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Draft law specifying the Russian CFC rules

15.09.2017
8 min read
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Pepeliaev Group advises that a draft law has been prepared on contentious issues of applying the Russian rules on controlled foreign companies (CFCs).

On 4 September 2017 the Russian Ministry of Finance published, for public consultation, a draft law proposing amendments to the Russian Tax Code. The draft in many ways confirms the Ministry of Finance’s position stated in its Guidelines[1] published in February this year.

The draft law also specifies and supplements current legislation on a number of key aspects: transactions with securities, winding up a CFC without tax exposure, and taxation of a CFC that is a member of a consolidated group of taxpayers.

Key provisions of the draft law:

Filing a CFC’s documents with the tax authorities

  • If a controlling party through a Russian entity owns a CFC that is entitled to a profit tax exemption, the controlling party is not obliged to confirm the right to such tax exemption provided that a Russian intermediary company has already filed relevant documents.

Transactions with securities

  • There is clarification of the procedure for calculating income received from and expenses incurred on a sale or other disposal of participatory interests, securities, or other financial assets. Income is determined based on the actual selling price of such assets; expenses are determined as the purchase price (if the assets were purchased in 2015 or later) or as the cost reflected in the CFC’s records at the first day of the 2015 financial year (if the assets were purchased before 2015).
  • When a CFC’s profits are being calculated the figures in its financials should be adjusted not only with regard to the revaluation of financial assets but also with regard to income (expenses) from disposals of financial assets.

CFC’s loss carried forward

  • The Ministry of Finance has confirmed its position that to carry forward its losses incurred in the three tax periods preceding 2015, the CFC’s financial figures for these three periods must be adjusted.
  • The total amount of losses carried forward may be adjusted by the amount of the revaluation of participatory interests and securities accrued since their purchase and until 2015.
  • If the taxpayer stops being a controlling party of the CFC, it loses its right to carry forward the losses of such CFC to the extent that they were not accounted for previously.

Winding up a CFC with no tax exposure

  • The list has been extended of the cases when an individual who has received property (property rights) after a CFC was wound up with no tax exposure may reduce his/her tax base by the cost of property determined based on the records of the liquidated CFC (not above the market value) as of the date when the property (property right) was received. Specifically, this right of a taxpayer occurs:

− Upon disposal of property (property rights) received after the СFC was wound up;

− If the payment was made in securities or participatory shares (or property rights). In this case the entities comprise not only Russian limited liability companies but also foreign companies whose issued (joint-stock) capital is divided into interests (contributions) among the founders (members);

− When the income was received from exercising property rights[2], regardless of whether this income was received by a taxpayer directly or upon such taxpayer’s instruction was transferred to third parties;

− Upon a sale of property received from exercising property rights gained after a СFC was wound up;

− Upon receipt of income, provided this income is not a distribution of profit of an unincorporated foreign entity and if the right to such income was obtained by a taxpayer upon his/her contribution to such foreign entity of property (property rights) received from the CFC;

− Upon the sale (redemption) of securities received from the wound-up CFC;

− When securities were received as a gift (or inherited) from a person who received them from a wound-up CFC.

  • If the decision to wind up a СFC was taken before 2016 but under a law or owing to litigation the winding up procedure cannot be completed before 1 January 2018, the liquidation benefit may be legitimately applied provided the CFC will be wound up within the subsequent 365 calendar days after the restriction on liquidation is removed.

Calculation of a CFC’s profit

  • If a CFC distributes its profits which have already been reported as income of a controlling individual and taxed in Russia, such income of a controlling individual is not subject to double taxation regardless of how the CFC’s profits are distributed, whether as dividends or otherwise.

Tax residency and permanent establishments of foreign companies

  • The draft law has specified the criteria that foreign companies should meet to be classified as Russian tax residents under article 246.2 of the Russian Tax Code as a result of performing any/all of the stated activities. Specifically, a foreign company cannot be classified as a Russian tax resident based solely on the fact that it performs the following activities in Russia: investment, financial, manufacturing, or other risk management and/or the approval of resolutions adopted by foreign companies in order to ensure compliance of such resolutions with the approved standards, guidelines, and/or policies.
  • If the exploration or mining activities of a foreign company are controlled from Russia while the work is performed abroad, such company will not be classified as a Russian tax resident.
  • A foreign company which is a party to a production sharing or similar agreement when all of the criteria below are met:

  1. Such foreign company is a party to such agreements or this company is incorporated and performs mining activities for minerals solely based on and under conditions of the agreement in question;
  2. These agreements are made with the state (territory), the government of such state (territory) or a government-authorised institution (government authority or a state-owned company) or the activities performed under such agreements are performed based on a mining licence (or similar permit issued by an duly authorised body);
  3. When at least 90% of the total income is received from being party to such agreements (contracts) within a financial period set by the company’s personal law with respect to preparing its reports for the respective financial year and this is supported by the entity’s report for the respective period; or the entity has not received any income for the said period, may be only classified as a Russian tax resident based on an application filed by such company independently.

  • The management of assets of a foreign investment fund performed in Russia as well as other activities directly related to the above functions do not on their own lead to the formation in Russia of a permanent establishment of such fund, or of foreign companies (of unincorporated entities) with the direct or indirect involvement of such fund and/or direct or indirect shareholders (members, stockholders, or partners) of such fund (company).
  • Activities performed in Russia through a broker or a commission agent as well as through an investment fund manager do not lead to a permanent establishment being formed in Russia.

Consolidated group of taxpayers

  • The draft law specifies the rules for calculating tax paid by a CFC that is part of a foreign consolidated group of taxpayers (“CGT”) in the country where it is registered[3]. The amount of tax is determined based on the financials in proportion to the share of the CFC (a) in the consolidated CGT’s revenue, (b) in the consolidated pre-tax profits of a CGT, or (c) in the consolidated net assets of a CGT.
  • The method for calculating the tax paid by a CFC should be fixed in the accounting policy and may only be changed once every 10 years.

What to think about and what to do

The draft law in many ways confirms the position of the Russian Ministry of Finance stated in its Guidelines and subsequent letters and improves a taxpayer’s position with regard to certain matters (e.g. securities transactions and a permanent establishment).

It is highly likely that his draft law will be adopted. It is expected that the provisions of the law will cover offences that occurred starting from 2016 which relate to the procedure for determining a CFC’s income for the financial years started from 2016, i.e. for periods when profits should be reflected as part of the controlling party’s (taxpayer) income for 2017 and subsequently.

In this regard, even as early as this stage, it is important to assess the impact of the expected amendments on the tax burden of international groups and to adjust their accounting policies accordingly with regard to the matters relating to the determination of a CFC’s income. First of all, it is necessary to update the rules for carrying losses forward and the policies regulating transactions with securities.

We also recommend paying special attention to the provisions covering matters of tax residency and the formation of a permanent establishment in Russia.

Help from your adviser

Pepeliaev Group’s lawyers have gained unique methodological experience in international taxation matters. They are ready to offer legal support as you adjust to the new rules for the calculation of a controlled foreign company’s income and other aspects covered by the draft law.



[1]Letter No. 03-12-11/9197 of the Russian Ministry of Finance dated 17 February 2017.

[2] The term ‘exercise property rights’ is not defined in the draft law. Owing to this we cannot rule out that the term may be construed narrowly by tax authorities.

[3] The amount of such tax is used to calculate the effective tax rate for a CFC and to offset tax paid by the CFC in the country where it is registered against the tax to be paid in Russia.

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