Russian legislation differentiates between a down payment (задаток) and a partial payment (аванс). Down payments, if agreed to as such in written form, are considered payment to guarantee an obligation – and there are no laws concerning how this type of payment should be taxed, a fact verified by Russian courts.

However, if the down payment is not agreed to in written form as a guarantee of contact closure, it will be considered a partial payment.

Consequently, a down payment should enter the VAT tax base not upon its receipt, but only when the contract is concluded and the down payment is calculated as part of the overall payment for the property. Specifically, at this moment, the down payment ceases to be a method of guaranteeing the contract and becomes part of the payment for the property.

2. Profit Tax

The same difficulties occur with profit tax calculations as occur with VAT calculations.

Paragraph 3 of Article 271 of the TC states that the date profit is received is the same as the date that goods, services, labor, or property rights are delivered or transferred; Paragraph 1 of Article 39 states that this occurs when the rights are transferred with compensation made.

Thus, in our opinion, the tax base for profit tax is calculated when property rights are registered, and not when the deed is drawn up.

However, the Ministry of Finance has at times changed its position on this matter. Ruling in some cases that the tax base should be calculated on the date property rights are registered is the date of entry, and in other cases that calculations should be made when the deed is drawn up. The courts have also not been unanimous in their consideration of this issue.

On the subject of amortization, it is clear that the seller must stop applying this as a deduction on the first of the month immediately following the month the deed was drawn up. As the seller is no longer able to use the property for profit after this, amortization deductions must stop with the same accounting period.

Residual costs of the sale may be deducted in the same month that taxable income from the sale is shown.

Purchase of Real Estate in Russia

1. VAT

One major question that arises with real estate purchases is: can the purchase of fixed assets be used as a VAT deduction under the category "capital investments?"

Disputes on this question have also arisen because the related law is convoluted. Paragraph 1 of Article 172 of the TC states that capital investment deductions may be made "in full after the accounting data is recorded on the fixed assets." On the basis of a literal reading of this, the authorities have determined that deductions can be made only if the purchase is recorded as a "fixed asset" and therefore, deductions to VAT are impossible because "fixed assets" and "capital investments" are considered separate categories under the Russian tax system. The two categories are, however, closely related. "Capital investment" is used in Russian accounting to collect the various associated costs of a purchase before moving that final cost into "fixed assets."

Some have also asked if the deduction can be made before the property rights have been registered. The Tax Authorities have stated that this is impossible. A few courts have agreed with their position.

Given this, can input VAT be claimed only after the registration of property rights?

As stated above, our opinion is that the seller must issue the tax invoice only once the property rights are registered by the buyer. Thus, the buyer can claim input VAT only after the registration of property rights, since without the tax invoice, the process cannot be completed.

Input VAT is usually claimed only after the final cost of the purchase is known – after it has been moved from the "capital investment" accounting category to the "fixed asset" category. However, if all other legal conditions for this deduction are met, a claim for input VAT can still be filed. The claim can only be paid by the tax service after the seller issues a VAT invoice, which, as we advise, should only happen after the new property rights are registered. However, the claim can be filed by the buyer even before this - and courts have ruled that such "early" claims are still valid and should be paid after the seller's Vat invoice is issued.

2. Profit Tax

For the buyer questions of when to begin amortizing the investment also arise.

According to Paragraph 8 of Article 258 of the TC, fixed assets can only be included into their amortization group after the corresponding rights to them are registered and the certifying documents are received from the state. Additionally, amortization on the property can only begin on the first of the month following the month in which the property was first put into use.

As both of these requirements must be met, it is clear that the soonest that amortization can begin is the first of the month following the month that rights to the property were formally obtained. The Ministry of Finance has also supported this conclusion.

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