investmentGATEWAY

Federal Law No.630365-6 Concerning the Introduction of Amendments to Parts One and Two of the Tax Code of the Russian Federation (Regarding the Taxation of the Profit of Controlled Foreign Companies and the Income of Foreign Organizations) (the Law) was approved on the 18thof November after its submission to the lower chamber of the Russian Parliament, State Duma.

The law was approved at the second and third hearings by State Duma which concluded that the law’s current wording is final. It is expected for the law to be passed by the upper chamber of the Russian Parliament, the Federation Council, by the 21^st of November 2014 and come into force on the 1^st of January 2015. It is presumed that the law will be officially published on the 1^st of December 2014 at the latest, after being signed as a law by President Vladimir Putin.

“Deoffshorisation”

A lot has taken place since the Russian President Vladimir Putin had called for the deoffshorization of the Russian economy in order to repatriate capital being channelled in offshore jurisdictions and to combat tax avoidance.

The Draft Law on Deoffshorization was initially made available for public discussion on the 18^th of March 2014 and the floodgates had opened. Since then, extensive discussions between the business community and governmental bodies have taken place both in Russia and abroad as this new Law is expected to significantly affect foreign jurisdictions as well. After a prolonged emotional rollercoaster caused by the various revisions of the initial text, the Draft Law was submitted to the State Duma and it was adopted on the 18^th of November 2014 in the second and third readings.

The Law focuses on four significant areas:

Controlled Foreign Companies (“CFC”)

The Law establishes a mechanism for the taxation in Russia of income of CFCs, in the case where such companies do not distribute their income to the benefit of Russian entities, controlling such companies. Thus, as per the Law adopted, the definition of a CFC refers to companies that are not tax residents of Russia and are controlled by individuals or legal entities that are Russian tax residents.

Control over the CFC shall be determined both by the ability of the controlling persons to exert influence on the decisions of the CFC with regards to the distribution of its profits and by their level of participation in the authorized capital of the company, of more than 25%. Also, in the case where the overall share of Russian tax residents in the company is more that 50%, then the level of participation in the company in order to determine a controlling person shall be reduced to 10%. It is important to note that the transition period which was previously set from 1 January 2015 until the end of 2017 has now been reduced. As such, a level of participation of 50% shall apply for the purposes of determining a controlling person up to the end of the year 2016.

The Law also defines the foreign companies that shall fall outside the scope of the legislation and their profits will be exempt from taxation in Russia:

• Non-profit organizations that cannot distribute their profits to the shareholders;

• Companies from the Eurasian Economic Union;

• Banks and insurance institutions operating in States that have recently concluded International Tax Treaties and have agreed to exchange information with Russia;

• Companies located in States that have recently concluded International Tax Treaties and have agreed to exchange information with Russia and their effective tax rate is not less than 75% of the tax rate in Russia;

• Companies located in States that have recently concluded International Tax Treaties and have agreed to exchange information with Russia and at least 80% of their income arises from active operating activities;

• Issuers of certain traded bonds (i.e. Eurobonds) if the interest income of such bonds is not less than 90% of the issuer’s total income;

• Foreign structures without a legal entity (under certain conditions) on the basis that the structure does not have the option to distribute profit as per its own law and its constituent documents;

• Foreign companies that are involved in certain industrial projects (i.e. under agreements with the foreign governments) resulting in income of not less than 90% of their total income;

Beneficial Ownership

The concept of “Beneficial Owner” is analysed in the Law as a means of preventing the abusive use of Double Tax Treaties for the sole purpose of taking advantage of favourable treaty provisions (reduced on nil withholding tax rates). As per the Law, the Beneficial Owner is the person who has the actual right to receive that income and bears the risks. It therefore stipulates that treaty benefits shall be used if Russian sourced income is paid to a foreign resident that is not the beneficial owner of said income under the condition that the tax authorities of the Source State are notified accordingly.

Tax Residency

In accordance to the provisions of the Law the tax residency of a foreign legal entity shall be determined on the basis of the place of effective management test. If the criteria set out below are met, the Russian tax authorities will have ground to characterize the foreign entity as Russian tax resident:

• The majority of the meetings of directors take place in Russia

• The executive management of the organization is primarily exercised from Russia

• The chief executive officers of the organization (persons authorized with the responsibility for planning, directing and controlling the activities of the enterprise) exercise the activities from Russia

In the case where it is determined that a foreign entity is effectively managed and controlled in Russia, it will be deemed to be a Russian tax resident and shall be subject to Russian corporation tax.

Russian Real Estate

The Law further adds that income arising from the sale of shares in companies whose majority of assets (more than 50%) either directly or indirectly consist of immovable property located in Russia, shall be taxed in Russia (subject to conditions).

Notably, the Law also provides for an exemption in the case where property is transferred to a Russian company by a shareholder (legal entity or individual) holding an interest of more than 50% in the receiving company. However, if the transferring company is resident in a blacklisted foreign jurisdiction, the exemption shall not apply.

Concluding Remarks

This piece of legislation will be quite tough on Russian residents and will bring about a major change in the outbound Russian tax landscape. It is vital that taxpayers take a long look of their existing structures and determine how these new changes affect their businesses. The Law will soon become a reality and taxpayers must be aware of what consequences this shall bring upon their structures, as well as their new obligations in terms of reporting to the tax authorities.

We are in the midst of significant changes in the international tax landscape and there is a need to change our mentality in order to keep up with the new order of things. The incorporation of companies in foreign jurisdictions is not as simple as it used to be. Corporations should retain the services of experienced international tax consultants for new and existing structures.

At Eurofast we are able to provide you with all the necessary professional guidance for the reorganization of your corporate structure, stemming from our extensive experience with the CFC rules of various European countries.