Analytics

Posted on July 22, 2019 (Sections 1, 2, 3, 4)

Updated on July 23, 2019 (Sections 5, 6)

Updated on July 24, 2019 (Chapter 7)

Updated on July 25, 2019 (Chapter 8)

Updated on July 29, 2019 (Chapter 9)

Updated on August 02, 2019 (Sections 10, 11)

Updated on August 05, 2019 (Chapter 12)

Added on August 06, 2019 (Instead of the Introduction)

Added on August 08, 2019 (Chapter 13)

Added on August 23, 2019 (Chapter 14)

 

Instead of the Introduction

The following overview of the current twists and turns related to the Settlement Agreement in respect of the tax dispute of Philip Morris Ukraine PrJSC has raised a great interest from readers and some questions from a part of them.

In particular, one of the questions is why actually Philip Morris Ukraine PrJSC tried to resolve the tax dispute through the mechanisms of investment dispute with reference to the treaties on encouragement and reciprocal protection of foreign investments when the claim to the court in Ukraine on this dispute already existed and before exhausting of remedies in these proceedings.

The answer to this question seems obvious – because Philip Morris Ukraine PrJSC was rather losing this dispute and there were the decisions of the first instance court and the expert opinion confirming the existence of violations by Philip Morris Ukraine PrJSC and the lawfulness of tax charges.

In a judgment of May 19, 2017, the court of first instance (see the link) reached the following conclusions:

“According to Article 67 of the Constitution of Ukraine, everyone is obliged to pay taxes and levies in a manner and in amounts prescribed by law.

The activity of a taxpayer is not questioned if it has a reasonable business purpose other than minimizing taxation.

According to the case file, it is evident that throughout the entire existence of Philip Morris Ukraine PrJSC it was engaged in the production of filter cigarettes for further sale of products, including for export.

For the needs of its own production, the company carried out the import of raw materials under customs declarations issued in the customs regime of “Import” type IM 40 with payment of all customs payments until April 14, 2015. Sales of products were carried out on the basis of the delivery contract as of May 19, 2011 No. EXP 11-007, also concluded with Philip Morris PERSON_7 S.A.

In the statement of claim, Philip Morris Ukraine PrJSC draws attention to the fact that only the choice of customs regime of processing at the customs territory of Ukraine made it possible to obtain an order for production of products under the contract as of March 27, 2015.

Regarding the allegation of a possible decrease in production volumes in the case of failure to receive an order for production of products under a contract as of March 27, 2015, the court states the following.

Revenues received by the company in 2014 (prior to the beginning of transactions in the “processing” regime) amounted to UAH 11.9 billion, taxable profit amounted to UAH 146.6 million.

At the same time, upon receipt of the contractual order, the company’s income for 2015 amounted to UAH 9.7 billion and having received a loss on the results of operations, the taxpayer declared a negative value of the corporate profit tax in the amount of UAH 280 million.

The “processing” transactions were finished by the company in March 2016. According to the results of the activity of Philip Morris Ukraine PrJSC for the 1st quarter of 2016, the income was declared at the amount of UAH 1.4 billion. and loss of UAH 1.2 billion.

In view of the above calculations, it may be assumed that the receipt of such an order did not lead to either an increase in the company’s income or an increase in payments to the budget.

Thus, the actions taken by the parties when concluding the contract No. N/A as of March 27, 2015 are not conditioned by the reasonable essence aimed at earning income, since there was already a similar supply agreement as of May 19, 2011 No. EXP 11-007 between them. Therefore, such actions were aimed solely at minimizing tax liabilities in connection with the implementation of additional import duty in Ukraine (implemented from March 01, 2015 to December 31, 2015)”.

In other words, in addition to analyzing compliance with the formal requirements (see full text of the decision), the court also noted that:

(i) the change in activity conditions actually coincided with the period of the additional import duty,

(ii) during the “processing” regime, the activity of the company was unprofitable (in contrast to the previous periods of normal activity, when the company had a significant taxable profit),

and concluded that “such actions were aimed solely at minimizing tax liabilities in connection with the implementation of an additional import duty in Ukraine.”

If you are firmly convinced that the conclusions of the first instance court are wrong, and hope that the facts and legal position of the company are sufficient to protect the position of the company in further examination of the merits in appeal and / or cassation and convince the court in the absence of tax law violations, then there were probably no reasons to apply for another extraordinary remedy (the applicability of which is moreover controversial to the considered case). Accordingly, application of an unusual (and perhaps expensive) remedy may be implicitly viewed at least as uncertainty of the taxpayer and the lawyers who conducted the dispute, with an estimation of the significant probability of a final decision not in favor of the company.

So, in fact, it was an attempt to circumvent the usual administrative practice of resolving tax disputes and to interrupt the court trial.

The legitimacy of such an attempt may also raise questions, including in terms of that same investment agreements.

For example, Art. VIII of the Investment Agreement with the USA contains the following provisions

“ARTICLE VIII

This Treaty shall not derogate from: (a) laws and regulations, administrative practices or procedures, or administrative or adjudicatory decisions of either Party”.

From the Ukrainian point of view, it would be more logical to wait for the proceedings to be completed and then to decide on the received notification on the investment dispute. If the right to an investment dispute exists, and there are reasons for it, then they would not disappear in resolving the dispute not in favor of the company (or in the case of settling the case by merits in the courts in favor of the company in subsequent instances, they would disappear, and thus the need for some other steps would disappear).

In this case is, the attempt to intervene the proceedings to interrupt it, at that not in the order of settlement, with the consideration of compliance with the requirements and limitations of the settlement legislation by the court, as required by law is quite clearly traced. In other words, an attempt to interfere in such a way the usual administrative practice of resolving tax disputes by reviewing the administrative decision taken under results of complaint, to interrupt the proceedings and to prevent a final settlement of the tax dispute in court is probably the main factor why attempt to apply for the mechanism of investment dispute was made at this stage.

1.

On July 12, 2019 information that the State Bureau of Investigation conducted searches at the State Fiscal Service of Ukraine (hereinafter – the SFS), the territorial department of the SFS in Kharkiv and Kharkiv Customs (see the link) stared to be spreaded on information portals. Further, it was reported in a press release of the SFS (see the link) and other sources that investigative actions were carried out with the purpose of seizure of documents related to the signing of the Settlement Agreement between Philip Morris Ukraine PrJSC and the State of Ukraine on settlement of tax dispute for UAH 630 million.

The statement of Philip Morris Ukraine PrJSC (see, for example, Ekonomichna Pravda newsletter) was published on the same day in connection with the searches, stating that the signing and execution of the settlement agreement fully complies with the legislation of Ukraine and Ukraine’s obligations under international investment protection agreements between Ukraine and the United States, as well as between Ukraine and the Swiss Confederation.

It was also reported in the statement that in January 2018, Philip Morris companies filed a notice of investment dispute under the above-mentioned international agreements. On December 05, 2018, the Cabinet of Ministers of Ukraine adopted the Resolution “On signing of the Agreement between Philip Morris International Inc.” (USA), “Philip Morris Global Brands Inc.” (USA), “Philip Morris Brands Sarl” (Switzerland), Philip Morris Ukraine PrJSC (Ukraine) and the State of Ukraine, by which it approved the draft Settlement Agreement (see the link). On January 31, 2019 acting Head of the SFS Oleksandr Vlasov signed the Settlement Agreement, and on April 12, 2019, the court case on contesting of tax notice decisions (hereinafter – the TND) was closed.

2.

At that, at the same time, the decisions of investigating judges to grant temporary access to objects and documents in the Unified State Register of Court Decisions (USRCD) in the framework of criminal proceedings No. 62019170000000505 as of June 19, 2019 initiated under Art. 367 of the Criminal Code of Ukraine, in particular:

• temporary access to documents and objects in possession of the Kharkiv District Administrative Court, namely court case No. 820/4931/16 with all annexes under the claim of Philip Morris Ukraine PrJSC granted by the ruling of the investigating judge of the Oktyabr District Court of Poltava as of July 11, 2019, in case No. 554/6241/19 (see link).

• temporary access to documents and things in the possession of the SFS Head department in Kharkiv Region regarding the case of Philip Morris Ukraine PrJSC granted by the ruling of the investigating judge of the Oktyabr District Court of Poltava as of July 11, 2019 in case No. 554/6241/19 (see link).

In particular, the investigative judge’s decisions stated: “The information on the mentioned criminal offense was brought to the URPTI upon the fact of improper performance of their duties by the officials of the Kharkiv Customs House of the SFS due to the misconduct, which resulted in grave consequences for the state interests in the form of losses to the state budget for amount of UAH 445,124 million“.

Also, based on the information provided in the decisions, criminal proceedings was opened in connection with the closure of the tax dispute in amount of UAH 445 124 046,41 for the main payment (actually, taxes) and UAH 190 213 848,97 of fines, i.e. totally for amount of more than UAH 635 million.

Details of what preceded criminal proceedings are set out in the mentioned decisions as follows (briefly and, for convenience, the facts are chronologically structured):

Philip Morris Ukraine PrJSC applied to the Kharkiv Customs House of the SFS with the application as of March 31, 2015 No. 770 on obtaining a permit for placing products under the customs regime of processing at the customs territory of Ukraine. In its application for a permit, Philip Morris Ukraine PrJSC stated that it undertakes to carry out operations on processing of goods at the customs territory of Ukraine in accordance with the requirements of the legislation of Ukraine.

On the basis of the documents provided by the company, on April 1, 2015, the Kharkiv Customs House of the SFS issued a permit for import and processing of goods for the term up to 300 days.

During the period from March 14, 2016 to May 10, 2016, a documentary unscheduled on-site audit of compliance with the requirements of the legislation of Ukraine on state customs affairs, in part of customs clearance of goods imported to the customs territory of Ukraine by Philip Morris Ukraine PrJSC in the customs regime “processing at the customs territory of Ukraine”, for the period from March 01, 2015 to February 29, 2016, the results of which were executed in the act as of May 24, 2016 No. 248/20-4014-12-07/00383231.

During the documentary unscheduled on-site audit of Philip Morris Ukraine PrJSC on state customs affairs regarding the properness of customs clearance of goods in the customs regime “processing at the customs territory”, for the period from March 1, 2015 to February 29, 2016, the following violations were found:

– decreased liabilities on import duty;

– decreased liabilities on additional import duty;

– the erosion of the value added tax base by the amount of import duty, additional import duty that resulted in reduction of value added tax liabilities.

On the basis of the mentioned act, the TNDs were issued on June 14, 2016, namely:

– No. 0000201412 on determining the amounts of monetary liabilities for the payment of “import duty” in amount of UAH 29 184 567,93 (UAH 19 456 378,62 – principal payment, UAH 9 728 189,31 – penalties);

– No. 0000211412 on determining the amounts of monetary liabilities for the payment of “additional import duty” in amount of UAH 161 740 871,19 (UAH 129 392 696,95 – principal payment, UAH 32 348 174,24 – penalties);

– No. 0000221412 on determining the amounts of monetary liabilities for the payment of “value added tax on goods imported into the territory of Ukraine” in amount of UAH 444 412 456,26 (UAH 296 274 970,84 – principal payment, UAH 148 137 485,42 – penalties), total – UAH 635 337 895,38.

Philip Morris Ukraine PrJSC filed administrative claim to the Kharkiv District Administrative Court to declare unlawful and cancel the abovementioned TNDs.

According to the conclusions under the results of the forensic economic examination as of February 28, 2017 No. 14400/16-45/3701-3703/17-45,… conclusions of the act of audit of the Head Department of the SFS in Kharkiv region as of May 24, 2016 No. 248/20-14-12-07/00383231 … are well-grounded and justifiable.

The administrative claim of Philip Morris Ukraine PrJSC to the Head Department of the SFS in Kharkiv Region, third parties – Kharkiv Customs House of the SFS, Ministry of Finance of Ukraine on cancellation of TND was dismissed by the Resolution of the Kharkiv District Administrative Court as of May 19, 2017 (see link).

Subsequently, on April 12, 2019, the Second Administrative Court of Appeal considered the appeal complaint of Philip Morris Ukraine PrJSC against the decision of the Kharkiv District Administrative Court of May 19, 2017 in case No. 820/4931/16.

The plaintiff’s (Philip Morris Ukraine PrJSC) representative filed a motion on closure of the case in connection with the elimination of violations that were a subject matter of the dispute.

The Panel of Judges (of the Court of Appeal) noted that according to the decision of the SFS as of March 22, 2019, No. 13787/6/99-99-11-01-04-25, based on the Settlement Agreement as of January 31, 2019, international treaties ratified by Ukraine, and para. 55.1 of the Tax Code of Ukraine (hereinafter – the Tax Code), the SFS canceled the defendant’s TNDs as of June 14, 2016, which were the subject of this dispute, by the decision as of March 22, 2019 No. 13787/6/99-99-11-01-04-25.

Considering the abovementioned, the Second Administrative Court of Appeal satisfied the motion of Philip Morris Ukraine PrJSC on closure of the proceedings in connection with the elimination of the violations which were the subject of the dispute, on April 12, 2019.

The decision of the Kharkiv District Administrative Court as of May 19, 2017 in case No. 820/4931/16 was canceled.

The proceedings in case No. 820/4931/16 under the administrative claim of Philip Morris Ukraine PrJSC to the Head Department of the SFS in Kharkiv Region, involving the Kharkiv Customs House of the SFS and the Ministry of Finance of Ukraine as third parties, on cancellation of the TND – closed.

At the same time, considering the circumstances determined by the ruling of the Second Administrative Court of Appeal as of April 12, 2019 in case No. 820/4931/16 as to the ground for cancellation of the TND as of June 14, 2016, namely para. 55.1 of the Tax Code, cancellation of decisions of the Head Department of the SFS in Kharkiv Region is possible only within the administrative appeal procedure.

However, according to the case file, the SFS, by the decision of August 25, 2016 No. 18462/6/99-99-11-1-1-20 upon results of the consideration of the complaint of Philip Morris Ukraine PrJSC, decided to uphold the TND as of June 14, 2016, issued by the Head Department of the SFS in Kharkiv Region.

Moreover, the lawfulness of actions as to the appointment and conduct of the audit as well as the lack of documents to confirm the lawfulness of the customs regime of “processing at the customs territory of Ukraine” were confirmed by the decision of the Kharkiv Administrative Court of Appeal as of August 1, 2016 in case No. 820/2517/16, by which the court dismissed the claim of Philip Morris Ukraine PrJSC on declaring unlawful and cancellation of the order of the Head Department of the SFS in Kharkiv Region No. 514 as of March 11, 2016 On conducting the audit of Philip Morris Ukraine PrJSC, declaring unlawful actions of the Head Department of the SFS in Kharkiv Region as to the appointment of the documentary unscheduled audit of Philip Morris Ukraine PrJSC based on the order No. 514 as of March 11, 2016.

Please note that the SFS website still contains a respective comment of tax officers as of August 2017, explaining what is the matter of dispute and that only the court by its decision may bring the dispute to the end.

3.

Therefore, the claim of Philip Morris Ukraine PrJSC was dismissed in the first instance.

And on April 12 of this year, the Court of Appeal canceled the decision of the first instance and closed the proceedings NOT under the results of the re-examination of the mentioned decision by the merits, and NOT by the parties’ amicable settlement (settlement agreement) [sic!], but because the SFS has already canceled the TND by decision as of March 22, 2019 No. 13787/6 / 99-99-11-01-04-25 with reference to the Settlement Agreement as of 31 January 2019, the relevant international treaties ratified by Ukraine and para. 55.1 of the Tax Code.

Such actions of the SFS as to the self-cancellation of the TND were interpreted by Philip Morris Ukraine PrJSC as an elimination of the alleged violation by the public authority. In connection with that, Philip Morris Ukraine PrJSC filed a petition to the Court of Appeal to cancel the first instance decision and to close the proceedings on the basis of para. 8 of Part 1 of Art. 238 of the Code of Administrative Procedure of Ukraine (hereinafter – the CAP).

The full text of the decision of the Court of Appeal on this issue is available for convenience by reference.

The Court of Appeal, in the decision on satisfaction of the petition and closure of the proceedings on the basis of para. 8 of Part 1 of Art. 238 of the CAP, in particular, stated: “The panel of judges notes that the Settlement Agreement as of January 31, 2019 and the decision of the State Fiscal Service of Ukraine as of March 22, 2019 No. 13787/6/99-99-11-01-04-25, by which tax notices-decisions of the Head Department of the SFS in Kharkiv Region No. 0000201412 as of June 14, 2016, No. 0000211412 as of June 14, 2016, No. 0000221412 as of June 14, 2016 were canceled, are not the subject of this case”. Thus, the Settlement Agreement and the decision of the SFS on the cancellation of the TNDs were not evaluated by the court.

Why is this point as important as the precise grounds for closure of the proceedings?

4.

To answer this question, it is worth to pay attention at Art. 238 of the CAP in general, and further to the conditions of closing proceedings due to amicable settlement:

“Article 238. Closure of proceedings in a case

1. The Court shall close the proceedings in the case:

1) if the case shall not be considered under the rules of administrative procedure;

2) if the plaintiff has abandoned the claim and the abandonment has been accepted by the court;

3) if the parties have reached amicable settlement;

4) if there is a court ruling or resolution to close proceedings in the case between the same parties, on the same subject matter and on the same grounds, which has come into force;

5) in case of death or announcement of the natural person deceased in the manner prescribed by law or dissolution of the legal entity, except the public authorities, which was one of the parties to the case, if the disputed legal relations do not allow the succession;

6) on contesting of the normative legal acts of the public authorities or their separate provisions, if the contested legal act or its corresponding provisions are recognized as unlawful and not in force by a decision of a court which has come into force;

7) on contesting of the individual acts and actions of the public authorities, if the contested violations of the public authority were modified or canceled by a court decision which has come into force;

8) on contesting of the decisions, actions or omissions of the public authority, if the contested violations have been eliminated by the public authority, and there is no reason to believe that the full restoration of the plaintiff’s rights and interests is impossible without declaration of the decisions, actions or omissions of the public authority unlawful after such elimination.

2. The court shall render a ruling on the closure of proceedings in the case and decide on the distribution of court expenses between the parties as well as on reimbursement of court fees from the budget. The court’s ruling on closure of the proceedings may be appealed“.

Art. 238 provides for the closure of proceedings due to the parties’ amicable settlement (settlement agreement) – para. 3 of Part 1 of Art. 238 – as a ground different from those provided in the same article – paragraph 8 – literally elimination of contested decisions by the public authority (TNDs in particular case).

So, we reiterate, the proceedings were closed under the CAP not based on the amicable settlement between the parties and not in the manner provided by the CAP for amicable settlement.

It may be assumed that the choice of the plaintiff to insist on the closure of the proceedings not by the amicable settlement (the existence of a settlement agreement), but by encouraging the SFS to act unilaterally, with reference to an already “corrected” SFS’s position as a basis for closing the proceedings caused by the intention to circumvent judicial control of the Settlement Agreement.

Rules for amicable settlement between the parties in similar court disputes are stipulated by the CAP. And the court refuses to approve amicable settlement if (Part 6 of Art. 190 of the CAP):

“1) the conditions of amicable settlement are contrary to the law or violate the rights or legally protected interests of other persons or are unenforceable; or

2) one of the parties to amicable settlement is represented by its legal representative, whose actions are contrary to the interests of the person he represents”.

We remind that the dispute in the court is on the taxes. Taxes are payable in the manner and amounts established by law (Article 67 of the Constitution). The taxation system and, taxes are established exclusively by the laws of Ukraine (Article 92 of the Constitution).

Therefore, if the taxes in this case were levied upon results of an audit under the law, then they shall not be waived under the laws and the proceedings shall not be closed due to agreements with the SFS or the Cabinet of Ministers.

The limits of amicable settlement and the procedure for its approval are defined in Art. 190 of the CAP (for convenience we give the article here in full):

“Article 190. Amicable settlement between the parties

1. The parties may settle the dispute in whole or in part based on mutual agreements. Amicable settlement between the parties may only relate to the rights and obligations of the parties. The parties may settle a dispute on the terms beyond the subject matter of the dispute, provided that such conditions of amicable settlement do not violate the rights or legally protected interests of third parties. The terms of amicable settlement shall not be contrary to the law or beyond the competence of the public authority.

2. Upon the motion of the parties, the court shall suspend the proceedings for the time necessary for them for amicable settlement.

3. The terms of the amicable settlement shall be set out in the application on amicable settlement. The application on amicable settlement of the parties may be submitted in the form of a single document signed by the parties or in the form of separate documents: application of one party on the terms of amicable settlement and the written consent of the other party to the terms of amicable settlement.

4. Before making a decision on amicable settlement of the parties, the court shall explain to the parties the consequences of such decision, and check if the representatives of the parties are entitled to perform appropriate action.

5. The terms of the amicable settlement between the parties shall be approved by a court’s ruling. When approving the terms of the parties’ amicable settlement, the court shall simultaneously close the proceedings.

6. The court shall render a ruling on refusal to approve the terms of amicable settlement and shall continue the proceedings provided that:

1) the conditions of amicable settlement are contrary to the law or violate the rights or legally protected interests of other persons or are unenforceable; or

2) one of the parties to amicable settlement is represented by its legal representative, whose actions are contrary to the interests of the person he represents”.

It is obvious that if amicable settlement does not establish the non-compliance of tax charges with the law, the cancellation of charges as a condition of amicable settlement is not subject to court’s approval.

The complexities of amicable settlement on tax issues were analyzed, in particular, in the information letter “Amicable settlement in tax disputes“. From then onwards, CAP has undergone significant updates, however, all of the key points we wrote about have been kept, although respective references may now be to the rules of articles other than those mentioned in the review. The conclusions of the review remain relevant.

Therefore, the fact that the court proceedings were actually closed not on the grounds and not by the procedure of the parties’ amicable settlement, but with reference to the fact that the tax officers corrected themselves is essential.

Probably, the Settlement Agreement could not be approved by the court due to non-compliance with the permitted terms of amicable settlement under Art. 190 of the CAP. It is difficult to state something more definite here without analysis and references to the text of the Settlement Agreement, which has not been found in public access. Therefore, the actions of tax officers on self-correction, the cancellation of TNDs, as the SOLE procedural basis for closing the proceedings have attracted such attention, including from law enforcement agencies, for a good reason.

5.

(Updated on July 23, 2019)

The grounds on which the SFS canceled the TNDs were stated in the decision of the Court of Appeal as of April 12, 2019 on closure of the proceedings as follows:

“… based on the Settlement Agreement as of January 31, 2019, international agreements ratified by Ukraine and para. 55.1 of the Tax Code, State Fiscal Service of Ukraine canceled tax notification decisions by the decision as of March 22, 2019 No. 13787/6/99-99-11-01-04-25…

The plaintiff’s representative at the hearing upheld the arguments of the motion on closure of the proceedings with reference to the elimination of violations that were subject matter of the dispute. He noted that the basis for cancellation is the provision of para. 55.1 of Art. 55 of the Tax Code, which provide for cancellation in connection with violations found…”.

Para. 55.1 of Art. 55 of the Tax Code stipulates:

“55.1. Tax notice decision determining the amount of liability of the taxpayer or any other decision of the controlling authority can be revoked by the controlling authority of the highest level within administrative appeal procedure as to such decision, and in other instances in cases of non-compliance of such decisions to the legislation“.

To what extent may this provision be applied in the present case, that is, after the completion of the administrative appeal procedure of the TNDs, during the consideration of a dispute in court and even when a decision of the court of first instance was rendered?

However, the decision of the lower level controlling authority may be revised under this provision. And in our case, as noted in the abovementioned decisions of the investigating judge, there is another decision of the SFS, the decision of August 25, 2016 No. 18462/6/99-99-11-1-1-20 on the results of the complaint of Philip Morris Ukraine PrJSC, which retained in force the TNDs on June 14, 2016 adopted by the Head Department of the SFS in Kharkiv Region.

That is, the decision of the SFS, which left the relevant TNDs in force, has been adopted earlier. This decision could not be revoked by the SFS on the basis of para. 55.1, since it confers the power to revoke decisions to a higher-level controlling authority. And the decision to leave the TNDs in force has already been taken by the SFS as a controlling authority of the highest level. In other words, the SFS is not a higher-level authority with respect to itself, and therefore has no power to revise its decisions under para. 55.1. Therefore, all we can do is to assume that the previous decision was not canceled, which means that there are two decisions in the case at the same time: the first is to leave the TNDs in force, and the second is to cancel the TNDs.

The next question concerns the existence of formal grounds for cancellation of the TNDs under para. 55.1. by the decision of the SFS as of March 22, 2019 No. 13787/6/99-99-11-01-04-25. Para. 55.1 states that cancellation is possible only “if such decisions are found non-compliant with the legislation”. It aligns with the statement pointed out above that taxes and the procedure for their payment shall be established exclusively by law according to the Constitution.

It is curious how and in what way the non-compliance of the TNDs contested in the court with the legislative acts was established? Considering that under para. 55.1 of the Tax Code it is obligatory condition to have the possibility of their cancellation, and, at least there are 1) the decision of the SFS to reject the complaint and to leave the TNDs in force as compliant with laws; 2) the conclusions of the examination confirming the legitimacy of the conclusions of the audit act on the basis of which the TNDs were adopted; 3) the decision of the court of first instance confirming the compliance of the adopted TNDs with the acts of legislation?

And also questions as to the actions of the SFS on the cancellation of TNDs, which are pending:

Part 2 of Art. 19 of the Constitution stipulates: “State authorities, local self-government bodies and their officials are obliged to act only on the basis, within the powers and in the manner provided by the Constitution and laws of Ukraine”.

Therefore, the cancellation of the TNDs at this stage by the decision of the head of the SFS may be considered legitimate under the Constitution only if it is carried out on the basis, within the powers and in the manner prescribed by the Constitution and laws of Ukraine.

In the case of administrative appeal, the manner is clearly provided directly by the Tax Code. Para. 56.10 of the Tax Code stipulates that the decision of the SFS, taken upon consideration of the taxpayer’s complaint, is final (and is not subject to further administrative appeal, but may be contested in court). In other words, the Tax Code does not stipulate other decisions of the SFS on this issue, but only provides for the possibility of judicial review. Therefore, the question arises, which provisions of the laws/Constitution of Ukraine envisage the manner in which the head of the SFS acted when canceled the TNDs beyond the administrative appeal procedure?

This issue is important for other taxpayers, in particular, to understand whether it then means that the mention of “other instances” in para. 55.1 of the Tax Code gives the head of the SFS the right of unlimited discretion to cancel even TNDs already confirmed during administrative appeal and even by the court decision. And that with this approach, any taxpayer who expects to lose a litigation in the courts may try to circumvent the court procedure of the dispute resolution – and once again contact the head of the SFS, find arguments and persuade somehow the non-compliance of the TND (confirmed within administrative appeal and court proceedings) with the laws, and therefore cancel the TND on his/her own regardless to the court proceedings?

The answer to this question is important, since another interpretation of para. 55.1 of the Tax Code is possible.

We remind that Art. 55 is called “Revocation of the decisions of the controlling authorities” and, accordingly, relates to the issue of the cancellation of the decisions of the controlling bodies as a whole, and not only as a result of an administrative appeal. Para. 56.1. of the Tax Code stipulates that “decisions taken by the controlling authority may be subject to administrative or judicial review.” And the cancellation of the TND is possible both during administrative and judicial appeals. For example, para. 60.1.4 of the Tax Code stipulates the revocation of the TND in case of its cancellation by a court decision. Therefore, para. 55.1. may have the following interpretation:

55.1. Tax notice decision determining the amount of liability of the taxpayer or any other decision of the controlling authority can be revoked

(A) by the controlling authority of the highest level within administrative appeal procedure as to such decision, and

(B) in other instances, in case of non-compliance of such decisions with the legislation.

In such an interpretation, other cases shall be the cancellation as a result of a judicial appeal (the court cancels the TND in case of non-compliance of the TND or other decisions with the legislative acts); and the higher-level controlling authority is only mentioned in connection with framework of the administrative appeal. Accordingly, the conclusion reached in the decision of the investigating judge (cited above) seems relevant:

“At the same time, taking into account the circumstances established by the decision of the Second Administrative Court of Appeal as of April 12, 2019 in case No. 820/4931/16 on the grounds for cancellation of tax notification decisions as of June 14, 2016, namely Art. 55.1 of the Tax Code of Ukraine, cancellation of the decisions of the HD SFS in Kharkiv Region is possible only during the administrative appeal procedure”.

Taking into account the other arguments presented above, this approach, in particular regarding the absence of another manner to cancel the TND than within administrative appeal, causes the conclusion that para. 55.1. of the Tax Code shall not in fact be recognized as legitimate basis for the cancellation of the TNDs by the decision of the SFS in the case under consideration (if they are considered to be canceled and the decision on cancellation was taken beyond the powers provided by the law).

By the way, even in the current situation, the question remains, what about the fines on these charges?

In fact, under the Tax Code, the fine shall be cancelled literally only in case of cancellation of the “basic” charges as a result of administrative or judicial appeal (no other cases are provided for):

“129.2. In case of cancellation of money liability (or part thereof) by accrued regulatory authority in administrative and / or judicial review, the interest fine for understatement of the period of the money liability (or part thereof) shall be cancelled”.

Since the cancellation of the charges was made not in the manner of administrative or judicial appeal, there are no literal grounds for the cancellation of the fine? And should it be accrued for all the time until the payment of the charges? It’s curious, what the tax officers’ accounting says on that issue?

In other words, there are many questions, and the answers to them are important and curious to other taxpayers in terms of certainty on the possible ways of resolving tax disputes. Such answers may be obtained either as a result of criminal proceedings or as a result of further development in the case (in particular, the attempts of the new management of the SFS or the STS to renew the case based on the mentioned fine or the execution of the right under Part 2 of Art. 238 of the CAP on appealing the closure of proceedings in the case, etc.

6.

(Updated on July 23, 2019)

In fact, there is something strange with cancellation of the TNDs in this case. Thus, Philip Morris representatives and the Ombudsman’s office at the press conference on March 27, 2019 argued that as of March 27, 2019, the TNDs had not yet been canceled (full video is available via the link). Despite the fact that the Settlement Agreement was signed by Mr. Vlasov on January 31, 2019, and according to the text of the Settlement Agreement, the TNDs shall be revoked within 30 days, i.e. until March 2, 2019. And as of March 27, they have not been recalled. We assume that the purpose of the abovementioned press conference was to encourage the SFS management to cancel the relevant TNDs.

However, as noted, in particular, in the decision of the Court of Appeal on closure of the proceedings, the respective TNDs were canceled by the decision of the SFS on March 22, 2019. That is, the cancellation allegedly took place 5 days before the press conference, at which it was stated that on its date, March 27, the TNDs, had not yet been canceled contrary to the Settlement Agreement.

Whom we should trust? If the most interested party on March 27 complains that as of March 27, the TNDs have not yet been canceled, and holds a press conference actually to induce the cancellation, and then it turns out that the TNDs were allegedly canceled earlier, on March 22? So, in these circumstances, can we believe that the cancellation actually took place on March 22? And if not, the decision contains false information, at least regarding the date of adoption.

7.

(Updated on July 24, 2019)

In order to consider what is happening, the text of the Settlement Agreement would be important. However, it is not officially available, which was reported by the SFS in response to a journalist’s request with reference to confidentiality of the agreement.

The question arises here too: if the text of the Settlement Agreement is confidential, and it is obvious that this requirement applies to all parties to the Settlement Agreement, then how should we evaluate the disclosure of at least certain terms of the Settlement Agreement by representatives of Philip Morris, in particular, at a press conference on March 27, 2019? In particular, there was stated that under the terms of the Settlement Agreement, SFS is obliged to cancel the TNDs within 30 days from the moment of signing the Settlement Agreement. Should such disclosure of at least certain terms of the Settlement Agreement by one of the parties be a breach of confidentiality by that party?

It is interesting that we received verbal feedback regarding the first parts of this analysis, and some persons state that the draft Settlement Agreement was available for some time to the public on the Cabinet of Ministers website (probably in connection to the resolution approving the draft Settlement Agreement). It is possible, since at that time it was a draft that had not yet been signed, and the terms of the confidentiality stipulated in the draft (if any) had not yet come into force. And those who allegedly have seen the draft (not agreement signed) also state that there was the following algorithm for closing the court proceedings:

Within 10 calendar days after the cancellation of the TND by the SFS, Philip Morris Ukraine PrJSC shall file to the Court of Appeal a petition on amicable settlement and petition on closure of the proceedings on the basis of amicable settlement, and the Head Office of the SFS in Kharkiv region shall file a statement on consent with the terms of amicable settlement to the court at the same time.

Unfortunately, as of today, we have only verbal assertions that it was stated in the draft of the Settlement Agreement, which at present we can neither confirm nor refute (we did not find the text of the draft on the Cabinet of Ministers site). Therefore, it is presented as unverified information about what the draft of the Settlement Agreement stipulated.
However, if this is true, and such provisions have been kept in the Settlement Agreement, which was actually signed (those who have access to its text can shortly check this), then the parties have violated the terms of the Settlement Agreement.

The withdrawal from the terms of the Settlement Agreement (presumed) of filing statement on amicable settlement by Philip Morris Ukraine PrJSC and the consent to the terms of amicable settlement with the expected closure of the proceedings on the basis of amicable settlement by the Head Department of the SFS, would then be a material violation the Settlement Agreement (if such conditions are actually in the signed Settlement Agreement) and result in the deliberate withdrawal of the Settlement Agreement beyond the court’s control required by the law upon closing the proceedings by the amicable settlement.

We have covered the details of the “global difference” of closure of the proceedings by amicable settlement in previous sections of this analysis.

8.

(Updated on July 25, 2019)

Meanwhile, the case seems to be gaining new round.

Thus, there are a number of new rulings in the court register, including some results of a search and seizure conducted on July 12, 2019:

(i)

In particular, it is established in the decision of the investigating judge as of 18 July 2019:

“In the course of the pre-trial investigation, during a search and seizure at the Kharkiv Customs House of the SFS on July 12, 2019 it was found that on September 02, 2017 during the investigation of criminal proceedings No. 42016000000001683 on the grounds of the criminal offense under Part 2 of Art. 364, Part 3 of Art. 212 of the Criminal Code, the investigator of the HID NP, on the basis of the temporary access order, removed the original documents from the premises of the Kharkiv Customs House of the SFS, in particular: 1) correspondence of the Philip Morris Ukraine officials with Kharkiv Customs House and its separated subdivision “PISOCHYN Customs Post” for the period from January 01, 2015 to July 01, 2016; 2) all customs declarations with packages of documents provided during customs clearance of goods by Philip Morris Ukraine PrJSC for the period from January 01, 2015 to July 01, 2016; 3) personal file of the head of the “PISOCHYN” customs post of the Kharkiv Customs House of the SFS, orders on his appointment and transfer; 4) all statements of Philip Morris Ukraine PrJSC regarding the permission for placing the goods in the processing customs regime.

It was also established that criminal proceedings No. 42016000000001683 … were subsequently transferred for pre-trial investigation to the HEAD DEPARTMENT OF THE SECURITY SERVICE OF UKRAINE IN KHARKIV REGION (61002, Kharkiv region, Kharkiv city, Kyiv district, 2 Myronosytska Street) where they were closed”.

In other words, the search and seizure revealed that the documents in the case of Philip Morris Ukraine PrJSC were not in possession of the customs house, since they were seized in 2017 by police in connection with initiated then case on the grounds of tax evasion and abuse of power by an official. In the future, the case was taken from the police by the SSU, where it was closed. And it seems to be that the documents were not returned to the customs house.

In this regard, the judge granted the investigation with access to the customs house’s documents possessed by the Security Service.

(ii)

Under the decision of the investigating judge as of July 16, 2019, a number of documents were arrested during the search and seizure at the SFS on July 12, including the original and drafts of the Settlement Agreement and a number of other documents related to this process.

You can also see the further targeting of the investigation regarding the examination of all circumstances of the preparation to and conclusion of the Settlement Agreement. And this is really important, and we will comment separately on the possible reasons for the conclusion of the Settlement Agreement.

So, the following decisions of the investigating judge are already available in the register of court decisions:

(i)

As of July 18, 2019 on granting the investigators with access to other documents of the SFS, supporting the process of preparation, conclusion and execution of the Settlement Agreement, as well as (interestingly!), all (sic!) decisions of the SFS taken by acting head O. Vlasov, on cancellation of the decisions of subordinate territorial bodies from September 5, 2018 to July 16, 2019.

Thus, it may be assumed that, in addition to continuing a more thorough examination of all documents that are directly related to the Philip Morris Ukraine PrJSC proceedings, the investigation intends to compare the cancellation of the TNDs regarding Philip Morris Ukraine PrJSC with other cancellation cases within the period from September 05, 2018 to July 16, 2019.

(ii)

As of July 18, 2019, on granting access to the documents of the Ministry of Justice regarding the actions as to the dispute and the Settlement Agreement with Philip Morris Ukraine PrJSC.

(iii)

As of July 18, 2019, on granting access to the documents of the Cabinet of Ministers regarding the actions as to the dispute and the Settlement Agreement with Philip Morris Ukraine PrJSC.

9.

(Updated on July 29, 2019)

Anyhow, perhaps the most interesting question in this case is where did this Settlement Agreement come from?

In fact, neither the Treaty between Ukraine and the United States of America on the encouragement and reciprocal protection of investments as of March 04, 1994 (see the link), nor the Agreement between the Swiss Confederation and Ukraine on the encouragement and reciprocal protection of investments as of April 20, 1995 (see the link) do not directly contain tax-related provisions and do not directly provide any possibility to address any tax issues under them.

The same applies to the abovementioned investment protection agreements – the issue may arise for consideration under these agreements if it is related to investment.

What exactly do investment agreements provide and guarantee? As an example, the agreement with Switzerland contains the following guarantees (in addition to Article 3 – approval of foreign investment into the territory of the country, which is clearly not relevant to the case):

“ARTICLE 4

Protection, Treatment

(I) Each Contracting Party shall protect within its territory investments made in accordance with its laws and regulations by investors of the other Contracting Party and shall not impair by unreasonable or discriminatory measures the management. maintenance. use, enjoyment. extension. sale and, should it so happen, liquidation of such investments.

(2) Each Contracting Party shall ensure fair and equitable treatment within its territory of the investments of the investors of the other Contracting Party. This treatment shall not be less favourable than that granted by each Contracting Party to investments made within its territory by its own investors, or than that granted by each Contracting Party to the investments made within its territory by investors of the most favoured nation, if this latter treatment is more favourable

(3) If a Contracting Party accords special advantages to investors of any third State by virtue of an agreement establishing a free trade area, a customs union, a common market or a similar regional organization or by virtue of an agreement on the avoidance of double taxation, it shall not be obliged to accord such advantages to investors of the other Contracting Party.

ARTICLE 5

Transfers

(I) Each Contracting Party in whose territory investments have been made by investors of the other Contracting Party shall grant those investors the unrestricted transfer of the payments relating to these investments, particularly of:

(a) returns on investments;

(b) amounts relating to loans incurred, or other contractual obligations undertaken, for the investment;

(c) additional contributions of capital necessary for the maintenance or the development of the investment;

(d) the proceeds, including possible capital appreciations, arising from the sale or of the partial or total liquidation of the investment.

(2) Transfers shall be effected without delay in a freely convertible currency. They shall be made at the rate of exchange applicable on the date of transfer pursuant to the exchange regulations in force.

ARTICLE 6

Dispossession, compensation

(I) Neither of the Contracting Parties shall take, either directly or indirectly, measures of expropriation, nationalization or any other measures having the same nature or the same effect against investments of investors of the other Contracting Party, unless the measures are taken in the public interest, on a non discriminatory basis, and under due process of law, and provided that provisions be made for effective and adequate compensation. The amount of compensation, interest included, shall be settled in the currency in which the investment was made or in any other currency accepted by the investor. It shall be paid without delay to the investor entitled thereto without regard to its residence or domicile.

(2) The investors of one Contracting Party whose investments have suffered losses due to a war or any other armed conflict, revolution, state of emergency or rebellion, which took place in the territory of the other Contracting Party shall benefit, on the part of this latter, from a treannent in accordance with Anicle 4, paragraph (2) of this Agreement as regards restitution, indemnification, compensation or other settlement.

ARTICLE 7

More favourable provisions

Notwithstanding the terms set forth in this Agreement, more favourable provisions which have been or may be agreed upon by either of the Contracting Parties with an investor of the other Contracting Party are applicable”.

It should be noted that the vast majority of Ukraine’s investment agreements have approximately the same conditions as to what is provided in the host country under the agreement.

Respectively, a common tax dispute shall not be considered as an investment dispute under the agreement and is not subject to resolution in the manner established by the agreement.

According to the world practice, tax disputes may be considered as investment disputes under similar agreements only when the situation may be qualified as expropriation (direct or hidden), violation of general international principles of law (this is recognized by arbitration practice as a foreseeable component of the warranties, even if it is not expressly stated in the treaty) and legitimate expectations, discrimination.

For clearness, the following may be considered as example of indirect tax expropriation: the introduction of corporate profit tax, e.g. at the rate of 50%, while the rules for determining profit for tax purposes imply that most relevant expenses cannot be deducted, and therefore the effective tax rate exceeds 100% of the actual economic profit, and therefore effectively results in the expropriation of capital in the respective part.

For an overview of the practice of applying investment treaties with respect to tax issues, see the example of a monograph (in English) on taxation of foreign investment in the context of international law (see the link). Although this monograph focuses more on tax-related disputes in the context of the Energy Charter, the considerable analysis of investment agreements as a whole is also provided.

From the information currently available to the public, the grounds for bringing the said tax dispute to the level of the investment dispute under the mentioned investment agreements are not explicit. We have not found any mention or justification of such a possible qualification, relevant to the dispute under consideration, neither from the Ukrainian side (from those involved in the process) nor from the other side in the public domain.

And clarity of these aspects would be important not only to understand whether an attempt was made to transfer that dispute into the field of an investment dispute, but also for the overall development of tax practice – to target other taxpayers as to what they may expect in similar conditions.
Although it is not the first and probably not the last dispute of Ukraine on investment agreements, including tax related ones. And in other cases, Ukraine was not afraid to go to arbitration (if the investor brought the case).

And perhaps the first step in such disputes is to clarify whether or not and to what extent the dispute may be considered as a dispute on breach of the investment agreement and, accordingly, be considered in the manner provided in the agreement. In other words, whether the arbitration court will have jurisdiction over a specific dispute under the agreement. In the considered case, it was not checked in the tribunal, since Ukraine was “afraid” and indisputably accepted all the other party’s allegations: both that there were grounds for qualifying the dispute as an investment dispute under the treaties (i.e., violations of fundamental rights and warranties under the treaty) , and that such violations of the fundamental warranties provided by the treaties to foreign investors and investments (see the text of the treaty on those warranties and rights provided above), which is unusual.

And, at least, the publicly available information does not see such “murderous” moments that would immediately lead to such a qualification of the situation and surrender by Ukraine even before appealing to arbitration, but only in view of the investors’ statement of availability, in their opinion , grounds for investment dispute. At least, we do not know of another such case. And one of the working rules of the same auditors – pay attention to the unusual to check first.

10.

(Updated on August 02, 2019)

Let us consider in more detail what exactly the investment agreements provide for through the example of the Treaty between Ukraine and the United States of America of March 04, 1994 on encouragement and reciprocal protection of investments as to the possible tax disputes, and why the doubts arise regarding the lawfulness of application of the provisions of this Treaty in relation to the tax dispute of Philip Morris Ukraine PrJSC.

The definition of disputes under the “umbrella” of this Treaty, and the procedure for their resolution are set out in Art. VI of the Treaty. Part 1 of the mentioned article, in particular, defines disputes that may fall under the “jurisdiction” of the Treaty:

“Article VI

1. For purposes of this Article, an investment dispute is a dispute between a Party and a national or company of the other Party arising out of or relating to

(a) an investment agreement between that Party and such national or company;

(b) an investment authorization granted by that Party’s foreign investment authority to such national or company; or

(c) an alleged breach of any right conferred or created by this Treaty with respect to an investment”.

In addition, the Agreement contains additional clarification-restrictions on its application in matters related to taxation:

“Article X

1. With respect to its tax policies, each Party should strive to accord fairness and equity in the treatment of investment of nationals and companies of the other Party.

2. Nevertheless, the provisions of this Treaty, and in particular Articles VI and VII, shall apply to matters of taxation only with respect to the following:

(a) expropriation, pursuant to Article III;

(b) transfers, pursuant to Article IV; or

(c) the observance and enforcement of terms of an investment agreement or authorization as referred to in Article VI(l) (a) or (b), to the extent they are not subject to the dispute settlement provisions of a Convention for the avoidance of double taxation between the two Parties, or have been raised under such settlement provisions and are not resolved within a reasonable period of time”.

Therefore, as we can see, the scope of the Treaty in relation to taxes is extremely limited.

As an example of a tax dispute subject to similar agreements, the recent dispute between ExxonMobil and Russia over the taxation of activities under the Sakhalin-1 Products Sharing Agreement (hereinafter – the Agreement) may be provided. It was already considered in arbitration in Stockholm, but the parties reached an amicable settlement during the process.

The subject of the dispute lies in the fact that the Agreement provided for a fixed 35% profit tax rate and the clause stating that the conditions of activity under the legislation at the time of signing shall be unchanged for the entire term of the Agreement. At the same time, there was also a provision in the Agreement stating that the conditions should be no worse than for other investments. And since the conclusion of the Agreement, the general taxation rate has been reduced, so the investor insisted on the application of a reduced (general) tax rate (not worse than for others), while the state insisted on the constant conditions. The dispute was resolved by the agreement stating that the investor waives the requirements for reduction of the applied tax rate and instead receives the extension of the Agreement. To read more about this, please see for example Forbes and Interfax publications.

The mentioned dispute may be probably attributed to the definitely classic investment dispute, which is subject to investment treaties and the procedure for their settlement provided by such treaties. Everything is clear here.

But everything is far from obvious in the tax dispute as to Philip Morris Ukraine PrJSC. Based on the publicly available information, it seems that the reference to investment treaties here may be rather artificial and even unreasonable. And only the condescending “perception by faith” of the respective statements by the Ukrainian side led to what we have.
The publication of the Settlement Agreement and respective documents with analysis on why Ukraine has accepted the claimed procedure and requirements from the legal point of view, may help to clarify the doubts arising.

It is appropriate to note that Part 8 of Art. II of the Treaty on encouragement and reciprocal protection of investments with the USA also contains the following provision:

“8. Each Party shall make public all laws, regulations, administrative practices and procedures, and adjudicatory decisions that pertain to or affect investments”.

We remind that the Party to the Treaty on encouragement and reciprocal protection of investments in this case is Ukraine.

11.

(Updated on August 02, 2019)

For a better understanding, it also makes sense to compare the current situation with Philip Morris Ukraine PrJSC, when the settlement agreement “happened”, with the cases where it “did not happen”.

For comparison, let us turn to the disputes between tax authorities and Morgan Furniture LLC. The register of court decisions shows at least 4 current cases in which Morgan Furniture LLC is trying to achieve results through a settlement agreement, but at least so far, according to public information, it is “without effect”.

(i) Case No. 460/2634/18

Rivne District Administrative Court, by the Ruling as of February 8, 2019, suspended the proceedings for the term of conducting the negotiations on the amicable settlement of the investment dispute for 6 (six) months, until August 8, 2019.

The reason for the suspension was the motion of the plaintiff, grounded by the fact that the procedure of settlement of the investment dispute was initiated, in the framework of which the dispute on tax issues could also be settled amicably. The following copies were submitted for confirmation: (a) the notice on the Investment Dispute in English and its translation into Ukrainian; (b) a letter from the Ministry of Justice of Ukraine … as of November 21, 2018 and other documents confirming receipt of the mentioned notice and commencing work on it, and (c) printouts of the resolution of the Cabinet of Ministers of Ukraine No. 946-p On signing the Settlement Agreement between the companies Philip Morris International Inc. (United States), Philip Morris Global Brands Inc. (United States), Philip Morris Brands Sarl (Swiss Confederation), Philip Morris Ukraine PrJSC (Ukraine) and Ukraine.

Thus, it is clear that the printout of resolution of the Cabinet of Ministers was used in this set as an evidence of the practical possibility of amicable settlement in tax disputes.

In spite of this, the tax authority objected such motion on suspension on the grounds (as literally stated in the cited court decision), “that this administrative case is subject to review only under the rules of national administrative justice, and there are no grounds for applying the rules of international arbitration. [Tax authority] stated that according to the wording of the Investment Dispute Notice, it is not possible to derive plaintiff’s arguments confirming that the dispute over its liability for violation of tax and currency laws of Ukraine is an investment dispute and is subject to consideration under the rules of international arbitration. The effective Tax Code of Ukraine does not provide procedure for revocation of tax notice decisions on the basis of the amicable settlement agreement with the taxpayer for which the monetary liability was defined upon the consequences of violations revealed within documentary audit. It also pointed out that the taxation issue shall not be resolved within settlement of the investment dispute at all”.

It is remarkable that it happened on February 8, 2019, i.e., after the mentioned Resolution of the Cabinet of Ministers No. 946-p as of December 05, 2018, on the approval of the Settlement Agreement with Philip Morris, and after January 31, 2018, when such Settlement Agreement was signed by the Head of the SFS at that time – Mr Vlasov. So, in Morgan Furniture LLC case, the tax authority did not accept the approach actually applied by the Cabinet of Ministers and personally by the Head of the SFS in the other, Philip Morris case, regarding the possibility of qualifying common tax disputes as investment disputes and their settlement under the procedures of treaties on encouragement and protection of investments.

However, the court did not consider the tax authority’s objections and suspended the proceedings until August 8, 2019 (it is coming soon), referring to para. 4 of Part 1 of Art. 236 of the CAP (which provides for a suspension when both parties ask for it) and the arguments that those who represent Ukraine in the investment dispute procedure are not a party to this proceedings and therefore cannot ask for amicable settlement, and therefore the motion may be satisfied even without the actual motion of the other party (although, we reiterate, the CAP provides for a suspension upon the motion of both parties when the tax authority objected).

This ruling on suspension of proceedings was not reviewed by merits in the appeal proceedings, since the tax authority did not initially pay the court fee when filing the appeal and the court of appeal left the ruling as of April 01, 2019 without action, and then refused to open the appeal proceedings by the ruling as of May 06, 2019, because although the court fee was subsequently paid, the tax authority failed to pay it within the terms set by the court, and the court did not consider the reasons for such failure as reasonable.

However, in similar cases (see below), similar decisions on suspension of the proceedings were cancelled by the court of appeal.

And in this case, less than a week was left until the expiration of the period pf suspension of the proceedings. It is no information as to the settlement agreement in this case. Therefore, it may be assumed that the settlement agreement goes sour here, and that the dispute will be considered and resolved in the administrative court in the ordinary manner (soon, after August 08, 2019).

(ii) Case No. 1740/2460/18

The Rivne District Administrative Court, by the ruling as of March 14, 2019, almost in the same way as in the case above, and on the same grounds (and with the same objections from the tax authority), suspended the proceedings for 6 months – until September 14, 2019. However, the Court of Appeal (here the tax authority has fulfilled the procedural requirements while filing a complaint), by the Resolution as of May 15, 2019, canceled the ruling on suspension of the proceedings, and addressed the case for further consideration of the merits.

At the same time, the Resolution of the Court of Appeal, for justification of such a decision, in particular, states:

“In support of its claims, the appellant notes that, in accordance with para. 4 of Part 1 of Article 236 of the CAP, the court suspends the proceedings in case where both parties are asking for amicable settlement, but the defendant, Head Department of the SFS in Rivne region, did not submit such motion to the district administrative court. In addition, the appellant notes that the issue of currency regulations and payment of taxes shall not be the subject matter of an Investment dispute, and that no specific privileges in the field of currency regulation and payment of taxes and fees are established by specific clauses of international treaties with investor’s state, therefore, amicable settlement between the parties in this administrative the case is impossible considering the effective legislation of Ukraine.

…

… a motion as of February 12, 2019 on suspension of the proceedings in the present case in order to give the parties time for amicable settlement, was filed only on behalf of the plaintiff, Morgan Furniture LLC.

In addition, the representative of the defendant in the court of first instance, Head Department of the SFS in Rivne Region objected to the suspension of the proceedings, pointing that amicable settlement is impossible under the claims under consideration.

In such a situation, the court of first instance had no grounds to suspend the proceedings on the basis of para. 4 of Part 1 of Article 236 of the CAP…”.

So, as we see, in this case, in the spring of 2019 (i.e., several months after the signing of the Settlement Agreement as to the tax dispute of Philip Morris Ukraine PrJSC), the tax authority took a sustainable position on the impossibility of amicable settlement and the inapplicability of the procedure for investment disputes in the ordinary dispute with the tax authorities in general.

For the sake of completeness, it should be noted that the case was further examined by the court in the ordinary manner. And under the decision of the court of first instance as of July 22, 2019, the claim was even partially satisfied. However, it is more important to us in this case that it is obvious that the settlement of the dispute with the tax authority due to the settlement agreement under the investment dispute procedure has not happened in this case too. At the same time, the tax authority consistently insists on the fundamental non-applicability of the mechanisms of investment dispute to disputes with a tax authority similar to the one under consideration.

(iii) Case No. 817/1200/15

The history of attempts to resolve this dispute through an amicable settlement procedure in an investment dispute, once again, is disclosed in a court decision on merits of this case – decision of the Rivne District Administrative Court as of March 01, 2019.

The case is pending since 2015 and concerns the currency fine for late exchange of the currency income. The company substantiates the inappropriateness of the imposition of currency fine, since the proceeds were not expected and the debt for exported goods is closed by offsetting. As regards the “first circle”, the claim for cancellation was rejected by the first instance and the court of appeal. However, by the decision of the Higher Administrative Court of Ukraine as of July 13, 2016, the cassation claim was partially satisfied, and the case was referred for reconsideration in the first instance. In July 2017, the case was appointed for a new hearing at the first instance.

By the court’s ruling as of August 12, 2016, upon plaintiff’s request, the Ministry of Justice of Ukraine was involved into the case as a third partyon the side of the defendant. The involvement of the Ministry of Justice of Ukraine is caused by the fact that an Investment Dispute Notice was filed in connection with this dispute, and the Ministry of Justice of Ukraine is the authority responsible for resolving such disputes under the law.

As specifically stated in the mentioned court decision:

“…On February 16, 2016 the Ministry of Justice of Ukraine received an investment dispute notice…, which was caused by the following actions of the state authorities of Ukraine: 1) adoption of the tax notice decision as of March 03, 2015 No. 0000212200, which the plaintiff’s liabilities were established to pay a fine of UAH 23 million in connection with the alleged violation of the Law of Ukraine “On the Procedure for Making Payments in Foreign Currency” by the STI in the Rivne district of the HD SFS in Rivne Region, and the initiation of judicial debt collection; 2) the adoption of the order as of April 29, 2015 No. 439 on the application of a special sanction, temporary suspension of foreign economic activity, to Morgan Furniture LLC by the Ministry of Economic Development and Trade of Ukraine; 3) the deprivation of the right of Morgan Furniture LLC to automatic value added tax refund.

…

According to the Applicants, the State of Ukraine violated the provisions (1) of the Treaty between Ukraine and the United States of America on the Encouragement and Reciprocal Protection of Investments as of March 04, 1994; (2) Agreements between the Government of Ukraine and the Government of the French Republic on Encouragement and Reciprocal Protection of Investments as of May 03, 1994; and (3) Agreement between the Government of Ukraine and the Belgian-Luxembourg Economic Union on Encouragement and Reciprocal Protection of Investments as of May 20, 1996 (hereinafter – the Agreements).

The applicants allege that the State of Ukraine violated the applicants’ rights to full protection and security, fair and equitable treatment, non-expropriation, equivalent compensation of investments.

The amount of the claims has been previously assessed by the Applicants at EUR 90 million, including loss of profit.

…

in accordance with paragraph 2 of the Procedure of Exercising the Protection of Rights and Interests of Ukraine during the Disputes Settlement, Cases Consideration in Foreign Jurisdictional Authorities with the participation of Foreign Entity and Ukraine, approved by Presidential Decree No. 581 as of June 25, 2002 (hereinafter – the Procedure), the Ministry of Justice of Ukraine is the authority responsible for the protection of the rights and interests of Ukraine during the dispute settlement, cases consideration in foreign jurisdictional authorities in cases with the participation a foreign entity and Ukraine”.

The court decision further explains that an interagency working group (hereinafter referred to as the IWG) was created under the procedures of the investment dispute, which instructed the Ministry of Justice of Ukraine, on May 18, 2016, applying to (1) the tax authorities suggesting considering the possibility of exercising the right to amicable settlement under the CAP, (2) the Ministry of Economy suggesting considering the possibility of canceling the special sanction temporary suspension of foreign economic activity, which was applied to Morgan Furniture LLC.

Particular attention should be paid to the arguments provided by the IWG in favor of such actions. First of all, it is stated (quoted from the text of court decision):

“The IWG’s decision is grounded by the fact that Morgan Furniture LLC is the largest manufacturer of cushioned furniture in Ukraine, the activity of the enterprise is export oriented. In case of a dispute settlement, the applicants are focused on expanding their business in Ukraine and plan to invest EUR 9 million in the furniture manufacturing during the next five years, to reach export revenues exceeding UAH 5 billion and to increase the number of employees up to 2,000. According to the applicants’ information, the business of Morgan Furniture LLC may bring UAH 80 million of taxes next year. The IWG expressed doubts on the feasibility of putting this business into risk for recovery of UAH 23 million of fines”.

In other words, the main part of the arguments is the point that if the business is too large, then the issue of compliance of this business with the legislation is no longer so significant, the feasibility has an advantage. As they say, all are equal [before the law], but some [who is larger?] is more equal than others.

It would be interesting to see, for comparison, what are the first-priority arguments of the IWG proposals in case of the tax dispute with Philip Morris Ukraine PrJSC.

However, for the sake of completeness, the court decision with respect to Morgan Furniture LLC also contains second-line arguments of the IWG:

“At the same time, the IWG has taken into account the case-law of the Supreme Court of Ukraine and the Higher Administrative Court of Ukraine formed during the consideration of cases in disputes similar to the dispute in case No. 817/1200/15”.

Further, it is also stated in the court decision that the Ministry of Justice of Ukraine applied, including to the Cabinet of Ministers of Ukraine, for the decision on the possibility of amicable settlement between the plaintiff and the defendant on the terms proposed by the Applicants. The decision of the Cabinet of Ministers of Ukraine is expected.

The court decision also draws attention to the fact that the Ministry of Justice of Ukraine recognizes that “taking the final decision on this issue is not within the competence of the Ministry. Issues of control over the compliance of economic entities with the legislation of Ukraine regarding the payments in foreign currency, the recovery of the fine provided in Art. 4 of the Law of Ukraine On the Procedure of Settlements in Foreign Currency from the residents of Ukraine are also not covered with the competence of the Ministry of Justice of Ukraine. Therefore, the Ministry of Justice of Ukraine does not have the right to evaluate the disputed legal relations on the merits“.

And therefore, the Ministry of Justice of Ukraine asks the court to consider the dispute on merits unbiased, if the amicable settlement does not happen.

By a court decision of September 1, 2017, in case No. 817/1200/15, the proceedings were suspended until the consideration of the application of the Ministry of Justice of Ukraine as of August 15, 2016 on amicable settlement between the parties by the Cabinet of Ministers of Ukraine.

As we can conclude from the further development of the case, the amicable settlement has not been reached.

On August 9, 2018, the plaintiff applied to the court with the motion on continuation of the case, which was satisfied by the Ruling of the Rivne District Administrative Court as of August 15, 2018.

Subsequently, as a result of the consideration of the case on the merits, the court decision was rendered on March 1, 2019, which mostly satisfied the claims: the TNDs were canceled. In short, the court derived from the fact that offsetting was not prohibited by law, including in foreign economic relations, and therefore the proceeds were not expected and, accordingly, the fine for non-receipt of proceeds in due time was imposed improperly.

This decision is currently under revision in the court of appeal. According to the ruling of the Court of Appeal as of July 29, the appellate hearing in this case is scheduled for September 18, 2019.

However, the consideration of this case on the merits is not so much important for us, as the fact that despite more than 3 years of attempts to settle a dispute through a settlement agreement in the context of an investment dispute, this has not been achieved. It is also important that the IWG’s arguments are somewhat overt in this case why it tends to recommend amicable settlement: while it recognizes that resolution of a dispute with tax officers is not within the competence of the Ministry of Justice of Ukraine, it is better not to touch large business since it is large, and abusing it is not worthy of strict compliance with the laws. It implies that we should not consider the legislation as equal for everyone. Is it possible to agree with that?

(iv) Case No. 460/3019/18

Here, as in the first and second cases mentioned above, the Rivne District Administrative Court suspended the proceedings for amicable settlement by the ruling as of January 17, 2019. And the Court of Appeal cancelled this ruling on suspension of the proceedings by the Resolution as of April 24, 2019.

The proceedings were recommenced, but under the ruling as of 16 July 2019 they were suspended again. However, for other reasons – before the entry into force of the decision in case No. 817/1200/15 (the third of the above cases), since the case establishes, including certain circumstances regarding foreign economic contracts, which are also relevant for this case.

As a result, we see that Morgan Furniture LLC has been persistently trying to resolve tax disputes during the last few years (at least since 2016), including through the mechanisms of settlement of investment disputes under investment treaties. At least 4 such cases have been found in the register where such attempts have been made. And that did not work yet in any case.

Although, the tax authority in these disputes consistently holds the position (including after the decree of the Cabinet of Ministers in December 2018 on approval of the Settlement Agreement regarding Philip Morris Ukraine PrJSC and signing of this agreement in January 2019), that such ordinary disputes with the tax authority do not fall into the category of investment disputes under the treaties on encouragement and reciprocal protection of investments, and should be resolved exclusively in the courts of Ukraine under the national law.

In the case of Philip Morris Ukraine PrJSC, the Head of the SFS at that time personally took a different position. Why?

12.

(Updated on August 05, 2019)

There are two turning points in the case with the Philip Morris Ukraine PrJSC Settlement Agreement. The dispute could probably not have been resolved in this way without them. Both of these points are related to the Head of the SFS, Mr. Vlasov.

The first moment is the signing of the Settlement Agreement on behalf of Ukraine by Mr. Vlasov, Head of the SFS, on January 31, 2019. Everything was at a preliminary stage until that time, despite the approval of the draft agreement by the Cabinet of Ministers. No obligations arised yet, under the agreement itself or otherwise in connection with this process. And the authorization of Mr. Vlasov by the Cabinet of Ministers to sign the Settlement Agreement in the version approved by the Cabinet of Ministers is a certain trap for him.

Let us explain by example:

Can the Cabinet issue resolutions which could oblige the SFS to cancel the TND? Even in general, not only those on which the administrative appeal procedure is completed, and even the decision of the court of first instance was rendered. Obviously not, since the Cabinet of Ministers as an executive power authority, under the Constitution (Art. 19), shall act only on the basis, within the powers and in the manner provided by the Constitution and laws of Ukraine. The Constitution and laws of Ukraine do not entitle the Cabinet of Ministers (or other non-tax authority, including those which delegated representatives as a part of an Interagency Working Group on this process) to cancel or assign (provide mandatory instructions under the law) to cancel taxes accrued in accordance with the procedure established by the Tax Code (including under the results of audit). We remind that tax issues shall be determined exclusively by the law, and therefore, shall not be settled otherwise than in the order established by the law.

It is impossible to oblige the SFS to cancel the TND. At the stage after the completion of an administrative appeal, the TNDs may be canceled only in court (including by the amicable settlement, however, in the order and in view of restrictions established by the CAP).

Therefore, if it is impossible under the law to oblige the SFS “from outside” to cancel the TND, they applied the option to accept such an obligation by the SFS on its own, via signing the Settlement Agreement by the Head of the SFS. Thus, it becomes an obligation, not by virtue of the external order of any other authority, but something like an “own” obligation of the SFS. And it becomes non-decently to get rid of the fulfillment of such a signed “obligation” on cancellation of the TNDs, even if it was accepted with lack of powers under the law: after all, “you have only yourself to blame”.

Mr Vlasov’s attempt to get out of this matter by reference to the fact that it was a collective decision (see the link) seems like a joke about the “permission” of the Queen of England:

«The deputy comes to the Parliament’s meeting dressed in obscene rags. He is not allowed, he must adhere to the polite manners and proper dress code, they say. Then he replies that he had permission from the Queen of England: “Once upon a time, I came to her for an audience in this clothes. I was expelled from it, but the queen said: “How terrible! You may only visit your Parliament in these clothes”»

Neither the Cabinet of Ministers nor the IWG had the authority to oblige the SFS to cancel the TNDs, so could they “approve” the action of the SFS to which the SFS was not legally entitled? And does such approval exempt from liability for acts out of the law? Does this resemble the “permission” of the Queen of England from a joke? And what if the Cabinet of Ministers and the IWG approved a bill that provides for robbery, would it legitimize the robbery?

Violation of the law motivated by “approval” or order … Seems like a question (“we just carried out an order”) answered not only by the law but also by the history, doesn’t it?

Our analysis leads us to the conclusion that the signing of the Settlement Agreement, which contains, in particular, obligations (of the signatory’s chaired authority) out of the statutory boundaries, does not have the proper legal basis, despite the formal approval of another authority.

It cannot be ruled out that Mr Vlasov understood this, and that it caused delays for various persuasions and convictions after December 05, 2018, when the draft Settlement Agreement was approved by the Cabinet of Ministers, until January 31, 2019, when the Settlement Agreement was signed by Mr Vlasov on behalf of Ukraine.

The second point is the cancellation of the TNDs by Mr. Vlasov’s decision, allegedly, on March 22, 2019 (see Section 6 above as to the uncertainty of this date). Until that moment, Mr. Vlasov still had the opportunity to come to reason and to declare that although the Settlement Agreement was signed by him in the form approved by the Cabinet of Ministers and within the powers delegated by the Cabinet of Ministers, he did not personally approve the relevant provisions of the agreement as the Head of the SFS (as we understand, Mr. Vlasov was not included into the IWG). Therefore, he worked under the instruction of the Cabinet of Ministers – he signed the Settlement Agreement (on behalf of the Cabinet of Ministers of Ukraine), but as a Head of the SFS, within the limits of his official powers and duties, cannot make a decision on cancellation of the TNDs in the manner not provided by law (since he shall act, we reiterate, as stipulated in Part 2 of Article 19 of the Constitution of Ukraine, solely on the basis, within the powers and in the manner provided by the Constitution and laws of Ukraine). If you want – take responsibility and cancel by yourselves. If everything is possible with reference to the Settlement Agreement and international treaties, then cancel, for example, the resolution of the Cabinet of Ministers!

However, there was, probably, an understanding that it was impossible to do “anything” with the only reference to the Settlement Agreement and international treaties on investment protection. Therefore, they tried to conceal, to make less obvious, the unlawfulness of the steps by directing to the authority that adopted the TNDs and the additional references to paragraph 55.1 of the Tax Code (the irrelevance of such references was considered in Section 5 above).

That was also a trap for Mr Vlasov. After personal signing of the Settlement Agreement, it became more difficult for him to allege that the respective provisions of the Settlement Agreement concerning the SFS (chaired by him) were non-enforceable. So, in spite of delay (the TNDs should have been canceled no later than March 2, 2019 under the Settlement Agreement, as we understand, but in fact, it has been done not earlier than March 22, 2019), Mr. Vlasov was convinced of the cancellation of TNDs.

How and by what methods he was convinced also matters, including for the validity of the Settlement Agreement.

For example, based on the analogy of the Vienna Convention on the Law of Treaties, the Agreement may be declared invalid/void, for example, for the following reasons:

Article 50. Corruption of a representative of a state or of an international organization

A State or an international organization the expression of whose consent to be bound by a treaty has been procured through the corruption of its representative directly or indirectly by a negotiating State or a negotiating organization may invoke such corruption as invalidating its consent to be bound by the treaty

Article 51. Coercion of a representative of a state or of an international organization

The expression by a State or an international organization of consent to be bound by a treaty which has been procured by the coercion of the representative of that State or that organization through acts or threats directed against him shall be without any legal effect.

Therefore, the establishment, of what happened to Mr Vlasov that initially led him to sign the Settlement Agreement and then the decision on cancellation of the TNDs, including in course of the pre-trial investigation mentioned earlier, is also relevant in order to establish the validity of the Settlement Agreement.

For the sake of completeness, it should be noted that the Vienna Convention on the Law of Treaties also identifies some other reasons why a treaty may be considered void.

In addition, as we see, many things in this case are related personally to Mr. Vlasov as the Head of the SFS at that time. So, the appointment of Mr Vlasov as the person authorized to sign the Settlement Agreement is very important. And those who offered it, probably understood, deliberately structured it as a commitment of some kind of personal obligation – a lever of pressure to encourage him further to cancel the TNDs.

If we proceed from the Procedure for the Protection of Rights and Interests of Ukraine in the Settlement of Disputes under the Presidential Decree, it would be more logical to see the Ministry of Justice as the key authority in this process under the said Procedure, as the signatory. Or why not the Ministry of Finance, as it was in Russia in the mentioned agreement with ExxonMobil (see the link), especially since the Minister of Finance Ms. Markarova was the Government’s Commissioner for protection of investments (see the link)?

And the person who actually signed the Settlement Agreement, as we see, matters in terms of ensuring the practical implementation of the Settlement Agreement. It seems that such an order of signing was planned from the outset (by whom?) for the purpose, at least, to attempt to achieve the cancellation of the TNDs, despite a doubtful legal basis.

But the Settlement Agreement was practically non-enforceable without the cancellation of TNDs by the SFS. And even with this cancellation, the case was not without further violations of the same Settlement Agreement: if the signed text of the Settlement Agreement contained a provision on the obligation of Philip Morris Ukraine PrJSC to apply to the court on closure of the proceedings based on amicable settlement, then withdraw from this provision was a substantial breach of the terms of the Settlement Agreement (in addition to disclosure of the confidential provisions of the Settlement Agreement at a press conference on March 27, 2019 as an element of pressure on the SFS to cancel the TNDs).

Time will tell what else will be probably revealed in the pre-trial investigation. And in the meantime, it can be stated that the case has not yet been finished, and we can still hear something interesting about it up to the renewal of the dispute on the respective TNDs.

13.

(added on 08/08/2019)

We are pleasantly surprised by the readers’ attention to this material and the questions that are actively raised by it. We perceive it as evidence of the real importance of the issues under consideration but not only of the curiosity of the review for reading. It encourages us for such inquisitive feedback.

We will try to answer those questions that we find more interesting, important and relevant, according to our vision.

And firstly, let us comment whether Philip Morris Ukraine PrJSC violated tax/customs legislation or not? And if so, should the case under consideration be construed as granting “indulgence” for breach with “forgiveness” of tax surcharges under the will of the Cabinet of Ministers and/or the tax authority?

Our comments:

Firstly, we do not have the legal competence to d e c i d e, whether there has been a violation. According to the Constitution and laws of Ukraine (and in particular the Tax Code), such competence is given only to the controlling authorities (the State Fiscal Service under the current structure) at the stage of execution of measures of tax control and administrative appeal. For the sake of completeness, it should be noted that taxpayers are also not deprived of the right to detect and admit their own mistakes (violations) and to make self-adjustments. In case of disagreement with a mistake established in due order by the controlling authority, the taxpayer has the right to file a lawsuit to a court, which may, accordingly, take a legally binding decision establishing whether there is a mistake. Therefore, establishing of the existence or absence of a violation of tax law, as a recognized legal reality, is the prerogative of the authorities granted with the competence to do so by the law. In addition, it shall be done in the order and in the manner prescribed by the law.

Everyone can consider something and form a certain view about something. Like we do it in daily life as to many things (politics, health protection, football etc.). Everyone can make their own assessment based on the information available (for example, the decision of the court of first instance in the case where the circumstances of the case and the relevant legal qualifications are sufficiently detailed, and/or other available information). However, only the decision of an authority competent under the law (tax authority or the court) may be valid from a legal point of view. Participants to the proceedings can only try to communicate their position to such authorities, which have the proper competence under the law, and hope that they will implement it in their decision and thus give legal significance to the adopted position.

As the Ministry of Justice acknowledges (as noted, in particular, in the court decision analyzed in Section 11), the Ministry of Justice is not entitled to give an assessment of the merits of the tax dispute. The IWG or other ministries, agencies, authorities or organizations do not also have such competence. By the way, the Cabinet of Ministers also does not have – it is not granted with such competence (powers) under the Constitution and laws of Ukraine. Therefore, no other authority or organization, except the SFS and further specialized courts, can decide whether it is a tax violation or not.

If we proceed from the decisions taken on the basis of tax audit and administrative appeal, including the decision of the SFS on the results of consideration of the complaint, which is final according to the Tax Code (para. 56.10) and may be further appealed only in court, there were violations.

As mentioned in more detail in Section 2, according to the case file, the SFS took decision on the results of the consideration of the complaint of Philip Morris Ukraine PrJSC by the decision as of August 25, 2016 No. 18462/99-99-11-1-1-20, which upheld the TNDs as of June 14, 2016, adopted by the Head Department of the SFS in Kharkiv Region.

By the way, we have not yet seen whether this decision of the SFS as of August 25, 2016 is mentioned in the decision of the SFS as of March 22, 2019, which cancelled the TNDs, and in what way, if so.

However, the real factors that led to the cancellation of the TNDs are more important than the subsequent actions (following a crucial decision on “obligation” to cancel) aimed at implementing the “obligation”.

As we understand from the public information, the “obligation” to cancel is contained in the Settlement Agreement, the draft of which with the authorization of Mr. Vlasov for signing, was approved by the resolution of the Cabinet of Ministers as of December 5, 2018. In fact, it was initial decision on cancellation of the TNDs. However, the absence of tax violation was not established and could not be established in the process that led to the mentioned resolution which essentially cancels the TNDs. In particular, since that process was not the activities of authorities competent under the law to establish (as a recognized legal reality) the existence or absence of a tax violation, and was not the actions of such competent authorities on the basis, within the powers and in the manner provided by the Constitution and the laws of Ukraine. The participants of the process that led to the resolution of the Cabinet of Ministers as of December 05, 2018, and the Cabinet of Ministers itself, are not granted by the Constitution and laws of Ukraine with the competence to cancel/repeal decisions of the SFS and the courts (e.g., the decision of court of first instance in the tax dispute, by which the violation was established).

Therefore, at the moment of making a public decision to cancel the TNDs at the level of the Cabinet of Ministers, the absence of tax violation was not established in the procedure established by the law, by the authorities granted with legal competence for this, acting in the manner established by law. On the contrary, the decisions of the authorities granted with the relevant competence on this issue by the law, adopted in accordance with the procedure established by the law, evidenced the existence of a violation.

Therefore, the decision to cancel the TNDs, incorporated into the text of the Settlement Agreement approved by the Cabinet of Ministers, was made not because absence of a tax violation was established at that time, but on the contrary – when the existence of a violation was recognized in the decisions of the competent authorities adopted by them in the procedure provided by the law.

The subsequent actions of the SFS and the closure of judicial proceedings with the cancellation of the decision of the court of first instance were caused by de facto decision-resolution of the Cabinet of Ministers as of December 05, 2018 and took place after and, in fact, for the execution of that resolution. That is, the absence of a tax violation was not established, and the dispute was settled due to the absence of a violation, but de facto the Cabinet of Ministers issued an “indulgence” for the tax violation established at that time upon instruction of the group.

It issued – let it be. But did it have the right to do so under the law? The right of tax “amnesty” is not granted to the Cabinet of Ministers under the Constitution and laws of Ukraine. It cannot be derived from international treaties, since they cannot grant to the national authorities competences greater than those granted by the Constitution and the laws. If it were otherwise, we should also thank the Cabinet of Ministers for being so gracious to the citizens of Ukraine in this case and not agreeing to include any other obligations into the agreement, if the possibility to do it is considered not limited by the competence of the Cabinet of Ministers under the law. Why couldn’t they act easier – agree to include in the Settlement Agreement the court’s obligation to cancel the decisions rendered in this case and take a new decision in favor of Philip Morris Ukraine PrJSC?. Why is it impossible? And why, on what grounds did those who prepared the draft agreement and adopted the resolution to approve the obligations under the text of the agreement conclude that it is possible to oblige the SFS to do so?

Oh, no wonder thar the CAP establishes (Part 1 of Art. 190) the possibility of amicable settlement only on terms that (i) do not contradict the law and (ii) are not beyond the competence of the public authority. But in this case, the whole bunch of non-compliance with these conditions is obviously present:

as we noted above, taxation is regulated solely by the law, and executive authorities (including the Cabinet of Ministers) are not authorized to change the conditions of taxation prescribed by law, in particular to “forgive” the accruals made under the tax laws as a result of the revelation of a tax violation.

Therefore, the Cabinet of Ministers acted beyond its competence and contrary to the law, considering the Cabinet of Ministers’ resolution as binding to cancel the TNDs. The fact that the SFS and personally Mr. Vlasov had a “space to maneuver” even after the resolution of the Cabinet of Ministers as of December 5, 2018 and even after the signing of the Settlement Agreement as of January 31, 2019, was considered in Section 12. Thus, we cannot relieve Mr. Vlasov from responsibility and point only toward the Cabinet of Ministers and those who acted there.

14.

(added on August 23, 2019)

Another question was received from Oleksandr Maidanyk: “If the customs authority has given permission for the processing regime, are the tax surcharges under post-audit adequate to the alleged unlawfulness of the application of such a regime, as well as the word-splitting as to the form of contracts (in the context of substance over form principle)?”.

Answer:

Thanks for your question.

It is somewhat related to the one commented in Section 13 of the review. That is, we do not have competence under the law to determine whether there was a respective violation of the law.

And with respect to our vision in the context of the priority of substance over the form, we can form it solely on publicly available information (we are not a party to the case and, accordingly, do not have access to those case files). If we proceed from the statement of the court of first instance in the case, in the aspect of the question raised (the substance and form ratio), it seems that there was no processing in fact, and the company commenced transactions as before (import of certain materials, production, and subsequent sale for export; without proper delimitation in accounting, without approval of the conditions of processing, neglecting the issue of the necessity to obtain additional permission for the use of the trademark in this case), and tried to give them (moreover, rather clumsily) a form of processing keeping the same nature and modus operandi of transactions.

The decision of the court of first instance, in particular, states:

“During the audit of the transaction carried out within the limits of the concluded contracts, with the purpose of approving or refuting the fact of the actual carrying out transactions of processing of goods placed in the customs regime of processing, the transactions were considered based not only on their form, but also on their economic substance.

The legal consequences of a transaction are determined by its substance and not by its external form. The tax consequences are determined according to the legal relationship that has actually arisen between the parties”.

Among other things, the court also proceeded from the fact that (as stated in the decision of the court of first instance):

“In accounting, transactions on posting, transfer to production and receiving finished products from goods placed under the customs regime of “processing at the customs territory “are recorded in the same accounts as identical goods placed in the customs regime of “import” with payment of all customs duties.

By its nature, Philip Morris Ukraine PrJSC conducts identical transactions with goods placed in the customs regime of “import” and “processing in the customs territory”.

The only difference between the transactions carried out is the payment of customs duties when goods are placed in the appropriate customs regimes”.

That is, it is not simply about establishing a number of violations of formal requirements for processing regime, such as those indicated in a court decision:

“If the goods have been imported into the territory of Ukraine for the purpose of processing, then the conditions of processing the imported goods shall be essential condition of the contract (regardless of its name) between the Customer and the Contractor. However, the subject of the contract as of March 27, 2015 No. N/A, as well as contracts No. 68321, No. 68425, No. 68317, No. 69469 was determined as sale (delivery)”.

and others (see the court ruling directly), but in essence, the fact of doing business as earlier, with the only difference, the attempt to provide activities with processing form without changing the essence of the transactions in order to avoid the payment of additional customs duties.

Those facts were cited in the court decision and led to the court’s conclusions:

“Mentioned facts indicate that Philip Morris Ukraine PrJSC conducts essentially identical transactions with goods placed in the customs regime of “import” and “processing at the customs territory”.

The only difference between the transactions performed is the payment of customs duties/or conditional full release from duties when placing the goods in the appropriate customs regimes.

…

It is evident from the case file that Philip Morris Ukraine PrJSC conducted transactions, in all cases, there were sales and not processing transactions both formally and essentially. According to the effective laws of Ukraine, such transactions are subject to taxation on a general basis”.

We hope that this commentary answers the question in the context of the priority of the substance over the form.

This review is already quite large, so we don’t plan to update it in the future. However, we do not abandon this topic and continue to monitor developments around the Philip Morris Ukraine PrJSC Settlement Agreement. We will publish further updates in separate materials on KM Portal.

The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.

Kind regards,

© WTS Consulting LLC, 2019