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Law on Controlled Foreign Companies 19.02.2015 16:13
On 24 November 2014 amendments to the Russian Tax Code, aimed to prevent using offshore structures by Russian resident individuals and companies to minimize or evade Russian and overall taxation, were introduced. The amendments came into force on January 1, 2015.
The amendments introduce absolutely new (for Russia) rules related to revealing and taxing incomes received by Russian business and individuals through belonging to them companies and structures registered in low tax jurisdiction. Well known worldwide concepts of controlled foreign company (CFC) and “beneficial owner of income” are now in the Russian tax law, what evidently will make life of taxpayers using such structures more complex and may make many terminate the previously beneficial arrangements.
Problems in the near future will arise not primarily because dolce vita is over and business has to accept the new reality and incur the expenses or in a hassle search for other optimization mechanisms, but rather due to the new rules accepted are far from being clear in many aspects making the potentially liable business and individuals in panic decide on whether to keep silence or obey. Further clarifications and amendments, may hopefully be introduced during 2015 what may remove the ambiguity and doubts. It is worth mentioning, that development and resulting clarity of the rules and application of such will much depend on strong willpower of the government to cease the offshore practice.
This update digest the rules and the uncertainties which become evident at first sight, while more problems will be discovered in practical application and we will follow up.
WHAT IS CFC The CFC concept provides that a non-Russian company or structure such as a fund or a trust may be treated as a CFC if it is controlled by a Russian tax resident. The law defines that a Russian tax resident shall be deemed to be a controlling person of the company or structure if owns more than 25% of the company or structure solely or 10% while more than 50% of the structure or company is owned by other Russian residents. There is a higher threshold of 50% for 2015, however. The ownership includes shares of spouse and dependent children, if relates to individual ownership.
WHAT IS RESIDENT COMPANY New Russian tax residency rules for legal entities provide that non-Russian companies which are actually managed from Russia could be treated, under certain conditions, as Russian tax residents. This would require them to calculate and pay Russian profits-tax. However the law is silent with regards to other Russian taxes which are ordinarily paid by Russian companies. Again, practical application is really doubtful as the authorities are poorly facilitated to trace such management. There is currently a similar mostly “paper” rule on acknowledgement of foreign company having a permanent establishment based on management from Russia. So application of the new Russian tax residency rules will depend on further development of practice and facilities of the authorities. Much discussion is expected because of conflict of the new Russian domestic residence rules and income taxation rules and provisions of the double tax treaties of Russia.
TAXABLE INCOME AND EXEMPTIONS The law provides that profits of a CFC are to be calculated based on its financial statements, where the CFC is registered in a jurisdiction which has a double tax treaty with Russia, and the financial statements are subject to an obligatory audit-Cyprus may serve as an example. In all other cases, the CFC's and Resident company profit for Russian tax purposes is calculated based on Russian tax rules, being Chapter 25 of the Russian Tax Code. Profit of the CFC which is subject to Russian taxation is to be reduced by the amount of dividends paid by this CFC. There is relief from Russian tax if income of CFC calculated accordingly does not exceed RUR 10 mln (RUR 50mln and RUR 30 mln in 2015 and 2016 respectively). The law provides that the profit of a CFC shall be exempt from Russian taxation if the CFC is:
1) a non-commercial organization which does not distribute profits;
2) established in the country which is a member of the Eurasian Economic Union (i.e. Belarus, Kazakhstan or Armenia);
3) a tax resident in a tax treaty partner jurisdiction, which provides for the exchange of tax related information and the effective tax rate for the profit of this CFC is not less than 75% of the average weighted Russian domestic tax rate (the rules on calculation of such rate are provided by the law);
4) a tax resident in a tax treaty country jurisdiction, which provides for the exchange of tax related information and the share of passive income received by this CFC does not exceed 20%; Passive income is defined in article 309.1 of the Tax Code and besides standard passive income the definition includes service income like marketing, consulting, advertising, provision of personnel.
5) a structure (such as a trust or a fund) and all the following conditions are met:
(i) the founder is not able to receive back the assets transferred to this structure,
(ii) the founder’s rights cannot be transferred to a third party except for cases of inheritance or legal succession,
(iii) the founder is unable to receive any profit from this CFC and
(iv) the structure is unable to distribute profits among its participants;
6) a bank or an insurance company, tax resident in a treaty partner jurisdiction which provides for the exchange of tax related information;
7) the issuer of traded bonds;
8) a participant to a production sharing agreement, or a concession agreement and other similar types of agreement with the State;
9) treated as the operator of new hydrocarbon sea block or if CFC is the shareholder of such operator. These are exemptions from paying tax in Russia. Even in the above cases, CFC is still not relieved to be revealed to the tax authorities by the owners.
OTHER CONCERNS Another aspect of the new rules applies to taxation of a non-Russian company's income, that is derived from the sale of shares of Russian or non-Russian companies, whose assets, directly or indirectly, consist of more than 50% of immovable property located in Russia. There question remains how this tax could practically be assessed and collected in situation where the seller and the purchaser are both non-Russian companies, without any representation in Russia.
Solutions must be tailor-made to the client’s specific and unique circumstances, including considerations for whether a foreign company or structure may be discovered by the tax authorities in case it has no transactions to/from Russia. Given the ambiguities and uncertainties, it is advisable not to panic but rather wait the law gets more clarity, remembering that although there is comparatively immaterial penalty for non-declaring offshore structures- from RUR 50K to RUR100K, there is no penalty for tax underpayment until 2017.
For more questions, please do not hesitate to contact Olga Cherkasova (firstname.lastname@example.org)