Mandatory removal of inactive legal entities from the Uniform State Register of Legal Entities (USRLE) by the decision of tax authorities
There is a big difference between a "fly-by-night" company registered in the name of nominal owners and an abandoned company that had real founders and managers. In the latter case there is a significant risk of unfavorable consequences, considering that criminal proceedings can be instigated against such persons under Article 199 of the Criminal Code of the RF. “Selling” a company and changing its founders and managers for nominal ones, changing the place of the registration and then abandoning the company still remains the least expensive and the most popular method of liquidation. True, the chance to be mandatorily excluded from the USRLE exists considering that this is how “fly-by-night” companies are removed from the Register. The period of waiting for “amnesty” is at least 12 months, but in practice, according to accountants’ forums it can take more than two years. What can happen during those months of suspense?
It might become too tempting for the tax authorities who, especially in case of existence of any “sins”, must and will start digging and analyzing all connections of the abandoned company in order to charge additional taxes. Other creditors will not stand aside either.
Furthermore, under Clause 2 of Article 49 of the Tax Code of the RF, where insolvency of a legal entity was caused by the actions of its founder, a subsidiary liability for payment of taxes and other creditor indebtedness can me imposed onto the latter. That’s not just theory, but real practice.
A field audit will be scheduled in order to estimate the amount of arrears. Considering that usually at that stage the company has no assets or personnel, all queries are addressed to the former manager or founder acting during the period in question. It’s not hard to find them with the help of investigators of the Ministry of the Interior. Most often at the time of inspection the former management does not have any records on the company’s activities in their possession as such records have been “handed over” under an acceptance act at the time of sale. In this case inspectors use estimated tax calculation by virtue of the right provided to them in case of failure to present the records within two months upon their request (cl. 7 art 31 of the RF Tax Code). If payments to the company under review were made through banks, the tax authorities normally use the total amount of the company’s income as the tax base without consideration of expenses that in this case cannot be substantiated! Accordingly, even if the company had no “old sins” the amount of the claim can be enormous. Of course this is improper, but it will have to be disputed in court.
I will mention subsidiary liability which is a weak spot of the founders and managers once again. Here’s one of the recent examples: the Judgement of the Arbitrary Court of St. Petersburg of August 14, 2009 in case No. А56-11933/2007. A St. Petersburg-based CJSC functioned for several years following which it has been abandoned. A court-appointed receiver authorized to identify the assets of the absent debtor (CJSC) in order to settle the creditor indebtedness did not manage to identify the assets in the absence of the primary records, but established the grounds for imposition of subsidiary liability onto the founder. The Court supported this claim and ruled that the founder, a physical person, must pay the total amount of indebtedness — 27 million Rubles.
Voluntary liquidation of an enterprise by the decision of its founders
The main advantage of this method is a possibility for the founders and managers to receive a permanent protection from tax, administrative and criminal liability for the period when they were in charge of the company for acceptable money, within acceptable time limits and not counting on the off chance.
The main disadvantage is tax inspection. Generally, there is a 90% probability of a field audit and in 99% of cases additional taxes, fines or penalties will be charged, otherwise the audit results may be disputed by supervising authorities. In other words, in the result of such audit the organization will get yet another creditor with strong negotiation advantage.
It goes without saying that the tax authorities will impose additional taxes on settlements with “fly-by-night” companies. In the absence of the primary records, such taxes will be determined on the basis of bank statements and the data of tax returns. Alternatively, the tax authorities might use their right provided for in Art. 31 of the RF Tax Code to use estimated tax calculation based on available information on the taxpayer and similar data on other taxpayers. Should the tax office be overloaded which is often believed to be the case and fail to make its claims within the given 2 months period, then in accordance with cl. 5 art. 63 of the Civil Code such claims will be excluded from the liquidation balance sheet and not be paid by the legal entity. This can be hoped for, but in practice the registering authorities will be refusing to liquidate the company on miscellaneous grounds while the audit is underway. The only chance to dispute such refusal is to appeal to court due to violation of the given timescales for consideration by the registering authorities.
The legal practice of such disputes is extensive but controversial. When the Inspection of the Federal Tax Service produces unsubstantiated by the law claims or requests documents not listed in the law courts should and do make judgments based on the requirements of the law, but quite often they also take the side of the tax authorities.
Let’s assume the worst and very real scenario: additional taxes have been imposed and included into the liquidation balance sheet. If the monetary funds in possession of a liquidated legal entity are insufficient to satisfy the claims of the creditors, a liquidator will sell the assets of such legal entity. A question to the liquidator: what if such finds won’t be sufficient?
Then in accordance with Art. 9 of the Federal Law on Insolvency (Bankruptcy) the liquidator must apply to an arbitrary court with a request of a debtor to be recognized insolvent (bankrupt). This shouldn’t be delayed as it’s much more dangerous to allow the tax authorities to initiate the bankruptcy procedure acting as a creditor as in this case there is a risk of subsidiary liability being imposed onto the founders/managers of a legal entity, as, for example, was the case under which on April 30, 2009 the Moscow City Court has ordered 15 million Rubles to be charged from a physical person — the owner and general manager of a limited liability company that had been declared bankrupt. In the aforesaid case the court-appointed receiver who was actively protecting the interests of the tax inspection has proven the existence of cause-effect relationship between the actions of the manager and tax indebtedness causing the bankruptcy of such legal entity.
Generally, voluntary liquidation is acceptable for organizations with either limited activities or totally inactive. It is also suitable for organizations that are ready to undergo tax audit, i.e. that are sure that their accounting records are well-kept and none of their contractors were “fly-by-night” companies. But this is a generalization. Being more specific, there are two questions and two answers. In absence of any tax claims to the company is it possible to undergo the tax audit with satisfactory result if the company is not sure ion its contractors? Is it possible to avoid liability in the event where the additional taxes imposed in the result of tax audit exceeds reasonable capacities of the founders if it’s impossible to dispute the audit result? In reality the answer to both questions is positive. Let’s say, that there are many examples supporting this statement, and we have been part to such cases. At the same time, in our opinion, all our actions remain within the legal limits. It is possible and advisable to influence the audit results choosing the place and time to “bury” the company correctly. Sometimes it’s advisable to find an appropriate location. The second issue is the bankruptcy procedure initiated by the debtor. We have already touched upon this issue and will consider it in more detail in the next section.
Involuntary bankruptcy of a debtor
If a company have indebtedness to the budget and/or other creditors but no means to redeem it, the only legal way to liquidate such company, write off its indebtedness and avoid the liability of the founders and managers is to have it declared bankrupt.
Let’s first see a bad example from actual legal practice. On October 11, 2009 the Arbitrary Court of Moscow made a judgement in respect of case No. А40-61317/09-74-256, according to which 18 million Rubles were to be collected from a physical person — the founder and manager of a Moscow-based LLC — due to subsidiary liability thereof. That was the ending of a story predetermined by legal shortsightedness of an entrepreneur. The limited liability company has been working on the market for 10 years, following which the tax authorities claimed outstanding taxes in a significant amount for the last two years of the company’s activities, which is quite a common occurrence. In accordance with Art. 9 of the Federal Law on Insolvency (Bankruptcy), not having a possibility to pay or dispute the claims the manager had to apply to arbitrary court with the statement of a debtor. But he chose another peculiar method of defense. Having received more advance payments of the company’s clients he transferred the ownership to a nominal holder. What can I say, quite a brave man. Half a year later when no payment was received the tax authorities applied to the court demanding that the company was recognized bankrupt. Bankruptcy proceedings have been initiated at the initiative of the creditor, the debtor failed to request that the company was declared bankrupt and, accordingly, did not nominate a receiver which was an important factor. The receiver appointed by the tax service with the assistance of the law enforcement authorities proved that the transaction between the founder and the nominee. Then, in absence of monetary funds, assets and primary records the company lodged with the court a motion to hold the founder as a physical person subsidiarily liable to the tax authorities and other creditors for the total amount of indebtedness. The court granted this motion.
Now let’s think of what could have happened should the manager of the company address experienced lawyers after receiving the claim of the tax authorities. A procedure of voluntary liquidation would have been initiated. A new manager — liquidator would take the charge of the company and receive all accounting, financial and other records under an acceptance act. The reasons for liquidation of the debtor would have been irrelevant.
They might have not been related to insufficiency of assets for discharge of all claims. There is another important aspect. If in the process of liquidation it is established that the debtor is not capable to satisfy the claims of all creditors the liquidation should proceed in accordance with the provisions of the law on insolvency.
Insufficiency (or sufficiency) of the assets of the debtor for complete discharge of claims of all creditors may be adequately established in the process of development of an interim liquidation balance sheet that contains the data on the structure of the assets of the liquidated legal entity, the list of claims made by the creditors and the results of their consideration. Where it is established that the value of the assets of the debtor (legal entity) in respect of which a resolution of liquidation is made is insufficient for discharge of the claims of all creditors, the liquidator must apply to court with the statement on declaring the bankruptcy petition. Which he will do. Otherwise in accordance with Article 226 of the Federal Law on Insolvency (Bankruptcy) the registering authorities will refuse the liquidation, and the founders, managers and the liquidators will bear subsidiary liability for all unsatisfied claims.
The Arbitrary Court will make a judgement declaring the liquidated debtor bankrupt, initiating bankruptcy proceedings and appointing a receiver. In such case the receiver shall be appointed from the list offered by the debtor and not the creditor which is the key point of the whole story! In accordance with Article 129 of the Federal Law on Insolvency (Bankruptcy) it is the receiver who presents the claims to the persons held subsidiarily liable for the liabilities of the debtor in presence of the grounds provided for in the law. Whether such grounds shall be seen by him or not is not certain, but if the receiver was appointed by the debtor there are reasons to hope that the company will be liquidated using the simplified procedure, the indebtedness will be written off and the activities of its founders and managers will be recognized as those undertaken in terms of usual business risks, i.e. they will not be held subsidiarily liable.
If a company already has indebtedness to the budget and/or other creditors and no possibility to redeem it, then the bankruptcy of the debtor is the only legal way to liquidate the company, write off its indebtedness and avoid the liability of its founders and managers. The only thing that the company needs to do is to find a liquidator and a receiver who will be loyal to the debtor from the members of the self-regulating organization of court-appointed professional receivers.
Change of the founders and management of the enterprise
In our opinion, this method has no individual value but is often used as a first, “technological” step in the process of liquidation. It allows to relieve the owners managers of the company expeditiously off the liability for subsequent activities of the company, to gain time and have grounds for further steps, e.g. change of legal address for a more remote location, and minimize the participation of the former owners and managers in the subsequent liquidation procedure.
Reorganization of the enterprise by way of consolidation or merger with another company
The main advantage of this method is as follows: In the event of successful completion of the reorganization procedure the former enterprise shall be considered to have ceased its activities upon making the respective entry into the USRLE. All its liabilities shall be transferred to its legal successor, including outstanding ones and those that have not been identified at the time of the reorganization. Furthermore, where in case of voluntary liquidation there is a 90% probability of field tax audit leading to imposing of additional taxes, fines and penalties, in case of reorganization the situation is quite the contrary. In practice, in 90% of the cases where an organization is not a major taxpayer or outstanding debtor, tax audit is not performed. Probably this is due to the fact that in case of reorganization the responsibility to pay taxes, fines and penalties still remains with the legal successor and their imposing shall not present a problem, considering that the tax authorities do not have a physical capacity to promptly audit all reorganized companies. Besides, even if a tax audit will be scheduled after the resolution on reorganization, it doesn’t necessarily mean that the reorganization will be suspended, considering that under Art. 50 of the Tax Code of the RF the responsibility to pay taxes, fines and penalties lies with the legal successor.
Under the aforesaid procedure the taxpayer doesn’t need to take any individual actions in order to be taken off the register. In the event where the tax department where the reorganized company had been registered is not aware of the fact that the company has ceased its existence due to reorganization by way of consolidation/merger and requests any records, it should be sent a copy of the certificate of the closure of business along with a letter of the former manager of the company stating that the latter is no longer an officer of the company and the latter have ceased its existence in result of reorganization,and all respective records have been handed over to the legal successor under a acceptance act. Apart from that a statement should be submitted to the Department of the Federal Tax Service requesting an entry to be made into the USRLE at the location of the legal entity on cessation of its activities with the certificate and extract from USRLE issued by the regional tax department attached.
The main disadvantage is the existence of a legal successor. While the legal successor remains formally active a threat of their being held liable for the activities of the predecessor companies and as a consequence imposition of subsidiary liability onto the former founders and managers by the tax authorities and other creditors remains. But it will be much more difficult to do. Apart from that, taking into consideration the provisions of the articles of the Civil Code of the RF, the purpose of reorganization must be conduct of business activities and not a simplified liquidation of reorganized legal entities. In the latter case the reorganization can be disputed. There are precedents where the tax authorities were applying to court and winning cases in the action for recognition of the successor’s registration due to the fact that the successor does not carry out any business activities, is not present at the registered address, does not submit accounting records, does not settle existing indebtedness or pay taxes.
To our mind, this method is worth considering. Taking into account it disadvantages, it can be viewed as a basic but not the final one in the process of liquidation. The disadvantages do not seem insuperable especially if the successor gets registered in a more remote and loyal region than the one where the predecessor was registered in. The same region can later become the “burying ground” for the legal successor in the process of its official voluntary liquidation. We should also keep in mind that the fact of registration of a legal successor automatically means termination of activities of the reorganized predecessor and taking thereof off the tax register.
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