One of the advantages of the Russian tax system is the flat and low tax rate for personal taxation.
There are a lot of individuals of significant wealth; however, most of them have taken the international route for investing. For example, they establish entities in Russia and also worldwide, opening bank accounts for investing both in Russia and worldwide.
As of 2015, there have been a lot of significant changes in the private client sector and its taxation.
An individual is considered as a Russian tax resident if he or she spends 183 days or more during 12 months (calendar year) in Russia; and a Russian tax non-resident if the period of staying in Russia is less than 183 days.
Based on the general rule that Russian tax residents are taxable on their worldwide income, Russian tax non-residents are taxable on their Russian-sourced income only.
In the Russian Federation, the Personal Income Tax (PIT) rate is a tax imposed on various income sources, such as:
- income of financial assets, such as dividend and interest income, capital gain;
- income from realisation of property (movable and immovable);
- rental income;
- material benefit – income on low rate loans;
- interest income on deposits;
- investment income on insurance instruments;
- gifts and inheritances;
- income from the liquidation or sale of shares of the companies; and
- profits from controlled foreign companies.
A flat income tax rate of 13 per cent applies for Russian tax residents to all types of income, with some exceptions, including the following:
- 9 per cent tax rate established in the amount of 9 per cent with respect to the income from mortgage-backed securities emitted before 1 January 2007 and also to the income of settlers of trust mortgage collateral received on the basis of acquisition of the mortgage participation certificate issued by the trustee of the mortgage collateral before 1 January 2007;
- 35 per cent tax rate is applied for:
- the cost of prizes and prizes received in competitions, games and other activities held with the purposes of advertising goods, works and services, in the part exceeding the amounts stated in the Russian Tax Code (RTC);
- interest income (bank accounts) in the part exceeding the amounts stated in the RTC; and
- amounts of economic gain on interest when the taxpayers receive borrowed funds in the part exceeding the amounts specified in the RTC.
A flat income tax rate of 30 per cent (unless reduced under double tax treaty (DTT) provisions) applies to the Russian-source income of the Russian tax non-residents with some exceptions, including the following:
- a 15 per cent tax rate applies to dividends received from Russian companies;
- a 13 per cent tax rate also applies to nationals of foreign countries who are highly qualified specialists under the special regime; and
- a 5 per cent tax rate in respect of dividends on shares of international holding companies under certain conditions.
The tax on the above-mentioned income is calculated as a percentage rate, which is applied to the tax base. Specific rates (reduced or standard) can be applied based on specific criteria.
Personal income is generally taxed at a 13 per cent tax rate and may be reduced by using certain tax deductions, such as social, investment and property. All the deductions are calculated based on the expenses related to medical treatment, expenses related to education (both individual and relatives), property bought or investments.
Before 1 January 2015, Russian tax residents were taxed at a reduced rate of 9 per cent for income generated from dividend payments and share participations. A 13 per cent rate is currently applied for this kind of payment.
The main distinctive features of Russian PIT are the flat-rate scale (however, there are plans to make it progressive2: as the first step, the Russian Tax Code should be amended and will include a new flat rate of 15 per cent for annual income above 5 million roubles as mentioned in the speech of the Russian President regarding the main steps connected to the covid-19 pandemic), the taxation of income below the minimum wage and the absence of joint tax return filing. The tax is transferred to the budget of the region and municipality of the employer's registration.
Inheritance and gift tax existed in the Russian Federation before 1 January 2006 and has been abolished since.
However, personal income tax may be payable by individuals receiving property by way of gifts, depending on the type of the property and its source. However, certain property received by individuals by way of gifts is included in the base of personal income tax depending on the property type and its source.
The market value of gifts received from organisations by individuals is generally used for personal income tax purposes.
Transactions between close relatives (i.e., spouses, parents and children, grandparents and grandchildren, brothers and sisters) are exempt from PIT.
An inheritance is generally exempt from tax; however, payments made to heirs in relation to an author's remuneration for inventions or arts should be taxed at the flat tax rate applicable to the individual tax residency status.
i Significant changes in Russian tax legislation
On 25 March 2020, the Russian president announced significant amendments in taxation regulations introducing the personal income tax on interest income of individuals from capital exceeding 1 million roubles. These provisions apply to income received from 1 January 2021.
Income in the form of interest received on deposits (account balances) in roubles in Russian banks, the interest rate on which during the entire tax period does not exceed 1 per cent per annum, as well as on escrow accounts, is not considered for the tax base calculation.
Should the income be denominated in a foreign currency, such income is converted to roubles for determining the tax base at the official exchange rate of the Russian Central Bank established on the date of the actual income receipt.
The tax base will be calculated as follows: the amount of income from all interests on deposits in Russian accounts (account balances) in excess of 1 million roubles minus the average interest income for the year on the deposit in the amount of 1 million roubles (depending on the key rate, which is determined by the Russian Central Bank).
The Bank has an obligation to submit information on the amounts of interest paid in respect of each individual to whom such payments were made during the tax period no later than 1 February of the year following the reporting tax period to the tax authority. Tax authorities will calculate the amounts based on this information.
The basic flat 13 per cent tax rate will apply to non-residents on this type of income. This part of personal income taxation is unusual because the existing Russian tax system does not include any cases of flat rate (13 per cent) applicable for the Russian tax non-residents.
The interest and the discount income received when redeeming outstanding bonds of the Russian organisations denominated in rubles and issued after 1 January 2017 as well as the amounts of interest on the state treasury obligations, bonds and other state securities of the former USSR, member states of the Union State and subjects of the Russian Federation, as well as on the bonds and securities issued by the decision of the representative bodies of local self-government are exempt from the list of the non-taxable types of income from 1 January 2021.
The income of realisation of financial instruments or redemption of bonds can be credited to an account of the Eurasian Economic Union or jurisdictions that exchange financial information with the Russian Federation as part of an automatic exchange of information.
ii Russian controlled foreign companies' rules
A Russian tax resident (controlled foreign companies rules apply both to an entity or an individual) is taxed annually on the retained profits of controlled foreign companies at a rate of 20 per cent if the controlling person is a legal entity or 13 per cent if the controlling person is an individual.
The controlled foreign companies' provisions are triggered in case a Russian tax resident has an interest of more than:
- 25 per cent (jointly with spouses and minor children – also considered as a controlling party of the controlled foreign companies); or
- 10 per cent (jointly with spouses and minor children) if total participatory interest of all Russian tax residents in the controlled foreign companies is over 50 per cent.
However, regardless of the participation interest, the person can be recognised as controlling if he or she has the ability to have a decisive influence on decisions about the distribution of profits (income) of such organisation.
This recognition of a Russian tax resident as a controlling person of controlled foreign companies entails an obligation to report on a foreign company to the tax authorities of the Russian Federation. This is a submission of a notification about occurrence, change or termination of participation in a foreign company, to file annual controlled foreign companies notifications and the submission of tax returns and pay personal income tax if the controlled foreign companies' profit exceeds 10 million rubles.
The taxable profits of controlled foreign companies can be calculated by using one of the following options:
- if the controlled foreign company is registered in a jurisdiction that has entered into a DTT with Russia and provides Russian tax authorities with relevant tax-related information, then its profit is calculated based on its financial statements made in accordance with the legislation of its origin jurisdiction (the financial statements must be subject to audit); and
- controlled foreign companies' profit is calculated in accordance with the RTC provisions. The general provisions can be applied at the taxpayer's discretion (this approach must be applied for five consecutive tax periods if chosen).
Foreign taxes paid on the controlled foreign companies' profits may be offset against the Russian tax liabilities charged on the controlled foreign companies' profits should Russian legislation or the laws of a foreign jurisdiction include such provisions.
Controlled foreign companies' taxable amount may be reduced by the dividend amount paid from such profits during the tax year in which they were formed and the subsequent 12 months.
As of 1 January 2020, it is possible to withhold and pay tax in Russia only once in case income is paid from a Russian legal entity to controlled foreign companies and the latter pays it to a Russian controlling tax resident.
iii Special administration regions in Russia
At this moment, it is possible to redomicile (relocate) the company from a foreign jurisdiction to the Russian Federation to special administrative regions (SAR). SAR includes the territory of Russky Island (Primorsky Territory) and Oktyabrsky Island (Kaliningrad Region).
For redomicilation of a foreign company in the Russian Federation, the company should be recognised as an international company (IC), which requires the following conditions to be simultaneously observed:
- the company must be recognised as a commercial corporate organisation;
- the company must have entrepreneurial activity in several jurisdictions, including in the Russian Federation (directly or indirectly controlled entities or through branches);
- the company should be registered in a jurisdiction that is a member of FATF or Moneyval (Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism);
- the place of registration of the company should be one of the territories that are included in the SAR;
- an application of the conclusion of an agreement on the implementation of activities as a participant of SAR should be submitted; and
- an obligation of the investment in the Russian Federation in the form of capital investments or investments in the authorised capital or contribution to the property of Russian society of at least 50 million roubles must be made within six months of registration.
For provision of tax benefits, the IC must be recognised by an international holding company, which requires the following conditions to be simultaneously observed:
- a re-domiciled foreign organisation must be created before 1 January 2018;
- the controlling parties of the IC became controlling parties of the foreign company in the period before 1 January 2017;
- in 15 days from the date of redomicilation registration of a foreign company, the following documents should be submitted to the tax authorities of the Russian Federation regarding the IC:
- the audited financial statements of a foreign organisation for the last financial year that ended before the registration date; and
- information about controlling parties of the IC.
On 3 August 2018, a set of special provisions was introduced for 'international business entities' registered in special administrative regions located in the Kaliningrad region and Primorsky territory (islands named Russky and Oktyabrsky).
The SAR participant can be a foreign legal entity (non-credit financial institutions, credit organisations, payment systems operators and operators of payment infrastructure services as well as companies registered in certain offshore jurisdictions are exempt).
The SAR foreign legal entity needs to enter into an agreement with the SAR management company and needs to be registered as an international company that redomiciles to the Russian Federation and is included in the participants' register of the SAR by the management company. Additional requirements may apply.
An international company may obtain an international holding company status providing certain tax benefits in the Russian Federation, as follows:
- 0 per cent tax rate for dividends received (in case of holding at least 15 per cent of a distributing company for at least 365 days and the distributing company must not be registered in a jurisdiction specified in the Russian 'blacklist' of offshore territories and jurisdictions);
- 0 per cent tax rate for the income gained from the realisation or another form of alienation of foreign and Russian companies' shares in certain cases; and
- 5 per cent withholding tax rate for dividends distributed by international holding companies to foreign residents and exemption of controlled foreign companies' (CFC) profits from Russian taxation is applied for the tax periods prior to 1 January 2029.
iv Submission of Russian tax returns to Russian tax authorities
Typically, personal income tax returns (the 3-NDFL form) should be submitted to the tax authority of the Russian Federation no later than 30 April following the expired year of receipt of income. The tax payment deadline is until 15 July following the expired tax period. However, in 2020, because of the worldwide pandemic situation with covid-19, the deadline for filing the 2019 Russian personal income tax returns (3-NDFL form) has been extended from 30 April for a period of 3 months. However, the deadline for tax payments under 2019 tax returns remains unchanged. Personal income tax, which is calculated based on the submission of a Russian tax return, should be paid by 15 July 2020.
In Russian tax legislation, there are also tax agents. They are responsible for the calculation of personal income tax for individuals and submission of the relevant tax forms (2-NDFL form). This rule applies only to certain kinds of Russian-source income: employment income, investment income from the Russian brokers of other financial institutes, etc. In this regard, in some cases, such as those mentioned above, tax agents quarterly calculate the personal income tax for individuals, complete the special form, withholding the appropriate personal income tax based on the kind of income and tax residency status. As a result, the Russian taxpayer receives a net amount of income and has the ability to exclude this income from the personal income tax return (3-NDFL form).
Within three months, starting from the date when the tax return was accepted by the tax inspector, the procedure of the desk tax audit begins. This process is carried out with respect to the taxpayer and the submitted tax return. In the case of a taxpayer finding out that information has not been disclosed or has not been fully disclosed in a tax return that has submitted to a tax authority, or finding mistakes that could be the result of an understatement of the amount of tax payable, the taxpayer shall be obliged to make necessary amendments to the tax return and to submit a revised tax return to the tax authority. In this respect, a revised tax return, which has been submitted after the expiry of the established time limit for the filing of a tax return, shall not be considered to have been submitted late. However, the three-month period will be recalculated from the day when the revised tax return was received by the tax authorities.
During a desk tax audit, the tax authority has the right to request the documents necessary for verification (for example, documents confirming the expenses that are accepted by the taxpayer as a reduction in the tax base). Also, in case of recognition of the errors or inconsistencies, the tax authority may send a request for clarification or amendments to the tax return. However, after three months, the tax authority should complete a desk audit.
If a violation is discovered, the tax authority will draw up a tax audit report. If the tax return does not contain errors, the tax authority will have to form a receipt for the payment of the calculated personal income tax.
v DTT amendments
At present, the Russian Federation has concluded 84 DTTs, and automatic exchange of financial information is carried out with 89 jurisdictions.
At the moment, the Russian Federation is negotiating with Cyprus on the issue of changing the DTT with respect to increasing the size of tax rates for dividend and interest payments.
Currently, DTT provisions have priority over local tax legislation.
vi Common reporting standard rules
The Russian Federation amended the Russian Tax Code for the purposes of Common Reporting Standard (CRS) at the end of 2017.
Russian tax authorities are able to obtain information on Russian tax residents' financial accounts from the tax authorities of partner jurisdictions.
Generally, financial institutions have an obligation to submit CRS reports related to foreign tax resident beneficiaries or clients annually by 31 May of the year following the reporting period.
According to the Organisation for Economic Co-operation and Development website, the Russian Federation receives tax information from 95 jurisdictions and sends tax information to 68 jurisdictions.
vii Recent 'deoffshorisation' measures
In April 2020, the Ministry of Finance of the Russian Federation sent official letters to the Ministries of Finance of Cyprus, Luxembourg and Malta with a proposal to revise the current provisions of their DTTs to increase the rate of income tax at the source of dividend and interest payments. These jurisdictions are widely used by Russian companies to create various corporate and financial structures. If the partner countries do not agree, the Russian Federation will withdraw from the agreements unilaterally. These potential changes can seriously affect the cross-border structuring for individuals.
Should the Russian Federation withdraw the DTTs unilaterally, it may lead to the following consequences:
- interest paid to individuals who are tax residents of foreign jurisdictions will be subject to a 30 per cent tax rate instead of reduced rates;
- individuals who are tax residents of the Russian Federation will not be able to set off the amount of tax paid abroad as personal income tax;
- an application for a set-off or refund of the amount of overpaid tax can only be submitted within three years; and
- certain grounds for tax exemption of profits of CFC located in the respective countries become inapplicable.
There are no special or unusual rules for succession in Russia.
iv WEALTH STRUCTURING AND REGULATION
Business operations can be conducted in the Russian Federation by using one of several organisational forms.
The most common entities for assets structuring used in the Russian Federation are:
- limited liability companies;
- open joint-stock companies;
- closed joint-stock companies;
- public and religious organisations (associations);
- partnership; and
- funds, etc.
There are separate business and non-profit organisations conducting a specific type of business activities (for example, insurance companies, credit institutions, stock exchanges, etc) and are not able to participate in other types of activities.
Traditional trusts do not exist in Russia; however, the Russian Civil Code includes the concept of fiduciary property management contract.
Generally, the tax liability of a business entity depends on the activity type and the chosen system of taxation (a simplified taxation system may be applied) and not on the organisational or legal form or ownership structure.
A foreign entity may conduct business in the Russian Federation through affiliates, branches, permanent establishments and other separate subdivisions. An affiliate or branch of a foreign company created for conducting activity may be operational in the Russian Federation only after receiving the proper accreditation.
A foreign entity must register with the tax authorities should it plan to work in the territory of the Russian Federation for over 30 calendar days a year.
Affiliates, representative offices and other separate subdivisions of a foreign company (if registered with tax authorities) are subject to all types of tax imposed by Russian legislation.
Taxation of partnerships and cooperatives is the same as taxation of other commercial companies. There is no transparency regime, the tax is paid by the partnership itself.
Non-profit organisations are subject to tax and charges imposed by current legislation. These organisations must include a report on their activities and management bodies, the use of funds and other property including the assets received from foreign entities in their accounting statements.
The principal legal act aimed at anti-money laundering in Russia is Federal Law No. 115-FZ 'On Combating Money Laundering and the Financing of Terrorism' (the AML Law) which became effective on 1 February 2002.
The AML Law imposes certain requirements on credit, insurance and other entities. These companies must perform due diligence procedures with respect to clients (including foreign public officials and their sources of assets) and beneficiaries and ask for certain types of information on payers in payment orders.
The designated entities are obliged to identify and report transactions of a suspicious nature to the Federal Financial Monitoring Service. These transactions include transactions (both cash or non-cash) of at least 600,000 roubles as well as real property transactions of at least 3 million roubles or their equivalent in foreign currency.
v CONCLUSION AND OUTLOOK
Starting from 2015, significant changes in the Russian tax system made it more similar to worldwide practice. At this moment, there are some new special administrative regions that could be 'off-shore zones' in Russia. This development could be attractive to new investors from abroad.
Unfortunately, based on the situation with covid-19, there should now be more steps taken towards changing the Russian tax system: changing DTT with jurisdictions that are popular for Russian investors; a new rate of PIT for high wealth individuals; and new rules for the taxation of investing income.
1 Alexander Golikov is a partner and Anastasiya Varseeva is an associate at BGP Litigation.