Amendments to the Russian Tax Code to raise investment attractiveness of Russian companies

Pepeliaev Group advises that Federal Law No. 368-FZ[1]  dated 9 November 2020 (the “Law”) has come into force which provides for a possibility to deduct a monetary contribution to a company’s property when a member withdraws from company, the company is liquidated or its membership interests/shares are sold. The Law has also introduced targeted amendments as to how an investment tax deduction should be applied.

1. Reducing income from the sale of a company’s membership interest (shares) by the amount of monetary funds contributed to its property when the company is liquidated or its members withdraw from it. 

Previously, tax legislation did not explicitly provide for any reduction of income from the sale of membership interests (shares) by the amount of contribution to property when the company was liquidated or a member withdrew from it (as opposed to a contribution to the issued capital with respect to which such possibility always existed). In their decisions, courts treated a contribution to property similarly as a contribution to capital for the purposes of applying benefits under international taxation treaties[2]; however, they did not give a direct answer to this question. Article 251(1)(4) of the Tax Code permits not to tax income from the liquidation of, or withdrawal from, the company in the amount not exceeding the contributions made to it, giving little guidance as to whether it refers to contributions to property. Moreover, the above provision does not apply to the sale of membership interests or shares. 

The amendments stipulate that when income is received from the sale of membership interests (article 268(1)(2.1) of the Tax Code) or shares (article 280(3) of the Tax Code), a taxpayer may decrease the income received also by the amount of monetary funds contributed to the company’s property. For the purpose of reducing the income, the above contribution is to be calculated proportionally to the ratio of the membership interest/shares sold to the total amount of such membership interest/shares owned by the taxpayer.

A similar possibility to deduct monetary funds in the form of a contribution to the company's property is provided to parties having received income from the liquidation of the company (para 1 of article 277(2) of the Tax Code) and from the withdrawal from it (para 2 article 250(1) of the Tax Code).

The amendments apply to taxpayers’ income received starting from 1 January 2021[3].

comment.jpgThe possibility to deduct monetary funds in the form of a contribution to a company’s property may raise the investment attractiveness of Russian business segment as it will allow deducting investments made previously when the sales income is received or in the case of a withdrawal from a business structure. This, in turn, will provide a guarantee to an investor that if it withdraws from a business project, its investments will be deducted, including contributions to property, where such contributions are very often used in practice to provide financial aid to a subsidiary.

The law does not establish any statute of limitations for deducting as expense a monetary contribution to property. If we apply analogy and use, for example, the Russian Finance Ministry's commentary on article 251(1)(1.1) of the Tax Code (repayment of a monetary contribution to the member within the limits of the amount paid previously)[4], we can conclude that the date when the monetary funds were contributed is irrelevant for reducing the income resulting from the withdrawal from a business.

The additional beneficial effect of the amendments is that they apply not only to Russian companies: there are no bans on applying them to foreign companies. 

At the same time, the amendments can be interpreted as restricting the deduction of non-monetary contributions to property. Such contributions are made less often as the legislation restricts the forms of contributions (article 66.1 of the Civil Code). Moreover, a contribution to property has not been excluded from the definition of a ‘sale’ (article 39 of the Tax Code) which entails the VAT risks. Therefore, in practice, contributions to property are made in the form of, for example, securities. A ban on deducting non-monetary contributions is at odds with the economic substance of the transactions; yet, the risk of such interpretation cannot be ruled out.

Lastly, please note that a distinction should be drawn between contributions to property and a so-called ‘compensation-free transfer’ (article 251(1)(11) of the Tax Code), which, as before, makes it impossible for a member (shareholder) to deduct as costs the value of the item transferred. These two transactions are distinguished on a formal ground, i.e. they have been formalised in corporate documents.

2. Investment deduction

The amendments imply targeted technical changes in the provisions regulating investment deduction for the corporate profit tax purpose[5]. For example, it is proposed not to deprive a taxpayer of the right to depreciate a fixed asset by the costs of creating (purchasing) same, where such costs were not deducted for the purpose of an investment tax deduction. It is further proposed that a taxpayer should be entitled to carry forward the unused tax deduction to the extent paid to the federal budget, similarly to the procedure stipulated for the part paid to the budget of a constituent entity of Russia.

Help from your adviser

Pepeliaev Group's team is ready to offer its assistance in analysing the tax implications of restructuring business assets, including assessing tax implications of investment decisions and controversial points of taxation of income from a withdrawal from business. 

[1] Federal Law No. 368-FZ ‘On amending parts one and two of the Russian Tax Code’ dated 9 November 2020.
[2] Clause 12 of the Overview of courts' practice of resolving disputes connected with protecting foreign investors (as approved by the Supreme Court’s Presidium on 12 July 2017).
[3] Article 3(4) of the Law
[4] Letters of the Ministry of Finance No. 03-03-06/1/9345 dated 14 February 2019 and No. 03-08-05/51772 dated 12 July 2019.
[5] Investment tax deduction is an alternative to the standard depreciation, it implies a possibility to reduce the profit tax by the costs of creating (acquiring) the fixed assets. 

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