Additions to the CFC taxation rules: indulgence and an increase of pressure

So that controlling persons can switch to the new regime[2], they are granted the right to submit to the tax authorities a notice to this effect before 31 December 2021 if the controlling person plans to switch to the new regime with regard to tax for 2021. If the controlling person decides to switch to the new regime already following the end of 2020, the specified notice should be filed no later than 1 February 2021. 

According to the new developments the established fixed amount of CFCs’ profit is RUB 38,460,000 for 2020 and RUB 34,000,000 for subsequent tax periods[3]  for all CFCs simultaneously. That is to say, the fixed amount of CFCs' profit establishes the general imputed tax base for all of the CFCs owned by a controlling person regardless of the actual financial result of each individual CFC according to its financial statements.

The transition to the new regime means that the controlling person will apply such regime taking account of the following specifics:

• the regime must be used throughout at least 3 consecutive tax periods (if the transition notice is submitted in 2020 or in 2021), or
• throughout at least 5 consecutive tax periods (if the transition is to take place in 2022 or if the regime is reapplied after withdrawal).

If the controlling person loses control of all of the CFCs during the period when it applies the new regime for the taxation of “CFCs’ fixed profit”, such controlling person will be exempted from tax for the subsequent tax periods. However if only a portion of control is lost the controlling person remains obliged to pay the previous amount of fixed tax.

The controlling person may not arbitrarily withdraw from the new regime ahead of time during the period when such regime is applied unless the conditions of this tax regime are changed at the initiative of the Russian public authorities. Withdrawal from the regime is allowed solely after the expiration of a 3 or 5-year period and solely if the relevant notice is submitted before 31 December of the year staring from which the taxpayer plans to withdraw from the taxation regime for “CFCs’ fixed profit”.

The transition to the new regime may be of interest for the owners of a large number of profitable CFCs, since it provides for the opportunity not to take into account the financial figures of individual CFCs and not to submit the financial statements to the tax authorities. The specified opportunity involves paying a fixed tax amount (of RUB 5 million) annually.  By applying this regime controlling persons will also be able to significantly reduce administrative costs on the preparation of the financial statements of CFCs as well as audit expenses (if needed).  However, the specified regime provides for some substantial encumbrances for controlling persons. For instance, when the CFCs’ profit is distributed, the controlling person will pay personal income tax: on the entire distributed amount (it will not be subject to the exemption set out in article 217(66) of the Tax Code) without the opportunity to reduce the specified amount by the amount of the fixed payments under the new tax regime, or by the amount of the tax paid abroad (by either the CFC itself or by the controlling person[4]) and without taking into account the loss that has been incurred,  which will actually result in an additional tax burden and in tax being imposed on many occasions. Moreover, if a CFC incurs a loss, such CFC will not be released from the obligation to pay the fixed payment annually until withdrawal.  Also, the regime of “CFCs’ fixed profit” will not provide for the opportunity set out in article 25.13-1 of the Tax Code of exempting CFCs’ profit from taxation.

2. The timeframes for submitting a CFC notice have been changed

Individuals who are controlling persons will be allowed to provide a notice of CFC membership before 30 April, rather than before 20 March (which is currently the case), of the year following the tax period in which the controlling person deducts the income/loss in the form of a CFC’s profit/loss. The change in the timeframes will not apply to controlling persons that are companies.

The change in the timeframes for individuals to submit a CFC notice has been brought in line with the timeframe for submitting a tax return in accordance with the 3-NDFL form, which is aimed at simplifying tax administration for individuals.

3. The rules regarding CFCs have been supplemented with respect to financial documents being requested and provided

According to the amendments adopted, a controlling person will be obliged to provide documents confirming the amount of a CFC’s profit/loss. Such documents are:

• A CFC’s financial statements;
• In the absence of the CFC’s financial statements - other documents confirming the CFC’s profit/loss for the financial year (for example, management reports and accounting records);
• An auditor's opinion regarding the CFC’s financial statements (in the event of a mandatory or voluntary audit).

The specified documents are provided regardless of the CFC’s financial performance (including in the event of a loss or zero financial result):

• together with a profit tax return - for legal entities;
• together with a CFC notice - for individuals.

If such documents are not provided the controlling person will be subject to liability in the form of a fine of RUB 500,000[5]. 

Also, according to the new article 25.14-1 of the Tax Code, the tax authority is granted the right to request any additional documents at its discretion for no more than 3 tax periods that have expired. The specified opportunity to request documents does not apply to controlling persons that have adopted the new taxation regime based on “CFCs’ fixed profit”. 

If a controlling person receives a request to provide financial documents such controlling person will be obliged to provide, within 1 month, the documents necessary for the exemption to be justified together with a translation of such documents into Russian (of the part that confirms the exemption, or of the part that sets out the amount of the CFC’s profit). 

If the requested documents have not been provided or if documents have been provided that contain inaccurate data, this will entail a fine of RUB 1 million[6].

In the event an adjusted CFC notice is provided (after a request for documents has been received) that does not contain any information that an exemption of a CFC's profit from taxation is applied, the controlling person will be released from liability for a failure to provide documents, since the previous notice will be considered invalid. 

Previously, submitting documents to confirm the amount of a CFC’s profit/loss together with a tax return was a right of a controlling person. According to the new regulation the specified submission is mandatory. The above measure is obviously aimed at increasing the efficiency of the tax administration of CFCs’ reports and at combating abusive practices when controlling persons’ obligations are determined. At the same time this will complicate the exemption of CFCs’ profit from taxation for those controlling persons that do not switch to the new regime for the taxation of “CFCs’ fixed profit”.

4. The fines for non-compliance with the CFC rules have been increased

The amendments are to change and add to the fines relating to the CFC rules. Apart from the above fines being introduced the fine for delaying the CFC notice will be increased. Now the specified violation will entail a fine of RUB 500,000 for each CFC (rather than RUB 100,000 as is currently the case). 

5. Other changes

• When determining the effective and average-weighted tax rates for the purposes of exempting a CFC’s profit from taxation, withholding tax on dividends from Russian companies is not taken into account and the dividends are not booked as profit for the purposes of such calculation. The specified adjustments are possible only if the controlling person’s beneficial ownership of the income is confirmed.
• The definitions of a “foreign holding company” and “foreign subholding company” are being changed and new criteria are being introduced for determining whether such companies are “acting” for the purposes of exempting the CFCs’ profit from taxation.

A foreign company is recognised as a foreign holding company for the purposes of the CFC rules if the controlling person holds a membership interest of no less than 75% in the specified foreign company and such foreign company holds a membership interest of at least 50% in another foreign company (at least one such company) and a membership interest of at least 15% in other foreign companies (if any). Another important condition is the period of membership (ownership of shares), i.e. at least 365 consecutive calendar days as at the date when the financial year ends in accordance with the private law of the foreign company. All of the conditions must be met simultaneously. 

 
A foreign company is recognised a foreign subholding company for the purposes of the CFC rules if the foreign holding company holds a membership interest of at least 75% in such foreign company, and such foreign company holds a membership interest of at least 50% in other foreign companies (at least in one of them) and a membership interest of at least 15% in other foreign companies. The condition concerning the period of membership is the same as for a holding company. 

 
When determining whether such companies are “acting companies”, the 5% criterion that applies to the “passive” income of such foreign companies does not apply to:

• Dividends from acting foreign companies or acting foreign subholding companies provided that the recipient of the dividends holds, throughout 365 consecutive calendar days, a membership interest of at least 50% in the issued capital of the foreign company paying the dividends;
• Dividends from foreign companies that meet at least one criterion for the exemption of the CFCs’ profit from taxation, except for the criterion of an international holding company, also provided that the recipient of the dividends holds, throughout 365 consecutive calendar days, a membership interest of at least 50% in the issued capital of the foreign company paying the dividends;
• Income from the sale or other disposal of shares (membership interests) in the specified companies.

Help from your adviser

Pepeliaev Group's team has extensive experience in advising and representing clients with regard to the issues entailed by the CFC rules. Our lawyers are ready to provide support to controlling persons in the transition to the new regime and with respect to CFC administration (including an analysis of the possibility of a CFC's profit being exempted from taxation) with a view to avoiding the increased fines. 

[1] https://sozd.duma.gov.ru/bill/990129-7
[2]The transition procedure is set out in the new article 227.2 of the Russian Tax Code
[3]Taking into account the upcoming increase of the tax rate from 13% to 15%

[4] Article 232(1) of the Tax Code

[5] Article 126(11) of the Tax Code
[6] Article 126(11-1)Tax Code