The first regional law providing for an investment tax deduction for profit tax

Pepeliaev Group advises that, on 22 March 2018, the Legislative Assembly of the Republic of Karelia adopted a law[1] introducing an investment deduction for profit tax.

The Republic of Karelia has become the first Russian region to exercise the right provided for by the Russian Tax Code (the ‘Tax Code’) to set an investment tax deduction (the ‘ITD’) for profit tax. The benefit targets investors which will invest funds in such an innovative sector as the production of bioactive food additives or medicines and materials used for medical purposes[2].

Please be reminded that the institution of the investment tax deduction (article 286.1 of the Tax Code) was introduced by Federal Law No. 335-FZ dated 27 November 2017. Taxpayers may reduce profit tax by the amount of expenses on the acquisition of new and/or on the reconstruction (modernisation, technical re-equipment) of fixed assets included in depreciation groups 3 to 7 [3]. However, such deductions can actually be applied if there is a law of a constituent entity of the Russian Federation providing for the entry into force of the ITD throughout the territory of such constituent entity[4].

The Law of the Republic of Karelia introduces an investment tax deduction on items of fixed assets relating to companies or standalone business units of companies located within the Republic and performing the following types of economic activity:

• the production of bioactive food additives;
• the production of medicines and materials used for medical purposes.

The Law sets an investment tax deduction of 50% of the amount of expenses, incurred in the current period, that are specified in article 257(1)(2) and article 257(2) of the Tax Code (with the exception of expenses on the liquidation of fixed assets)[5].

The amount of the deduction reducing the amount of the tax (of the advance payment) to be paid to the budget of the constituent entity of the Russian Federation cannot exceed the established maximum amount. The amount in question is determined in accordance with article 286.1(1)(3) of the Tax Code as the difference between two estimated tax amounts to be paid to the budget of the constituent entity of the Russian Federation which are calculated without taking the ITD into account:

• the tax amount calculated in accordance with the general rate of 17%[6],
• the tax amount calculated provided that the tax rate is applied that is determined by the decision of the constituent entity of the Russian Federation, i.e. 8.5% according to the Law of the Republic of Karelia[7].

Therefore, when the Law of the Republic of Karelia is applied, the maximum ITD value by which the tax to be paid to the budget of the constituent entity of the Russian Federation may be reduced actually corresponds to the tax amount calculated at the rate of 8.5%.

If 50% of the amount of expenses turns out to be less than (equal to) the estimated maximum amount, the deduction will be equal to the specified amount of expenses.

If the specified share of expenses exceeds the maximum value, the deduction may include expenses equalling the maximum amount, and the remaining part may be carried forward to future tax (reporting) periods (article 286.1(9) of the Tax Code)[8].

If a company applies the ITD it may reduce the profit tax amount which is to be paid to the federal budget by the amount of 10% of the expenses on the acquisition and modernisation of fixed assets (article 286.1(3)(1) of the Tax Code). Such reduction may result in the tax amount reducing to zero.

The Law of the Republic of Karelia applies the new regulation to legal relationships that started from 1 January 2018, i.e. the Law can apply retroactively.

Help from your adviser

Pepeliaev Group's specialists have extensive experience of advising on issues of establishing and applying tax benefits at the federal and regional levels. Our team is ready to provide legal assistance to companies in connection with the introduction of the investment tax deduction, including in connection with assessing whether it is reasonable to decide to use it in each specific case.