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Russia toughens up on Controlled Foreign Corporations
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Russia toughens up on Controlled Foreign Corporations

New amendments to the Tax Code of the Russian Federation in late 2014 have tightened the screws on Controlled Foreign Corporations (CFC). In the government’s drive for comprehensive business de-offshorisation, business owners with Russian citizenship will be forced to disclose their foreign assets and CFCs will no longer enjoy double tax treaty benefits for revenue earned abroad.

In particular, the move targets Russia’s most successful entrepreneurs, many of whom own assets through organisations registered abroad. A large number of these companies fall under the jurisdiction of controlled foreign corporations via Russian ownership and/or managmement.

A new definition of CFC

To fall into the category of CFC, the corporation is a non-Russian tax resident and the controlling entity of the business is one or more Russian tax resident. The definition has been stretched to include pass-through entities that generate income such as collective investment vehicles, trusts, partnerships and funds.

A controlling entity is defined as any organisation or private individual (along with his/her spouse and children) with ownership interests totalling 50% or more of a company. From 2016 onwards the ownership threshold has been reduced to 25% and even 10% for foreign coporations where multiple Russian tax residents have total ownership interests exceeding 50% of the company.

“Even when an individual’s share in the CFC is lower than the threshold, they could still be recognised as a controlling entity if they exercise direct control over a foreign company for personal benefit or that of their spouse or children,” said Tranio lawyer Ekaterina Shabalina.

Multiple definitions of tax residence

The Russian authorities have extended tax definitions:

  1. A private individual is a resident:
    • for any stay of 183 days or more during 12 consecutive months according to Part II, Article 207 of the Tax Code of the Russian Federation;
    • if their permanent home or centre of vital interests is located in Russia according to the Letter by the Federal Tax Service ОА-3-17/87 dated 16 January 2015.

    In either case, the individual is considered a tax resident even if they are abroad for 183 days or more out of the year. According to Russian law, permanent residence is defined as fully-owned residential property and the individual’s registration to that address. A centre of vital interest is considered to be family, main business or place of work.

  2. A legal entity is a resident if:
    • the foreign company is registered in the Russian Federation (in accordance with international tax agreements);
    • the “place of effective management” of the foreign company is located within the Russian Federation.

    The place of management is determined according to main and additional criteria specified in Article 246–2 of the Russian Federation Tax Code,” Miss Shabalina explained.

New tax rules

  1. Lower thresholds

    In 2015 profit exceeding RUB 50 million of the controlling entity’s declared revenue is taxable according the CFC law. Starting next year, the threshold will be progressively lowered to include more and more businesses owned by Russians or managed in Russia. In 2016 the minimum threshold will drop to RUB 30 million and RUB 10 million from 2017 onwards. Corporate tax in Russia is 20% and income tax is 13%.

  2. Taxable income

    The CFC law covers most forms of active and passive income:

    • dividends (excluding those paid by Russian companies to the controlling entity if they are a beneficial owner);
    • profit or asset redistribution including dissolution of a company;
    • interest on debt obligations;
    • intellectual property rights;
    • sale of stock/shares or transfer of rights to a foreign company that is not a legal entity;
    • futures trading;
    • sale of property;
    • leasing operations including lease or sublease of property, except for vehicles or shipping containers used for international transportation;
    • sale of shares in mutual investment funds;
    • consultancy services including legal, accounting, staffing, auditing, engineering, advertising, marketing and data processing services;
    • scientific research and development engineering.

Non-taxable profit options and risks

The CFC will be exempt from tax if their passive income does not exceed 20% of the total revenue.

There are some legal ways to protect profits against taxation but they are not without risk.

  1. Ceasing to be a resident of RF

    If tax residency is relinquished, the controlling entity:

    • may be recognised as a resident in another country with a tougher tax regime;
    • will have a heavier tax burden in RF: 30% for income from dividends for private individuals and 15% instead of 0% or 13% for legal entities;
    • forfeits tax exemptions: capital gains will be charged on the sale of property after three years’ ownership; property acquisition expenses can’t be deducted.
  2. Transferring the company to a trust

    If the controlling entity hands over the company to a trust. However, this arrangement has its own risks:

    • no right to income from asset management or assets from the liquidated company;
    • no control over the trust company, otherwise CFC rules apply;
    • risk of mismanagement by trust company;
    • settlor and beneficial owner information still disclosed to tax authorities.
  3. Participating in CFCs via Russian public companies

    The public company, not its founder, will be recognised as the controlling entity.

Exemptions

Despite the broad definitions and far-reaching rules, some companies are exempt:

  • nonprofit organisations;
  • companies incorporated and located in the Eurasian Economic Union (EEU);
  • legal entities with foreign taxes exceeding 75% of the weighted average corporate tax in the Russian Federation (if the country of incorporation has a treaty banning double taxation with Russia);
  • foreign companies, holdings and subholdings generating active revenue (revenue from real estate leasing and selling is not considered as active);
  • banks;
  • insurance companies;
  • companies participating in the extraction of commercial minerals under agreements with foreign countries or territories;
  • companies with activities related to bond yields including issuers of marketable bonds, companies earning interest from marketable bonds, entities with rights and obligations on marketable bonds issued by another foreign company;
  • operators, direct shareholders or members of the new marine raw hydrocarbon deposits.

Liability for breaching regulations

Violations of the CFC Rules will be punished if the involvement of a foreign company in a CFC is not disclosed in a timely manner or if the information provided proves insufficient or untrue. Concurrently, CFCs will be held liable for overdue taxes or undeclared revenue.

Violation Liability Laws describing the liability
Tax resident of RF doesn’t file the notification of participation in a foreign company before 15 June 2015. Fine: RUB 50,000 Part II, Article 129.6 of the Tax Code of the Russian Federation.
Controlling entity acquired shares in a foreign company OR its total shares changed before 15 June 2015 and hasn’t notified tax authorities within one month OR the information provided was wrong. Fine: RUB 50,000 Part II, Article 129.6 of the Tax Code of the Russian Federation.
Notification provided after 20 March of the next year, (in the new tax year) after the notification should have been submitted OR the information provided was wrong. Fine: RUB 100,000 Section 7, Article 6.1; paragraph 2, Section 3, Article 25.14 of the Tax Code of the Russian Federation; Part II, Article 4 of the Federal Law 376-FZ of 24 November 2014.
2015–2017: controlling entity fails to pay CFC taxes in full or at all. Fine of RUB 100,000–500,000 OR 1–3 years income OR Prison sentence from 4 months to 6 years* Article 198 (for individuals) or 199 (for companies) of the Criminal Code of the Russian Federation.
From 2018: controlling entity fails to pay CFC taxes in full or at all. Fine of RUB 100,000–500,000 OR Fine of 1–3 years income OR prison sentence from 4 months to 6 years. Article 198 (for individuals) or 199 (for companies) of the Criminal Code of the Russian Federation.
Fine: 20% of unpaid tax but not less than 100,000 rubles. Article 129.5 of The Tax Code of the Russian Federation.
* For unpaid taxes amounting to RUB 600,000 for individual or RUB 2 million for companies earned over three financial years.

Consequences of the CFC legislation

Stronger CFC laws will face Russian entrepreneurs with some tough decisions. The sweeping definitions allow tax authorities to pursue any individual residing abroad and earning revenue off business activities. Not only that, it also opens a new floodgate: the scrutiny of family members. Concurrently, foreign companies with operations on Russian soil will also have to navigate the new CFC laws. With the Russian ruble stagnating at all-time low and high capital flight, this move may simply encourage more foreign companies to exit the market. The law comes into effect during an all-time low in international relations and Russia’s progressive withdrawal from the global economy.

Tax authorities will undoubtedly ask controlling entities to disclose information ther sources of income and transactions from the previous years. Moreover, these new rules leave little room for creative cross-border accounting of revenue for successful Russian citizens and companies. It would be wise to seek well-informed advice as the controls tighten and overheads no doubt increase. In any case, any company or individual who may meet the criteria of a controlling entity in the future would do well to monitor the situation as further changes and clarifications are expected in 2016.

Yulia Kozhevnikova, Tranio

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