A tax manoeuvre in IT: the law has been adopted
Pepeliaev Group advises that, the State Duma has adopted the law which implements a tax manoeuvre in the IT industry.
Please note the following key points.
1. Profit Tax Benefits for IT companies
The law introduces a profit tax benefit for IT companies - profit tax is established at the rate of 3%.
Criteria for obtaining this benefit are the same as for obtaining a benefit for insurance contributions (formulated in article 427 of the Russian Tax Code (the “Tax Code”)): the company should be a software developer, be accredited by the Russian Ministry of Communications and Mass Media, have average number of staff of at least 7 people, and to gain at least 90% of income from a certain activity in IT.
At the same time, article 259(6) of the Tax Code loses its force. It provided for the right of IT companies to simultaneously write-off expenses on purchasing computer equipment without applying the general deprecation rules to it.
2. The decrease of the insurance contributions rate and adjustment of conditions for applying this benefit.
The law decreases the rate of insurance contributions to 7.6% and adjusts the list of the types of activities income from which should be taken into account when 90% threshold is determined for obtaining the insurance contributions benefit (and for profit tax, since the conditions are worded similarly).
What has been added to the types of income from IT activities?
It is possible to book income from grating rights to use software under licence contracts, including “by way of granting a remote access to the software” via the Internet. Further, income from providing software updates and additional functional capacities is booked for the purposes of obtaining the benefit.
We can remind you of cases of Mail.ru Games concerning the VAT benefit. The company did not pay the VAT on the above mentioned “additional functional capacities”. The user downloaded a game and played it for free; however, the user purchased additional items, i.e. armour, weapons, etc. For a long time the company litigated with the tax authorities concerning the possibility of applying the benefit with regard to these additional functional capacities of the software, proving that they also represent, in essence, the transfer of the rights to use computer programs. The disputes ended when Mail.ru Games finally got a positive explanation from the Russian Federal Tax Service.
Sooner or later, a similar question would arise with regard to insurance contributions benefit. Whether income from providing these additional functional capacities should be booked for the purposes of the benefit? The law answered ‘yes’ to this question.
What has been removed from the income from IT activities?
Firstly, the law expressly provides that the income should be received from the sale of copies of the genuinely developed software, the grant of exclusive rights and of the rights of use under licence contracts with respect to the genuinely developed software.
Currently there is no such reservation concerning income, though article 427(1)(3) of the Tax Code states that the benefit is granted “to Russian companies that carry out activities in the area of information technologies, and develop and sell programs developed by them”. This gave grounds to the Russian Ministry of Finance and the Federal Tax Service to comment that only the sale of copies and providing of the right to use the software developed by the taxpayer can be used in types of activities from which the income should be received.
How should this new development be interpreted? Did the legislature not mean it previously, and was it possible to book income from the software that was not one's own software? Or was the same meant previously, but the adopted law has simply adjusted the wordings that were not clear enough? Let’s see how the case law will develop.
Secondly, income from granting the rights to use software are directly excluded, if such rights imply obtaining the possibility of distributing advertising information and/or of having access to it, publishing offers concerning the purchase (sale) of goods (work, services), or property rights in the Internet, searching for information about potential buyers (sellers) and/or entering into transactions.
Therefore, the companies that develop software for advertising purposes, for entering into transaction on the platform, and for searching for potential sellers and buyers are deprived of benefits. It is irrelevant that these IT companies developed programs and databases and granted access to them under a licence contract.
Thirdly, now, for the benefit purposes, the amount of income for determining the 90% threshold does not include income from assigning rights to claim the debt that arose when the income was booked stated in the list of income booked for the purposes of applying the benefit.
Such addition will allow IT companies to transfer the right of claim against the debtor which failed to pay for IT goods and services (work) and retain the right to apply the benefit.
3. Benefits for companies in the area of design and development of devices of electronic component base and electronic (radio electronic) products.
The law also provides for the profit tax benefit (at the rate of 3%) for companies which carry out activities involving design and development of devices of electronic component base and electronic (radio electronic) products. Conditions are the inclusion in the specific register, an average number of staff of at least 7 people, gaining at least 90% of income from the sale of services (work) involving the design and development of these devices. The insurance contributions benefit has been also introduced for these companies.
4. The transformation of VAT benefit.
Finally, the law amends the conditions for applying the VAT benefit (with regard to the transfer of exclusive rights and of the right to use computer programs and databases) according to article 149(2)(26) of the Tax Code.
The main amendment is that the subjects of the benefit have been significantly narrowed. The law provides for retaining this benefit only for the software included in the Unified register of Russian computer programs and databases. This register is provided for by article 12.1 of Federal Law No. 149-FZ ‘On information, information technologies and the protection of information’ dated 27 July 2006. One of the prerequisites for having your software included in this Register is that the rightholder of the software should be either a Russian citizen, or a Russian public entity (the Russian Federation, a constituent entity of the Russian Federation, a municipal unit), or a Russian commercial company in which Russian citizens and/or Russian public entities hold, directly or indirectly, more than 50% of its capital.
In the second reading, the new version of the provision lost a reference to the “licence contract” as a ground for obtaining a benefit for the transfer of rights to use software. On the one hand, this gives additional options for having the transactions involving the use of Russian software exempted from VAT. On the other hand, this requires from taxpayers a thorough legal analysis in each case in order to ensure that the transaction performed can be considered as the transfer of right to use software.
|The law has supplemented the wording of benefit. The new version will stipulate that the VAT benefit will be granted both if rights to software are transferred through a remote access via the Internet, and with regard to software updates and additional functional capacities.|
What to think about and what to do
The law significantly amends the taxation procedure of IT companies. These amendments will come into force from 1 January 2021. In order to prepare for them we recommend:
- checking whether the company meets the conditions for the purposes of applying benefits for IT and, accordingly, whether it obtains and/or retains the right to benefits taking into account the law adopted;
- ensuring that wordings of contracts and source documents do not prevent from obtaining benefits and making necessary changes;
- implementing necessary preparatory actions to apply benefits from 2021.
For IT companies that earn income from software for the purpose of distributing advertising, searching for contracting parties and entering into transactions, and that have their own software developers department within their structure it is worth considering possible business advantages of spinning off such department into a separate legal entity. Of course, such a spin-off should be aimed at achieving business purposes and be combined with real changes in organisational interaction and management.
Help from your adviser
Based on our diverse experience of advisory and litigation work with regard to taxation of IT companies we are ready to explain in detail the contents of the new provisions, assess their application to the specific business operations and situations, prepare a justification of business restructuring and to work through other issues associated with the adaptation of companies to the tax manoeuvre.