The Ministry of Finance of Russia has recently issued a draft law on “Amending Parts one and Two of the Tax Code of the Russian Federation” pertaining to corporate tax on Controlled Foreign Companies and more effective tax administration of foreign organizations. The proposed draft law forms an integral part of Russia’s announced de-offshorisation plan.
The Draft Law introduces the following three concepts:
(a) Controlled foreign companies (CFC)
(b) Tax treatment of foreign companies based on tests of management and control
(c) Rules on taxation of the indirect disposal of Russian real estates
In regards to Controlled Foreign Companies, the proposed CFC rules provide that the scope of application of the Russian tax will be expanded in order to include Russian tax residents, either legal entities or individuals, that have in their corporate structure non-Russian Companies having their management and control in a “blacklisted” jurisdiction. The current list of blacklisted territories contains only offshore jurisdictions, however for the purposes of the proposed CFC rules the said list may be expanded so as to include jurisdictions with which Russia has a double tax treaty, possibly meaning popular European jurisdictions. There have been whispers that Cyprus might be included in the list, however Moscow has not yet made any official announcement on the matter.
Effectively, the proposed CFC rules provide that if there is “control” in relation to a CFC or at least 1% direct or indirect equity participation in a company registered in a Blacklisted country, a notification has to be submitted to the Russian tax authorities informing thereof and, if there is “control” or over 10% direct or indirect equity participation in such company, Russian tax has to be annually paid on the full amount of the CFC’s undistributed profits in proportion to the participation share (20% corporate tax or 13% personal income tax). What the proposed rules essentially mean by that is that tax shall now be paid even if the said profit is not distributed directly to the Russian taxpayers and is not remitted to a Russian bank account.
The Draft Law defines a CFC as a foreign company which meets all the following conditions during any period which begins or ends during a calendar year:
• a company is not a tax resident pursuant to the Tax Code or the applicable tax treaty;
• a company is resident in a jurisdiction included in the list of territories offering beneficial taxation of income (the List), which will be approved by the Ministry of Finance;
• a company is controlled by tax residents (legal entities and/or individuals) according to the Tax Code; and
• a company is not listed and/or admitted to trading on one or more stock exchanges included in a list approved by the Central Bank of Russia in consultation with the Ministry of Finance.
Very importantly, the term “control” is further expanded, under the draft CFC rules, so as to include not only profit distributions by virtue of direct or indirect equity participation but also distributions pursuant to participation in an agreement on management of structures or “other specifics of relations”. Therefore, the new rules will be also triggered in cases of shell “paper” companies or “paper” structures usually employed to conceal the true nature of the ultimate beneficial owner.
Failure to abide by the new regulations may lead to considerable sanctions with even criminal repercussions. Notably, the regulations provide for a penalty of RUB 100,000 for failing to notify the authorities, RUB 100,000 for refusing to grant the requested information to the Russian tax authorities and 20% (not less than RUB 100,000) of the entire profit, not of the unpaid tax, for any failure to pay the tax.
The Draft Law makes clear though, that the CFC rules will not apply in case a non-Russian company voluntarily deems itself to be a Russian tax resident and thereupon pay all respective taxes.
Another significant provision of the Draft Legislation regards the definition of Russian legal entities which is extended for tax purposes to incorporate foreign legal entities which have Russia as a place of actual management and control as well as to foreign legal entities which are considered as Russian tax residents under any international tax agreement. More particularly, the proposal defines “management and control” as the determining factor in acknowledging the Russian tax liability of a company.
As also stated above, the proposed rules introduce amendments on the taxation of indirect disposal of Russian real estate. Specifically, it is noted that a disposal of shares by a foreign company which are held either in the capital of a foreign or a Russian company, whose assets consist directly or indirectly of more than 50% of real estate situated in Russia, shall be subject to corporate income tax in Russia. This amendment is clearly purporting to stand as a burden in the extensive use of foreign structures, i.e offshore companies, collective investment structures, wealth planning structures and many more, in the sale and purchase of real estates situated in Russia.
Despite the rising concerns (and even alarm) amongst many Russian Companies and/or High Net Worth Individuals, the introduction of CFC rules is a matter which will require careful examination by an experienced international tax professional. In the constantly changing world of international tax planning, advanced planning is the key. As such current structures should be reviewed in order to assess possible solutions.
Asides from specific structuring another very important issue to be considered is that of substance, where a commercial purpose must be present. Additional substance assists in proving that a commercial/business purpose exists. For this reason, merely satisfying the management and control test required by the Cypriot Tax Authorities may not be enough for the purpose of the Russian Tax Authorities. Again an experienced professional can asses and provide recommendations on whether your entity is substance proof. Each structure is unique and thus each should be reviewed on a case by case basis.
Finally, please keep in mind that the proposed changes are not expected to take effect at any time earlier than the 1st of January 2015. The Draft Legislation is at the time undergoing a public discussion. Until the time of its implementation, its current version may be significantly altered.
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