Сlarifying the rules for calculating taxes on income from capital and other amendments to the Tax Code to come into force from 2019

Pepeliaev Group advises that amendments have been made to the Russian Tax Code that clarify the rules for calculating taxes on income from capital, and that other tax changes have been made[1].

1) The procedure has been clarified for calculating corporate profit tax and personal income tax with regard to contributions to companies’ capital

When a member’s expenses on the acquisition of membership interests (shares, unit trusts) are exceeded by the amount of money or the value of other property (property rights) a member of a Russian company receives upon withdrawal from the company or when the property of a liquidated company is distributed among its members, such excess is treated as dividends.

There is now a clearer answer to the question of when a member of a company receives income if the company’s issued capital is reduced and a contribution is returned. Previously, the Russian Ministry of Finance used to change its position. Between 2014 and 2016 the clarifications were positive. [2] In 2017 the position became negative for taxpayers: the money that was received was considered to become available only provided that the reduction of the capital was mandatory in accordance with civil (corporate) legislation.[3] Negative case law also developed.[4] However, recently the Russian Ministry of Finance has changed its position[5] again, and now the positive approach is enacted in the Russian Tax Code (the “Tax Code”).

If a member, upon withdrawal or liquidation, receives property in kind, the value of such property, for the expenses on the disposal of such property to be subsequently booked, is the value that was assessed when the property was received (usually the market value).

Literally, the text of the amendments concerns only “Russian” companies, and in this connection it is unclear whether this approach should apply to foreign companies. We believe it is possible to answer this question in the affirmative, since similar economic relationships must have similar tax consequences. Recognising as dividends the positive value difference when a member receives property in kind from a company means that the company's transfer of the property to the member in the case of withdrawal or liquidation is not a sale of the property and VAT does not apply in this case. However, no express provisions on this issue have been introduced into part one chapter 21 “Value Added Tax” of the Tax Code, and the tax authorities may think otherwise.

2) If membership interests in the charter capital or if shares are sold after 5 years of ownership, a tax exemption may be applied regardless of the time when the interest or shares were acquired (before 2011 or later)

The applicable law provides for an exemption from tax on income from the sale of a membership interest in the issued capital and certain types of shares of Russian companies after 5 years of ownership.[6] However, such exemption is currently applicable only if the membership interest or shares were acquired in or after 2011[7]. The amendments cancel this limitation. However, the limitation is cancelled only for the future.

Taxpayers who have acquired a membership interestand ”exempt” shares before 2011 are entitled to a tax exemption if the shares remain in their possession until the beginning of 2019.

3) A tax exemption applies to non-residents for taxation purposes if property is sold after long-term possession

Current legislation provides for an exemption from the tax on personal income from the sale of property if such property remained in the individual’s possession for a certain period. However, at present, such exemption is applicable only to Russian tax residents. [8] The amendments cancel the limitation from 2019.

The amendments allow the exemption to be applied, in particular, by persons who previously lived in Russia as tax residents and who retain property in the country but wish to sell it.

4) Confirming the “beneficial ownership of income” and applying the “pass-through approach”

The requirements in force over the last several years have been clarified. According to such requirements, for the benefits set out in international treaties to be applied when tax is withheld at source, confirmation is required that the resident of the country which is a party to the treaty is the beneficial owner of income.

An express statement has been introduced into the law that the right to dispose of the income must be determined for each individual payment. However, for types of income other than dividends, the income may be unified into a group of payments within the framework of a single contract.

In the case of the “pass-through approach”, when the direct recipient of income acknowledges that it is not the beneficial owner of income, the income will be regarded as having been paid to the person which is the beneficial owner of income (if it is known). It will become possible to apply the “pass-through approach” to payments in a jurisdiction with which Russia does not have an international tax treaty.

The law expressly provides that the “pass-through approach” is applicable not only to dividends, but also to other types of income. In the case of dividends, there is a mandatory condition that there must be direct or indirect membership of the paying company. However, the requirement that the “pass-through approach” must be applied in proportion to the membership interest has been repealed.

No withholding tax is payable when dividends are paid to a foreign person on quasi-treasury stock, when the company paying the dividends itself has controlled the foreign recipient of the dividends (has had at least a 50% interest) for a year (365 calendar days or more).

The procedure for confirming the beneficial ownership of income has been simplified for a number of categories of recipients of income: (1) for individuals; (2) for sovereign wealth funds of foreign states; (3) for companies in which the Russian or a foreign state has at least 50% direct ownership interest (except for non-transparent jurisdictions); (4) for foreign companies more than 25% of whose corporate securities are traded on an organised market in Russia and in countries of the OECD. It is sufficient for such persons to provide an assurance that they are beneficial owners of income, and companies also need to provide documents confirming compliance with the above conditions.

Some new rules will be applied retroactively to payments made from 1 January 2018.

5) The tax service has been given the opportunity to determine the specifics of registering new categories of taxpayers with tax authorities

The Russian Federal Tax Service has been given the opportunity to determine the specifics of registering with tax authorities categories of taxpayers depending on the volume of the revenue from tax (levies and insurance contributions) and/or indicators of financial and business activity (including the total volume of income received, the average number of employees and the value of assets).

The amendment authorises the Russian Federal Tax Service to assign any categories of taxpayers to specialised tax authorities, not only major taxpayers, as at present. The Russian Federal Tax Service expressed its intention to change the procedure for registering taxpayers, for example, to make specialised inspectorates the higher inspectorates for regional inspectorates. Ultimately, in the area of tax administration, the specialisation of the tax authority is prioritised over the local accessibility of such tax authority to the audited person. The costs on tax compliance may somewhat increase.

6) The amount of default interest imposed will not exceed the amount of the tax arrears

The adopted law provides for a rule that an amount of default interest will not exceed the amount of tax arrears on which such default interest has been assessed. The new rule will apply to arrears that have emerged after the effective date of the law.

For the new rule to be applied, the software which the Russian Federal Tax Service uses to reconcile statements with budgets will need to be configured, and this may cause temporary failures during such reconciliation. It is highly likely that the new rule will not have any practical significance, since with the current key rate of the Bank of Russia in place, even an increased rate of default interest for long-term late payment is unlikely to result in the default interest exceeding the arrears.

What to think about and what to do

The amendments that have been made to the taxation procedure with respect to income from capital make the relevant rules more economically reasonable and predictable. It is possible that the tax consequences of the amendments will become notably more favourable for your business or individual transactions.

Help from your adviser

Pepeliaev Group’s lawyers are ready to assist in the practical application of the new taxation rules with regard to income from capital.