On September 2, 2014 the Russian Ministry of Finance posted the third revision of the draft law on taxation of controlled foreign companies - CFCs (hereinafter the “Draft Law”) on its site.
Generally the approach to CFC taxation has not changed as compared to the wording posted on May 27, 2014 (as a general rule, the scope of the regulations shall cover all foreign companies controlled by Russian residents, i.e. not only the offshore companies from the so-called “black” list). However, certain provisions of the draft law have been reviewed for the taxpayers’ benefit. Thus, the interest in the capital to recognized control has been increased; a revenue threshold leading to a duty to pay taxes on CFC’s revenue; tax amnesty has been granted for the interim period: exemption from taxes has been granted for income arising from repatriation of the assets and capital to the Russian Federation and from tax liability with certain restrictions.
KEY PROVISIONS OF THE NEW REVISION
- A Russian tax resident shall be recognized as a controlling party should the threshold of his participation in a foreign company’s capital be 25% (earlier 10%). Where 50% of a foreign company’s capital is held by Russian tax residents, only a 10%-interest shall be required to recognize a party as a controlling one. An interim period shall be provided for until 2017: a Russian resident’s interest in the capital will need to exceed 50% for such a foreign company to be recognized as controlled.
- Taxpayers shall have to notify the tax authorities about interests held in the capital of any foreign companies, should such interest in the capital exceed 10%. Before 2017, a notice will need to be submitted only provided that the interest exceeds 25%. Notice on interest in a CFC shall be submitted no matter how large the interest is.
- CFC revenue shall be taxable where the aggregate amount of the annual revenue exceed RUB 10 million (earlier RUB 3 million). In 2015-2016, interim provisions shall be in force, under which the total amount of CFC’s annual revenue shall exceed RUB 50 million and 30 million respectively.
- Foreign companies and instrumentalities owning real property in the Russian Federation shall have to notify the Russian tax authorities about their participants.
- Starting from 2018, failure to pay taxes for CFC’s revenue shall be made liable for. Moreover, Russian companies shall be exempt from taxes on income in form of property resulting through winding-up of their foreign subsidiaries in order to facilitate repatriation of the capital and assets to the Russian Federation.
CONTROLLED FOREIGN COMPANIES
The rules provide for two types of entities that may be classified as controlled foreign companies (CFC), these are foreign legal entities as understood by the Russian Tax Code, and non-corporate entities, e.g. trusts, foundations, partnerships, associations.
A foreign company shall meet the following two criteria to be classified as a controlled company:
- a company shall not be a Russian tax resident;
- Russian tax residents (individuals or legal entities) shall be its controlling parties.
The following foreign companies shall not be classified as CFCs:
- public companies;
- non-profit organization that shall not distribute the revenues obtained between shareholders (participants, founders) or other parties as per their personal law;
- foreign entities registered as per the laws of the European Economic Council member states;
- banks and insurance companies acting pursuant to licenses and registered in the states put on the list of countries ensuring tax information exchange with the Russian Federation;
- foreign companies involved in projects under PSAs;
- foreign companies domiciled in the jurisdictions ensuring tax information exchange with the Russian Federation, should the effective tax rate applied for taxation of such company’s operation income exceed 75% of the Russian income tax rate (i.e. 15 %);
- non-corporate entities,
whose founder shall not be able to own the assets after such trust has been established;
whose founder shall not get any direct or indirect income from such entity;
where the founder's rights related to his/her personal status may not be transferred to a third party, unless by way of inheritance or universal legal succession.
The criteria shall be met simultaneously. An entity shall be excluded from CFCs until it is capable to distribute income in favour of the founders or beneficiaries.
- Foreign SPVs established to place Eurobonds, and namely foreign companies
issuing marketable bonds; or
authorized to earn interest payable under marketable bonds; or
having obtained rights and obligations under the marketable bonds issued by another foreign company (provided that certain criteria have been met).
An individual / legal entity shall be a controlling party if they exercise control over a foreign company or entity for their benefit or for that of their affiliated persons jointly or individually. Exercise of control shall mean exercise of influence, or an ability to exercise decisive influence on decisions of a foreign company or a person managing entity’s assets on distribution of revenues.
Within the interim period (until 2017) a direct / indirect interest in a foreign company's capital calculated together with those of the affiliated persons shall exceed 50% to recognize control.
After 2017, this share shall exceed 25%. However, control may be recognized where the interest accounts for 10% provided only that in aggregate the Russian tax residents hold 50% in such foreign company's capital.
DUTY OF NOTIFICATION
- All Russian tax residents shall notify the tax authorities:
- about participation in a Russian company, where the interest in its capital exceeds 10% (the rules shall not apply to participation in associations and limited liability companies);
- about participation in a foreign company, where the direct or indirect interest in its capital exceeds 10% (interim provisions shall be in force until 2017, whereunder a notice shall be sent should the interest exceed 25%);
- about participation in a controlled foreign company.
Starting from 2018, failure to notify about participation in a foreign company shall be subject to a penalty amounting to RUB 50 thousand, an equivalent violation with regard to a CFC shall be subject to a penalty amounting to RUB thousand.
In 2015-2017, no penalties shall be applied.
TAXATION OF CFCs’ REVENUE
In Russia CFC's revenue shall be taxable (PIT/income tax) with its controlling individual or legal entity, a Russian tax resident.
Revenues shall ne determined as per Section 25 of the Russian Tax Code (corporate income tax). The tax base shall be calculated separately from a resident’s income from other activities. The revenue amount shall be documented with CFC's financial statements and an auditor's report (where auditing of statements in mandatory).
CFC's revenue shall be taxable in the Russian Federation should its aggregate annual amount exceed RUB 10 million. A higher limit shall be provided for 2015-2016: the annual revenue amount shall exceed RUB 50 million and 30 million respectively.
TAX RESIDENCE FOR LEGAL ENTITIES
The Draft Law shall introduce a concept of tax residence for legal entities. Foreign companies shall be recognized Russian tax residents where such companies are effectively managed from the Russian Federation. The main criteria to identify the place of effective management are:
- more than half of BoD and/or another governing body meetings in a year being held in the Russian Federation;
- governing management being mostly exercised from the Russian Federation;
- the chief (governing) officers mostly exercising their activities with regard to a relevant foreign company in the Russian Federation.
The Draft Law shall provide for additional criteria to be applied where the above conditions are met for two states at a time.
CONCEPT OF A BENEFICIARY OWNER
The new rules shall introduce a concept of an actual / beneficiary income owner, i.e. a person entitled to individually use or dispose of, the income. However, the rules shall also introduce restrictions on, or denial of a right to benefits provided for by the international treaties on avoidance of double taxation (exemption or a reduced tax rate), where an income owner is not its actual / beneficiary owner.
Where an income recipient is not its beneficiary owner and in this regard shall not be entitled to benefits, the next one in the chain of income recipient may be eligible to benefits (should there be an agreement between Russia and the jurisdiction such party is domiciled in). If the final effective owner of dividend income is a Russian tax citizen receiving income through a chain of participation in foreign legal entities, the national tax rates, of which 0%, may be applied if additional criteria are met.
REAL PROPERTY AND DEALINGS IN STOCKS / SHARES THEREIN
The Draft Law shall provide for the new taxation rules for foreign companies’ income from sales of stock / shares in Russian companies whose more than 50% of assets are real property in the Russian Federation.
The new rule shall cover incomes from sales of fractional shares in companies (including the foreign ones) that directly or indirectly hold real property in the Russian Federation, as well as incomes from financial derivatives of such shares and fractional shares (except where shares are marketable on a regulated market). Please note that as of now only income from sales of shares in Russian companies shall be taxable in Russia. Thus, the scope of the new rule shall be substantially extended.
Exceptions have been provided for
- dealings in securities at foreign exchanges;
- dealings in securities of companies and entities being collective investment instruments (the number of investors shall be at least 50, each of them holding at most 5% of the capital);
- non-speculative sales (5-year antiquity test).
Besides, the Draft Law provides for an exception for this income type, under which all passive transactions shall be taxable through withholding at source. It is clear that in this case taxation shall be as per the standard procedure, i.e. through filing of a tax return and tax payment by the seller. However, it is unclear how this will be implemented where the seller of shares / fractional shares has not been registered in the Russian Federation, such persons do not have to file tax declarations.
The Federation Council’s Committee for Budget and Financial Markets has drafted amendments to the current provisions of Article 199 of the Russian Criminal Law “Corporate Tax and Duty Evasion”. The draft amendments have been submitted to the State Duma on September 8, 2014.
The senators suggest setting an additional qualifying crime attribute, i.e. commission of an offence involving non-disclosure or distortion of information with regard to controlled foreign companies and controlled transactions.
It should be noted that failure to pay taxes for incomes accumulated with CFC shall be covered by the provisions of Art. 199 of the Russian Criminal Code as amended.
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At this stage we would recommend to assess the existing foreign corporate instrumentalities as to the new taxation rules being applied to them, to the need to alter them, and namely to transfer to Russia or other jurisdictions.
We believe the amendments will be updated again. We will follow up on the Draft Law's passing through all legislative stages and keep you updated on all developments.
In all cases we will be glad to discuss the effect of the said amendments for your business.
 The previsious revisions were published on March 18, 2014 and May 27, 2014 respectively.