The Corporate Tax Planning Law Review: Russia
Tax reforms are an ongoing process in Russia. Specific tax implications for the implemented business structures in Russia highly depend on, for example, the type of activity performed, investor residency and applicable tax treaties. Therefore, advance consultation with tax specialists is highly recommended.
Recent major developments include the introduction of rules on taxation of profit of controlled foreign companies (CFCs), enhancement of beneficial ownership rules, as well as tax residency of foreign companies. In February 2019, the second reiteration of the tax amnesty programme ended. Along with tax exemptions for liquidation of CFCs, the tax amnesty was part of what were known as 'de-offshorisation' provisions.
Other important developments include the entry into force of the OECD-Council of Europe Convention on Mutual Administrative Assistance in Tax Matters, and the signing of the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (MLI and BEPS). Russia also implements provisions of the CRS Multilateral Competent Authority Agreement and the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports.
i Entity selection and business operations
The most popular business vehicles in Russia are limited liability companies (LLCs) and joint-stock companies (JSCs). An overwhelming majority of businesses are in the form of LLC. Partnerships are rare.
The main taxes for companies that implement the standard taxation regime are corporate income tax and VAT. Other taxes include property tax, transport tax, land tax, excise tax and water tax; biological resources use fee; mineral extraction tax; and gambling tax.
There are also five special tax regimes that may be used by companies depending on their type of activity:
- single agriculture tax;
- simplified system of taxation;
- single tax on imputed income;
- taxation of production-sharing agreements; and
- the patent system of taxation.
These special tax regimes allow the taxpayer to pay a unified tax instead of the various taxes described above. The special tax regimes are only applicable to business vehicles that meet certain criteria (e.g., type of activity or profit amounts).
Also, starting from 2015, Russia has introduced the concept of CFC that implies taxation of undistributed profit of controlled foreign companies at the level of the controlling person in Russia.
Domestic income tax
Corporate profits tax applies to worldwide income of resident legal entities. Non-resident business vehicles are taxed on income from Russian sources attributed to a permanent establishment (PE) and certain 'passive' types of income not attributed to a PE (withholding tax). The standard rate is 20 per cent (3 per cent payable to the federal budget and 17 per cent to the regional budget. Regional authorities may reduce their tax rate from 17 per cent to 12.5 per cent for certain kinds of taxpayers). The tax period is the calendar year. Advance tax payments are payable on a quarterly basis. Interim tax returns must also be filed on a quarterly basis.
Depending on the type of income, the following reduced tax rates may apply:
- On dividends – zero per cent, 13 per cent or 15 per cent. The 13 per cent rate applies to dividends received by Russian corporations. The 15 per cent rate applies if the recipient of the dividends is a foreign corporation. The zero per cent rate applies to the dividends received by a Russian corporation if the recipient has held at least 50 per cent of the payer's equity capital for more than 365 days, subject to certain limitations.
- On interest on certain types of state and municipal securities – 15 per cent.
- On income from the operation, maintenance or rental of vessels, airplanes or other mobile vehicles or containers in international traffic – 10 per cent.
Withholding tax rates on the Russian-sourced income of foreign companies may also be reduced based on the relevant double tax treaty provisions. Tax authorities and courts currently pay special attention to the fact whether the foreign recipient of the income has beneficial ownership to it and, thus, may apply double tax treaty benefits.
Dividends received by legal entities or individual tax residents from Russian or foreign legal entities are taxed in Russia at a flat rate of 13 per cent.
There is also a special participation exemption for holding companies. Specifically, a zero per cent rate applies if:
- a payee holds at least a 50 per cent interest in the share capital of the dividend-paying company;
- the interest is held for at least 365 days without interruption;
- the company paying the dividend is not resident in an offshore tax haven (the list of corresponding countries is approved by the Russian Ministry of Finance (the black list) and mostly consists of low tax and non-treaty jurisdictions); or
- subsidiaries of the foreign companies are subject to taxation with regard to their economic activity, income sources and property in Russia.
With regard to taxation of a branch or representative office of a foreign company certain specifics exist. The Russian legislation provides that a regular business activity of a foreign investor in Russia through a branch or representative office is considered as activity performed through a permanent establishment (PE) (i.e., fixed place of business involved on regular commercial activities) of a foreign company in Russia, if the activity relates to:
- use of natural resources;
- construction, installation, mounting, erection, calibration or operation of equipment under the contracts;
- sale of goods based in their own or leased stocks in Russia; or
- performance of works, services or other activities, other than preparatory and auxiliary activities.
Should a foreign corporation form a PE in Russia, it will be taxed in relation to the profit of this PE at a 20 per cent tax rate. Alternatively, tax implications may arise for a foreign company if it receives passive income from the Russian sources (e.g., dividends). There is a list of income (provided for in the Russian Tax Code), which is deemed to be received from the Russian sources. Other income of foreign corporations is not taxed in Russia.
Deductibility of interest on intercompany loans is in certain cases restricted by thin capitalisation rules. In particular, these rules limit the deductibility of interest charged on loans from foreign affiliates defined as 'foreign controlled debt'. The rules apply to loans and other debts to the following entities that are:
- made to a company by a foreign entity that is affiliated to the Russian debtor (based on certain specific criteria determined by the Russian Tax Code);
- made to a legal entity that is affiliated to the foreign legal entity mentioned above (i.e., 'sister loans');
- guaranteed or otherwise secured by an affiliated foreign entity mentioned above; or
- guaranteed or secured by a Russian affiliate of the foreign entity.
The deductibility of interest is limited by 12.5:1 debt-to-equity ratio for banks and leasing companies and 3:1 debt-to-equity ratio to other entities. Interest on excess debt is non-deductible and is treated as a dividend subject to withholding tax. Where the taxpayer has negative net assets, the entire amount of interest accrued on the controlled debt will be non-deductible and treated as a dividend.
Special rules apply to investment loans (provided for construction of new facilities for the production of goods or provision of services in Russia). These loans (if they meet legislative criteria) are exempt from the thin capitalisation rules.
ii Common ownership: group structures and intercompany transactions
Ownership structure of related parties
Profits of a foreign subsidiary are imputed to a parent company resident in Russia where a foreign subsidiary is deemed to be a CFC. CFCs are legal entities or unincorporated entities (for example, trusts, funds, partnerships and associations).
A legal entity is considered to be a CFC provided the entity is not a Russian tax resident and is controlled by Russian tax residents (both individuals or legal entities). An unincorporated entity (structure) is considered to be a CFC where the structure is controlled by a Russian tax resident (both individual and legal entity).
An individual or a legal entity is recognised as the controlling person of a company or structure if its participation interest exceeds 25 per cent (50 per cent in financial year 2015), whereas a 10 per cent threshold applies provided that the total participation interest in a company or structure of Russian tax residents exceeds 50 per cent.
Individuals may also be deemed controlling persons if they do not meet the above criteria but control the legal entity or a structure in their own interest or in the interest of their spouses or minor children. Exercising control over a CFC means having a determining influence (or ability to have a determining influence) over a CFC's decisions related to the distribution of its net profit. Such control may be based on direct or indirect participation in CFC or under management agreement or resulting from other special relations with a legal entity, or by virtue of the agreement or governing law in case of a structure.
Domestic intercompany transactions
Intercompany transactions have always been subject to the special interest of the Russian tax authorities. The Russian tax authorities would analyse economic substance of such transactions (e.g., intercompany services have often been targeted as lacking economic justification) and pricing arrangements (i.e., deviation from the market price).
Historically these transactions have been subject to transfer pricing rules. However, starting from 1 January 2019, domestic transactions with affiliates (related parties) are exempt from transfer pricing rules. This exemption, however, will not apply if one of the parties enjoys certain beneficial tax regimes (e.g., residents of special economic zones) and the annual transaction amount exceeds 1 billion roubles.
International intercompany transactions
Intercompany transactions in Russia are subject to transfer pricing rules. The transfer pricing rules are mainly based on the arm's-length principle established by the Organisation for Economic Co-operation and Development (OECD) transfer pricing guidelines and apply to controlled transactions since 1 January 2012.
Controlled transactions include:
- cross-border transactions with affiliates (related parties) exceeding a certain threshold;
- transactions with independent companies located in certain jurisdictions from the black list of the Russian Ministry of Finance;
- foreign trade transactions involving certain exchange trade goods (for example, oil, metals and commodities);
- transactions with domestic affiliates if one of the parties enjoys certain beneficial tax regimes (e.g, residents of special economic zones) and the annual transaction amount exceeds 1 billion roubles; and
- transactions between members of a consolidated group of taxpayers (provided that the transaction does not involve extracted mineral products) are also exempt from transfer pricing control.
iii Indirect taxes
Corporate taxpayers in Russia are subject to VAT. No special VAT registration applies. There is no sales tax in Russia. Excise taxes may apply depending on the type of activity performed (e.g., sale of alcohol products, tobacco). Starting from 2019, the VAT tax rate has increased from 18 per cent to 20 per cent.
There are also reduced VAT rates of 10 per cent and zero per cent in relation to certain kinds of operations. Sometimes a computed tax rate should be applied (with respect to the VAT amounts withheld and paid by tax agents).
Generally, input VAT is offset against output VAT. Tax authorities would often scrutinise the grounds for the VAT offset and may deny it based on, for example, the lack of required documentation, employment of various tax avoidance schemes (such as using 'shell company' providers).
VAT is also payable by non-resident business vehicles for the supply of goods, works or services in Russia. Generally, the supply of goods is subject to Russian VAT where the place of supply is Russia. The place of supply is deemed to be located in Russia if:
- the goods at the beginning of their shipment are located in Russia or other territories under its jurisdiction; or
- the goods are located in Russia at the moment of their sale and are not further shipped.
Works and services are usually subject to the Russian VAT based on the place-of-supply rules (a diversified list of exemptions is available). There is a list of services that are deemed to be supplied in the jurisdiction of a customer and, therefore, cannot be subject to Russian VAT with the foreign customer (for example, consulting, marketing and advertising). Where a non-resident business is not registered in Russia for tax purposes, the tax is paid by the Russian entity under the reverse-charge method.
Special rules apply to foreign companies dealing in e-commerce. Specifically, electronic services provided by foreign companies to Russian customers are subject to Russian VAT.
International developments and local responses
i OECD-G20 BEPS initiative
In 2017, Russia joined the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS developed under BEPS Action 15.
The first round of automatic exchange of financial account information took place in Autumn 2018.
Russia is also implementing the transfer pricing documentation requirements developed as part of BEPS Action 13, including the master file, local file and CbC report.
ii Tax treaties
Russia has an extended network of bilateral tax treaties (with approximately 82 jurisdictions).
In some of the treaties there are 'limitation on benefits' provisions. In addition, by joining the Multilateral Convention Russia has agreed to introduce the 'principal purpose test', aimed at combating treaty-shopping, into most of its treaties.
Russian tax authorities and courts widely use a concept of unjustified tax benefits. It is a court-made doctrine that was first introduced in Resolution No. 53 of the Plenum of the Supreme Arbitrazh Court 'On Assessment by the Arbitrazh Courts of Justifications for Taxpayers Receiving Tax Benefits' dated 12 October 2006. It was further developed in substantial court practice.
In July 2017, new unjustified tax benefits rules were introduced into the Russian Tax Code. The rules apply to cases when the taxpayer misrepresents economic events in statutory and tax accounting, or performs transactions with the principal purpose of underpayment of tax or obtaining tax offset (refund), or where the obligations under a transaction were not actually performed by the counterparty or its subcontractor authorised by contract or by law.
The above rules are generally aimed at combating aggressive tax-planning schemes and shell companies.
Scrutiny towards outbound payments to foreign entities is a growing trend in Russia. Such payments are often disputed based on the grounds that the recipient has no beneficial ownership to such income. In this case, tax benefits under the applicable double tax treaties are denied. Tax authorities and courts also pay special attention to the economic substance of the outbound intercompany payments. If it is lacking, the payments to the foreign parent company may be reclassified into dividends and taxed in Russia.
Outlook and conclusions
Russia remains a challenging tax environment. Russian tax legislation is subject to active reforms that aim to, inter alia, reflect major international initiatives for tax transparency. Ongoing tax reforms include introduction and further enhancement of the CFC rules and amendments to the transfer pricing rules.
1 Sergey Kalinin is head of the tax practice and Olga Morozova is a senior associate at Egorov Puginsky Afanasiev & Partners. he information in this chapter was accurate as at April 2019.