Amendments to the special administrative region (SAR) regime. Part I: new benefits and new requirements

Pepeliaev Group advises that the regulation of the activities of the SAR residents have been amended[1]. A new law has been published that extends the list of tax benefits for international holding companies (“IHCs”) (Federal Law No. 66-FZ dated 26 March 2022). In addition, on 25 March 2022, Federal Law No. 18-FZ dated 25 February 2022 comes into force, which introduces additional requirements to apply tax benefits and provides for the possibility of obtaining the status of an ICH for Russian companies as well. We have considered the amendments proposed by these laws in aggregate and as completely interdependent.

The amendments being introduced, in our opinion, contain quite large-scale proposals for the residents of SARs. Among such proposals: the possibility of moving to a SAR for Russian companies, an increase in the use of preferential tax rates for IHCs, as well as a highly precise adjustment of the requirements for the possibility of obtaining the status of an IHC. Read about all this and more in our alert below.

1. Opening the SAR regime for Russian companies

The amendments provide that a Russian company may also become an IHC. The conditions for a Russian company to obtain this status are similar to those established for foreign companies:

  • the company was created before 1 March 2022 and at least 3 years have passed from the date of its creation to the date of the application;

  • there is a constant composition of the controlling persons from 1 March 2022 for one year after redomiciliation (except for inheritance); and

  • the company is registered in the territory of a SAR.

In addition, in order to acquire the status of an IHC, a Russian company must be ‘released’ from the region where it was previously registered: 6 months before submitting an application to acquire the status of an IHC, the company must notify the regional government of this. If its share of income tax in the budget of the constituent entity was more than 1% in any of the three previous years, then the regional government can send its objections to the registration of the company in the SAR to the management company on Russky Island or Oktyabrsky Island. 

Most likely, this new development was a response to the EU's statement about the ‘malicious’ SAR regime, as if it was closed to Russian companies. 

In our opinion, this regime could be interesting, for example, to Russian holding companies that have a stake in capital of less than 50% and most of their proceeds from passive activities, as well as to those Russian companies that own CFCs (their profit is not taxed until 2029 according to the provisions of article 25.13-1(1)(9) and article 251(1)(58) of the Russian Tax Code). 

2. New benefits for IHCs

1) 0% on dividends received and income from the sale of shares (membership interests)

To the existing conditions (ownership of at least 15% of the capital in the company paying the dividends for at least one year), new requirements have been added for the IHC to receive the rate of 0% on dividends received: actual presence, investment of at least RUB 300 million in the SAR, and other requirements established by the new article 284.10 of the Tax Code (see below). IHCs that became such before 25 February 2022 will be able to apply the benefit until the end of 2025 in its previous form (starting from 2026 these companies also must comply with the terms of article 284.10 of the Tax Code). For indirect ownership in a Russian company in the periods from 1 January 2021 to 31 December 2023 year, this rate is applied subject to compliance with the additional condition that dividends are credited to IHCs’ accounts within 180 calendar days from the date of their payment.

The possibilities for applying a 0% rate in the event of the sale or other disposal (including redemption) of shares (membership interests in the issued capital) of Russian or foreign companies received by the IHC have also been expanded. Now IHCs can apply a 0% rate when shares/membership interests are sold of Russian or foreign companies even if they were included in the issued capital of an IHC a year before or after the status of an IHC was obtained as a result of a reorganisation according to the provisions of its foreign law.

2) 5% on dividends, interest and royalties received by IHCs

Owing to the amendments, IHCs have the opportunity to apply a 5% tax rate on income generated in the form of dividends, interest and royalties - subject to the condition of compliance with article 284.10 of the Tax Code.

In other cases, the rate of income tax will still be 20%.

3) 10% withholding tax on paid dividends, interest and royalties

Before the amendments, only public IHCs could use the preferential tax rate (5%) for dividends paid.

Now an IHC will be able to apply a preferential rate of 10% tax at source on dividends, interest and/or royalties paid to a foreign person, provided that the IHC complies with article 284.10 of the Tax Code and that the recipient of income has the actual right to the income and is not ‘blacklisted’ by the Russian Ministry of Finance[1].

In other cases, the general rate of tax at source (15% on dividends, 20% on royalties and interest) will apply or double taxation treaties will apply. 

The provisions on preferential rates will apply to tax periods starting on 1 January 2023. The new preferential rates themselves (5% and 10%) are valid until 2036.

Therefore, on the one hand, new benefits have been introduced, but new restrictions have been introduced on their application (article 284.10 of the Tax Code). Moreover, these restrictions also apply to the ‘old’ benefit on dividends: the new IHCs are set in a stricter framework compared with existing residents, who will be able to apply a 0% rate on dividends according to the previous rules for another three years.  

3. Additional requirements for IHCs with regard to preferential tax rates

A new article 284.10 has been introduced into the Tax Code, which establishes new conditions for obtaining tax benefits for IHCs:

  • at least one controlling person of an IHC should be a Russian tax resident or a citizen of the Russian Federation;

  • the management and decision-making of an IHC should be carried out in Russia. The new law (adopted by the Russian State Duma on 22 March 2022) has already supplemented that this criterion is complied with if the following conditions are met at the same time: the work of the executive body, the board of directors and the general meeting of shareholders is carried out only in Russia; when making decisions, the general director is actually present in Russia; during each meeting of the Board of Directors and General Shareholders’ Meeting, the participants are actually present in Russia, the minutes of their meetings comply with the Russian legislation;

  • more than 90% of income is passive income, including income from the provision of services, the place of sale of which is Russia (article 148 of the Tax Code);

  • more than 70% of expenses for the purchase of goods, works, services are incurred in Russia (the place of sale is Russia);

  • at least 15 specialised employees are present on the company's staff (full employment, participate in the sale of the IHC’s services, tax residents of the Russian Federation, live in the constituent entity of the Russian Federation where the IHC is located);

  • the presence of an office with an area of at least 50 sq.m. owned or used within the SAR.;

  • investments in infrastructure (the construction or reconstruction of social and cultural, transport, energy, engineering facilities, housing and communal services) in the amount of RUB 300 million within 3 years.

In addition, article 284.10, which has not yet come into force, has already been supplemented with a new condition on the immutability of the composition of controlling persons: 75% of the controlling persons should be the same as they were as of 1 March 2022.

If the company ceases to meet the specified criteria, the right to the benefit is lost ‘retroactively’ and additional taxes and default interest are paid.  

As you can see, the legislator has established rather strict requirements for actual presence in the territory of the SAR (substance), aimed at ‘landing’ companies in Russia. This applies to both the physical and legal presence of management in the SAR. The IHC must conduct real economic activities characteristic of a holding company. Taking into account the requirement for the availability of personnel, with whose participation some active actions are still supposed to be carried out, the structure of passive income includes income from the provision of services, the place of sale of which is Russia, as defined for VAT purposes. In addition to difficulties with office space, businesses may have difficulties meeting investment requirements: not every investment is ‘counted’. Please note that the new rule on the amount of investments for obtaining a tax benefit does not cancel the existing ‘entrance’ ticket to the SAR (RUB 50 million to register an international company). 

4. Joint and several liability of contracting parties for non-payment of tax by an IHC

A new article 284.11 is introduced into the Tax Code, which establishes that the IHC and taxpayers generating income from it, or tax agents paying income to it, are jointly and severally liable for paying tax on such income.

It is clarified that the obligated person to pay the tax is primarily the IHC itself. And if the IHC, in the necessary cases (for example, the loss of the right to a preferential tax rate), has paid additional tax on both received and paid income, this obligation is fulfilled. 

At the same time, if, for example, it turns out that the IHC has unreasonably applied the 0% rate on dividends received, and it is impossible to collect tax from it for some reason (bankruptcy or lack of property), the tax can be collected from its member.  

5. Other changes

1) The grounds for the loss of IHC status are being clarified

According to the amendments, the status of an IHC will not be lost if, within one year from the date of obtaining the status of an IHC, a new controlling person appears as part of the controlling persons who have gained control over the IHC:

  • as a result of inheritance;

  • as a result of the reorganisation of the former controlling person (by separation, division or transformation);

  • if the new controlling person is recognised as a Russian tax resident; and

  • if the new controlling person is a Russian citizen. 

A similar position applies to Russian companies that apply to move to the SAR.

Additional criteria for the loss of IHC status are also being introduced:

  • a foreign person has not been excluded from the register of foreign legal entities in the state of registration within 6 months (or other period established by personal law);

  • in relation to a Russian company that moved to the SAR, changes will be entered into the Unified State Register of Legal Entities on the change of location to a territory outside the SAR.

2) Some types of income and expenses of an IHC will not be recognised for income tax purposes.

The amendments provide that the income and expenses of an IHC in the form of a positive exchange rate difference arising from the revaluation of property in the form of currency valuables (with the exception of securities denominated in foreign currency) and claims, the value of which is expressed in foreign currency, or at the markdown of liabilities, the value of which is expressed in foreign currency, are not taken into account when determining the tax income tax bases.

It is also provided that the income and expenses of the MHC from the implementation of foreign projects for the extraction of minerals (including geological studies and exploration) under PSAs, concession, license and other risk agreements/contracts are exempt from taxation.

3) Public IHCs are no longer tied to the need for shares to be traded on foreign stock exchanges of OECD member states

Now the provisions of article 24.2(4) of the Tax Code apply to IHCs in which the share of participation of public companies (direct or indirect) is 100%, and shares (depositary receipts) of such public companies are traded on both Russian and foreign stock exchanges. At the same time, the tie-in to the mandatory presence of a stock exchange in an OECD member state has been cancelled. The only restriction for such public companies is that the state in which the stock exchange is located should not be included in the list of states (territories) that do not ensure information exchange for tax purposes (the list is specified in article 25.13-1 of the Tax Code[2]).

4) It is supposed to introduce a so-called ‘grandfather clause’ for IHCs

The introduction of a ‘grandfather clause’ will help to protect the IHC from various changes in tax legislation with regard to corporate income tax, property and transport taxes. Such protection will be in effect from the moment when the status of an IHC is acquired until its possible loss.

[1] Order No. 108n of the Russian Ministry of Finance dated 13 November 2007 "On approval of the list of states and territories providing a preferential tax regime and/or not providing for the disclosure and provision of information during financial transactions (offshore zones)”.

[2] Order No. MMV-7-17/511@ of the Russian Federal Tax Service dated 11 October 2019 “On approving the list of states (territories) that do not ensure information exchange for tax purposes with the Russian Federation, and on invalidating Order No. MMV-7-17/786@ of the Russian Federal Tax Service dated 4 December 2018”.

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