The dangers of business fragmentation: what entrepreneurs need to know

In the modern business world, companies are constantly looking for ways to optimize the tax burden. One of these methods is business fragmentation, in which the company’s activities are artificially divided into several legal entities or individual entrepreneurs. At first glance, this seems like a reasonable way to save on taxes, but there are serious risks behind it.

What is business fragmentation?

Business fragmentation is the division of a single company into several entities in order to obtain tax benefits. For example, an organization may create several subsidiaries or individual entrepreneurs, each of which applies a preferential tax regime. As a result, the total income tax is reduced, since each entity pays less taxes compared to what a single structure would have to pay.

However, when such a division is artificial, that is, not caused by the real needs of the business, it can be regarded as tax evasion. In such cases, the tax authorities have the right to demand payment of taxes in full, as well as impose penalties.

Signs of artificial business fragmentation

The key signs that indicate artificial fragmentation are:

• The creation of new legal entities or sole proprietors without a real business need, solely to obtain tax benefits.
• The redistribution of profits to dependent entities using preferential tax regimes, which leads to an underestimation of the total profit of the business.
• The formal allocation of certain types of activities with their transfer to new entities, which actually remain under the control of the main owner.
• Involvement of family members in business activities solely for the purpose of tax savings.
  Joint activity of the founders or managers of the company in the status of sole proprietor to minimize the tax burden.
• Artificial separation of a single production process.

If the tax authorities see signs of business fragmentation in the company’s actions, they can recognize these actions as illegal, impose additional taxes, and also demand payment of penalties and fines.

Courts and tax authorities: a unified approach

Courts dealing with disputes over business fragmentation usually support the position of the tax authorities. The main argument is that such actions pursue a single goal — saving on taxes, which contradicts the norms of tax legislation.

This position was reflected in a recent letter from the Federal Tax Service of Russia dated July 16, 2024 (No. BV-4-7/8051@). The letter provides the legal positions of the courts, which are actively used in resolving disputes related to business fragmentation.

Conclusion

Splitting up a business solely aimed at obtaining tax benefits is a risky practice. Entrepreneurs should carefully consider all possible consequences before deciding on such a step. In case of doubt, it is better to consult with experts to avoid potential problems with tax authorities and courts.

A source: https://buh-a.ru/novosti/11-novosti/295-opasnosti-drobleniya-biznesa-chto-nuzhno-znat-predprinimatelyam