On 18 March, 2014 the Russian Ministry of Finance has made available for public discussion the draft law on taxation of undistributed profits of controlled foreign companies (CFC), residency criteria for companies, and taxation of indirect transfer of ownership in real estate located in Russia (through the sale of shares of companies more than 50% of whose assets directly or indirectly consist of real property located in Russia). The full text of the draft law can be found at the following link: http://www.minfin.ru/common/upload/library/2014/03/main/KIK_2014-03-18.docx.
Below is a brief overview of major provisions of the proposed measures:
Pursuant to draft CFC rules Russian tax residents (legal entities and individuals) will be obligated to pay Russian corporate profits tax (CPT) on the attributed CFC profits at a rate of 20% or personal income tax (PIT) at a rate of 13% accordingly.
- CFC is a foreign company or an entity (fund, partnership or any other form of collective investment vehicle) that is resident in one of the jurisdictions from the “black list” of the Ministry of Finance (with the exception of a company whose shares are traded on a qualifying foreign stock exchange);
Based on the current version of that provision of the draft law we cannot explicitly conclude that the above “black list” of jurisdictions is the list adopted by the Order of the Ministry of Finance No. 108n, which in particular does not include Cyprus and Luxembourg. Recently in a number of interviews representatives of the Ministry of Finance stated that for the purposes of application of CFC rules a new “black list” of states and territories providing for favorable tax regime may be drafted, which list may potentially include Cyprus and Luxembourg.
- Taxpayers who are deemed to control CFCs are those Russian tax residents (individuals and legal entities) who exercise control over the CFC (main influence on decisions of the CFC with regard to distribution of its profits) and, in particular, who directly or indirectly hold more than 10% of the capital in the CFC;
- Income of a CFC includes undistributed income computed in accordance with the RF Tax Code in relation to all activities of a CFC (active or passive). The income of the CFC is apportioned pro-rata and attributed to a Russian taxpayer.
Current rules do not provide for the possibility of reducing the resulting Russian tax liability by a credit for any foreign tax paid by the CFC in a foreign jurisdiction, which may increase the tax burden for the Russian taxpayers.
The draft law also introduces additional compliance obligations for Russian tax residents (individuals and legal entities) such as a regular notification of the Russian tax authorities about all CFCs as well as about participation in foreign companies registered in “blacklisted” jurisdictions where such direct or indirect participation in the capital exceeds 1%.
The draft law stipulates substantial penalties for underpayment (in full or in part) of tax on attributed income of the CFC (fivefold and sevenfold increase of penalties for companies and individuals respectively).
Foreign legal entities effectively managed from Russia would be treated as taxpayers (i.e. tax residents) in Russia. In accordance with the proposed rules a legal entity would be deemed to be effectively managed in Russia if one of the following criteria is satisfied:
- meetings of the board of directors (or another management body of the legal entity) are held in Russia;
- steering management of the legal entity is performed from Russia;
- top managers of the legal entity perform their activities in Russia;
- bookkeeping is performed in Russia;
- archives of the legal entity are stored in Russia.
The proposed provision does not define the term “steering management” and does not specify the nature of activities of the top management in Russia that could potentially give rise to Russian tax residency of a foreign legal entity; such lack of clarity could lead to different interpretations by the tax authorities. For example, in different jurisdictions management resulting in a tax residency could mean day-to-day management (e.g. Switzerland) or strategic management/key decision making (e.g. the United Kingdom).
- In accordance with the draft law companies deriving capital gains from alienation of shares in Russian and foreign companies more than 50% of whose assets directly or indirectly consist of real property located in Russia should be subject to withholding tax in Russia at a rate of 20%
However, currently the draft law does not specify a mechanism for the payment of tax if the share purchase agreement is concluded between foreign companies. It is also necessary to take into account the provisions of the effective double tax treaties that may provide an exemption from taxation of capital gains in Russia (for instance, the Russia-Cyprus DTT).
Currently the draft law is undergoing a public discussion and, therefore, its current version is not final. As of today, there is no information when the draft law will be submitted to the State Duma of the Federal Assembly of Russia.
We advise that our clients undertake the following actions:
- Analyse existing foreign companies and entities and estimate the potential tax effect from enactment of the law
- Assess additional costs associated with compliance with new CFC rules, such as collection of documents from CFCs, translation of such documents into Russian, compilation and audit of financial statements, computation of the tax base in accordance with Russian tax rules etc.
- Determine how the current holding structure can be modified in order to mitigate the effect from introduction of the contemplated measures.
We will be glad to keep you informed regarding the latest news on legislative initiatives on deoffshorization (including the status of the draft law).