President has signed Deoffshorisation Law. A summary of new rules.
November 2014 / Issue No. 40
One of the most discussed legislative initiatives of 2014 has become a law . We previously highlighted the amendments to this draft law after each of its readings in the State Duma. Now we provide a summary of new rules to be applied starting from 2015.
Please note that lawmakers may amend the law in effect and, thus, we do not rule out the possibility that the rules will be reshaped in 2015 and afterwards.
The Controlled Foreign Company (CFC) rules introduce Russian taxation of profits of foreign companies and non-corporate structures (including trusts) controlled by Russian tax residents (controlling parties).
In particular, a controlling party of a CFC shall mean an individual or legal entity with a direct or indirect interest in the CFC (for individuals — jointly with spouses and minor children):
over 25%; over 10%, if total participatory interest of all
Russian tax residents in the CFC is over 50%. 2015 will be a transition period, during which a higher
participatory share threshold of 50% will be applied.
Profits of certain CFCs will not be taxed in Russia, while the obligation to provide respective notification will remain in place.
For example: a CFC is permanently domiciled in a “good” jurisdiction (treaty country except for those countries that do not exchange tax information with Russia) and EITHER has an effective tax rate of at least 3/4 of average weighted Russian tax rate  OR the CFC’s income from passive operations amount to not more than 20% of its income.
The list of exceptions is quite big  but it does not include public companies.
A controlling party must submit to the tax authorities documents certifying compliance with the conditions, under which CFC income is not taxable in Russia.
CFC income will be subject to a 20% rate if the CFC is controlled by a legal entity and a rate of 13% if it is controlled by an individual. The profit amount can be reduced by the dividends paid out of the CFC’s profits (certain specific aspects should be taken into account).
Russian tax will be imposed only on the profits of CFCs determined in periods starting in 2015. Such profit will be declared for the first time by Russian legal entities on 28 March 2017 in their corporate income tax returns for 2016 (individuals, respectively, will declare CFC profits on 30 April 2017).
CFC profit is taxed in Russia if it exceeds the threshold of RUB 10 million (other thresholds will apply in the transition period: in 2015 – RUB 50 million; in 2016 – RUB 30 million).
Profits of a CFC taxed in Russia shall be determined on the basis of financial statements prepared in accordance with its personal law (on the condition that said financial statements are subject to mandatory audit under the CFC’s personal law and that the company is permanently domiciled in a treaty country) or under Russian Tax Code (Chapter 25) rules in other cases .
A fine for underpayment of CFC tax is set at 20% of the underpaid tax amount, but not less than RUB
100,000. Fines shall not be charged in respect of CFC profits of 2015, 2016, 2017.
The law sets special rules for accounting for CFC losses, and also allows for credit of tax paid by CFC under foreign or Russian laws (including tax paid by permanent establishment of CFC in Russia).
Moreover, the law permits to deduct profits of the CFC already accounted for by other Russian controlling parties in case of indirect participation in CFC (with regard to participatory interest).
A tax relief is proposed for groups, which will decide to liquidate foreign structures falling under the CFC rules. Income in a form of property received by Russian shareholders will not be taxed, while the tax base of such property will be determined as its book value under accounting data of the liquidated company (but not more than its market value or the actually paid cost of shares (participatory interest) in the liquidated CFC (the smallest out of 3 values should be taken). These provisions shall remain in effect until 1 January 2017.
If, before its liquidation, a CFC sells its securities and property rights to a Russian controlling party (or its affiliated company), the respective CFC’s taxable profit in Russia will amount to zero (on the condition that the liquidation procedure is over by 1 January 2017). The controlling party will accept such securities and property rights in accordance with the CFC’s accounting data, although not higher than at their market value.
Thus, the CFC will “transfer” the tax base of its assets to a Russian controlling party and no income will be taxable in Russia. Russian parties still have time to consider whether it is reasonable to apply the restructuring mechanisms set up by lawmakers.
Taxpayers will have to file several types of notifications to the tax authorities, including:
- notification on participation in foreign companies (if direct or indirect participatory interest is above 10%), as well as on incorporation of foreign non-corporate structures or on control over such structures (certain specific aspects should be taken into account here). The fine for failure to provide this information or provision of misstated information is RUB 50,000.
- Notification on CFC (the fine for a failure to provide information or provision of misstated information is RUB 100,000 for each CFC).Foreign companies and structures owning taxable property in Russia (this generally concerns real property in Russia) will have to report on their participants (founders, beneficiaries, managing parties, etc.). Failure to provide this information will entail a fine equal to 100% of the property tax assessed on the real property owned by such foreign company.
We recommend that you now assess the resources required for complying with the new requirements for notifications, as well as for collecting documents (if any)
certifying that the profits of controlled companies should not be taxed under CFC rules, and for recalculating CFC profits in accordance with the rules set in Chapter 25 of the Russian Tax Code (if applicable).
Tax residency rules
Residency rules for legal entities will change. Starting from 2015, foreign organisations managed from Russia can be recognised as Russian tax residents. Russian tax residency means that the worldwide income of such companies will be taxed in Russia.
The new rules set three basic and three additional criteria for determining place of management (among other things, they determine the place where the majority of meetings of the board of directors takes place) . There is some uncertainty as to how these criteria will be applied.
The new rules specify situations that do not affect the residency status (e.g., preparation of consolidated financial statements in Russia). Nevertheless, when assessing the risk of a company being deemed as a Russian tax resident, we recommend that you evaluate all facts and circumstances, even if formally the activities exercised in Russia attributes to such exemptions.
The rules also specify situations when a company may be deemed a Russian tax resident only on a voluntary basis (e.g., when a company is permanently domiciled in a treaty country (and is a tax resident there under the DTT) or if a company is a foreign holding and complies with certain conditions). It is still unclear how the tax authorities will interpret these standards in practice.
Tax residency of individuals will continue to depend on the number of days of their stay in Russia (more or less than 183 days).
“Beneficial ownership” concept
The ability to apply lower tax rates under a DTT will depend on whether an entity receiving income is the beneficial owner of such income (i.e. whether it has the right to determine its future economic use).
To answer this question, the entity’s functions, powers, assumed risks and fact of transfer of income (fully or in part) to third entities are considered.
Nonetheless, lawmakers did not come up with a concise test of beneficial ownership, which means that Russian tax agents will not be entirely comfortable applying reduced tax rates on income paid abroad. When making any payments, they will have to consider the risk of additional tax and penalties to be paid at their own expense (please note that it is possible to charge tax to a tax agent as per the stance of the Supreme Arbitrazh Court (SAC) provided in the SAC Plenum Resolution No. 57 of 30 July 2013).
The law mentions a tax agent’s right to request a confirmation that a foreign organisation is a beneficial
owner of income (and we advise applying this right). At the same time this provision seems most disputable in the law because it deals with a right, rather than an obligation, it does not specify the format of such confirmation or sufficient actions that a tax agent should perform in order to avoid potential penalties for failure to withhold tax.
Please also note that, in its Letter No. 03-08-05/36499 of 24 July 2014, the Russian Finance Ministry provides sample documents that a tax agent may receive to confirm the identity of the beneficial ownership.
If the tax agent becomes aware of who is the real beneficial owner of income, the law allows for using a corresponding treaty with the country where this beneficial owner resides (for dividends, indirect interest is treated as direct interest).
If the beneficial owner is a Russian tax resident, the income paid is taxed under the Russian Tax Code rules (please note than zero tax rate on dividends is applied under additional conditions). In such cases, the tax authorities must be notified about the payments made.
Indirect sale of immovable property
All sales of Russian immovable property in a form of sale of shares of Russian and foreign companies owning such property, regardless of a number of ownership
levels, will be taxed. However, the law does not provide a specific mechanism for paying this tax in Russia. For example, in a situation when one foreign company sells shares of a second foreign company, which indirectly owns immovable property in Russia (a threshold of 50% of assets applies), to a third foreign company, the Russian tax on income received from sale must be paid, but the procedure of payment is not clear. However, one should not ignore corresponding tax risks because the tax authorities will become more aware of owners of Russian immovable property in light of 2 facts. First, the law requires disclosure of ownership chains. Second, Russia has ratified the Convention on Mutual Administrative Assistance in Tax Matters, which we discussed in October 2014 in our Tax Flash Report No. 33.
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The information contained in this flash report does not constitute professional advice. PwC is not responsible for any damages that may be incurred by any parties if their actions or failure to act were based on their reading of this flash report. For assistance with specific questions, we advise that you contact a PwC professional in the relevant line of service.
What does this mean for you?
2015 will start with a law signed by the President. We expect the current rules to be polished and better defined as they are rather complex and have not been tried in real-life situations with actual figures.
Should you require any assistance in assessing your tax burden or dealing with your deoffshorisation matters, VML’s experienced team would be happy to assist you.
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