The Finance Ministry intends to continue fine-tuning the Tax Code's provisions on cross-border payments
Pepeliaev Group advises that the draft law proposing minor adjustments to parts one and two of the Tax Code has been presented for public hearings.
In mid-May the draft Federal Law “On amendments to parts one and two of the Russian Tax Code (in relation to implementing certain provisions within the principal lines of the Russian Federation’s budgetary, tax and customs tariffs policy)” was published on the federal portal or regulatory legal acts[1]. The draft law has not yet been put before the State Duma, but the anticipated amendments deserve close attention from the Russian business community.
The draft law is extensive and it encompasses the rules of both part one and part two of the Russian Tax Code (the ‘Tax Code’). While examining the draft law we have paid attention only to the most significant changes in the taxation of cross-border payments.
A ‘pass-through’ approach
In terms of the application of the so-called ‘pass-through’ approach, at the moment, the Tax Code allows for the 0% rate of the corporate profit tax to be used with respect to dividend income received by a foreign company if the beneficial owner of such income is a Russian company (subject to certain conditions being met) or an international holding company (‘IHC’).
The draft law, in turn, proposes that this beneficial rate be abolished for both Russian companies and IHCs. Thus, if the amendments proposed by the Finance Ministry are adopted, Russian companies and IHCs indirectly participating in Russian companies through foreign entities and applying a ‘pass-through’ approach to such payments will be able to use only the 13% tax rate.
In addition, the draft law also abolishes the provision establishing that the indirect participation of every subsequent person who enjoys beneficial ownership of income in the Russian company that is paying income in the form of dividends is considered equivalent to direct participation.
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The adjustments proposed by the Finance Ministry continue the 'deoffshorisation' policy in relation to the Russian economy and directly correlate with the anticipated changes in the DTTs with Cyprus, Malta and Luxembourg in terms of raising the taxation of income in the form of dividends and interest payments. In our opinion, the Finance Ministry is primarily proposing that Russian businesses refrain from using foreign transit companies and start using more actively the rules of the Tax Code that allow for dividends from subsidiaries to be taxed at the rate of 0%. |
Expansion of the benefit for foreign companies that are recognised as tax residents of the Russian Federation
The draft law also proposes that foreign companies recognised as tax residents of the Russian Federation be permitted to use the beneficial tax rate of 0% with respect to dividend income received from Russian companies under a compulsory, rather than a voluntary, procedure provided that certain conditions are met.
Setting out in greater detail the conditions of the benefit for sales of Russian companies’ shares
At present, to sell the shares of a Russian company free of tax the taxpayer must have had uninterrupted ownership of such shares (or must have held them by virtue of another property right) for a period of 5 years; the shares must be non-traded and, at the time when such shares of a Russian company are sold, the company’s assets in the form of real estate must account for less than 50%. It is now being proposed that the last condition be abolished.
It is proposed that income of a participant in a mutual investment fund be regarded equal to the receipt of dividends
According to the anticipated amendments the income of participants (including foreign companies participating in mutual investment funds (‘MIFs’)) from the trust management of property that constitutes an MIF will be recognised as dividends for the purposes of withholding tax in the Russian Federation.
Moreover, it is planned to expand the list of MIFs of which units being sold/redeemed/otherwise disposed of is recognised as passive income from a source in the Russian Federation. Among other things, it is proposed that the treatment of income from the sale/redemption/other disposal of units of closed-type MIFs classified as annuity funds or real estate funds be also extended to the units of closed-type MIFs classified as combined, as well as of other funds in which 50% of the assets consist, directly or indirectly, of real estate located in the Russian Federation.
Therefore, the proposed amendments are aimed at expanding the taxable base, i.e. potential income of the Russian state budget, and at preventing abuse of civil law constructs on the part of taxpayers when transactions involving the sale of Russian real estate are disguised as transactions involving the sale of units of a fund. Should the amendments be adopted, such payments will be subject to withholding tax in the Russian Federation just as with the sale of shares / participatory interests of which the value consists primarily of real estate located in Russia. The tax rate will be 20%.
Elimination of double taxation when personal income tax is charged on dividends from a foreign public company
Amendments relating to personal income tax that are set out in the draft law stipulate that double taxation is eliminated for individuals who are tax residents of the Russian Federation in relation to dividends from foreign public companies that have previously received income in the form of dividends from Russian companies. This is ensured by way of the individual reporting on such income in the tax return according to the 3-NDFL form (provided, however, that a number of conditions are met).
Individuals will qualify for a reduction of such tax by the amount of the Russian withholding tax that the Russian company has withheld when paying out dividends to the foreign company.
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These adjustments, if adopted, will allow for economic double taxation to be eliminated when dividends are paid from Russia by way of transit through a foreign public company to a beneficiary that is a Russian tax resident. They will also allow income to which Russian tax residents have beneficial ownership to be brought out of the shadows. Nevertheless, even if the amendments are adopted, the following practical issues will remain unresolved:
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What to think about and what to do
The content of the final version of the draft law has not yet been ultimately determined, because it remains at the stage of public consultation until the beginning of June. Once the public consultation is over, the amendments to the Tax Code proposed by the Finance Ministry may be adjusted. Similar adjustments and corrections may take place at the stage when the draft law passes through the State Duma.
Pepeliaev Group’s team will follow up on the fate of the draft law and inform you of any significant developments. However, we recommend performing a stress-test of structures already at this point to check their conformity with the anticipated changes. If any risks are identified it would be prudent to consider the subsequent strategy of conducting cross-border business, such as the liquidation of foreign companies or a change of foreign companies’ tax residency, including a possible move to a Special Administrative Region.
Help from your adviser
Pepeliaev Group’s team provides a wide range of services relating to the taxation of cross-border transactions. Our lawyers advise on various issues of Russian and international taxation, perform stress-tests of the structures intended for conducting a cross-border business and act on behalf of clients at both the pre-trial and trail stages of disputes over cross-border taxation.