Taxation of a unit investment trust’s property – the rules have changed

Pepeliaev Group notes that Federal Law No. 308-FZ dated 27 November 2010 has amended the chapter of the Russian Tax Code dealing with property tax and land tax. In particular, these amendments make property tax and land tax applicable to the property and land plots of unit investment trusts. The law comes into force on 1 January 2011.

Under the amendments, taxes will be paid by the management company in respect of the property of a unit investment trust (“UIT”). The rate is to be established by the legislation of the relevant region but it may not be higher than 2.2%.
The changes put paid to one of the most substantial tax benefits of conducting business through unit investment trusts.
This new development may significantly increase the tax burden on investments made through UITs. Data from the portal Investfunds.ru shows that the net wealth of UITs currently amounts to RUB 449.86 billion – a major slice of the Russian investment market.

Pepeliaev Group commentary. It is worth remembering that this is not the first recent development to add to the difficulty of conducting business profitably through a UIT.

Major investments in UITs are often put in place using Cyprus companies as a conduit. Under the Protocol, signed on 7 October 2010, to the Agreement for the Avoidance of Double Taxation between Russia and Cyprus, payments via an intermediary from UITs to Cyprus residents are treated as dividends. They are therefore, under the general rule, taxable at source in Russia at a rate of 10%.

Aside from this, income from investments in funds formed primarily to invest in real estate is treated as income from real estate and this is taxable in Russia at the general 20% rate.

The amendments were prompted by the practice of transferring property to private closed unit investment trusts for the sole purpose of obtaining a benefit and with no genuine aim of holding it in trust to be managed with a view to deriving profit. The fiscal authorities elected not to go down the road of reclassification of specific operations and proving the lack of business purpose (this has been the practice abroad, especially in respect of similar actions by a major retailer in the USA). Instead, they have abolished the benefits completely, including for law-abiding investors.

Recommendations

Existing business structures need to be considered carefully in the light of the additional tax burden imposed on them, with a view to potential restructuring.

Pepeliaev Group’s lawyers have vast experience in supporting investments in real estate. They will offer any help you need in assessing the impact of the changes on specific investment projects and the potential for restructuring those projects.