The third stage of the “Offshore amnesty” will require that foreign companies be redomiciled to Russia and funds be repatriated from foreign accounts
It is unclear at this point when exactly the third stage of the “amnesty” will start: one of the draft laws specifies 1 May 2019, while another states 1 June. When the third stage starts will depend on how fast the draft laws are examined by the State Duma.
At the new stage a special tax return may be filed, just as before, including when special tax returns are submitted within the scope of the preceding stages. Yet, it is not allowed to file a repeat tax return within a single stage or to file an adjusted return.
At stage three, the guarantees contemplated by the “amnesty” are provided on condition that, on the date of the tax return, the filer:
1) does not have any controlled foreign companies (CFCs), and presents a written assurance to this effect, for which there is no set form;
2) transfers all the funds from foreign accounts to Russia and attaches a report regarding the movement of funds on the bank account (deposit) outside the Russian Federation for the period from 1 January 2019 until a date within 15 calendar days before the submission of the tax return or until the date on which the bank account (deposit) is closed.
Both the above conditions are compulsory and it is not sufficient to comply with just one of them.
At least three options are possible for meeting the first condition:
1) a CFC being liquidated (it would be prudent to start the liquidation as soon as possible bearing in mind the anticipated timeframes of the third “amnesty” stage);
2) a CFC being recognised as tax resident of Russia (for this to be done the CFC should open a standalone subdivision in Russia and file a tax residency application);
3) a CFC changing its place of incorporation – the CFC’s domicile may be changed for special administrative areas in Kaliningrad Region and in the Primorye Territory.
Whichever of the above options is chosen, we believe that the filer will have to provide an assurance to the effect that there is no CFC.
Each of the above options may be connected with tax implications and practical difficulties, in particular:
It remains unclear how the second condition concerning the repatriation of funds is to be performed. Pursuant to the draft laws a report on the movement of funds has to be submitted in 2019. Yet, it is still possible to report an account closed prior to 2019. This means a possible wider interpretation that the third stage of the special reporting procedure will apply to funds returned to Russia before 1 January 2019.
It would be preferable to have more clarity in the draft laws relating to the above and some other issues, but it is impossible to guarantee that the ambiguities will be eliminated.
One of the draft laws provides that individuals who were not tax residents at the end of 2018, but will become such residents at the end of 2019, will be allowed not to pay tax on the profit of a CFC recognised in 2019 (in other words, profit on the basis of the CFC's reports for 2018).
Conditions and consequences of a foreign company being redomiciled
As noted above, one of the ways to return assets is to change a foreign legal entity’s country of incorporation to Russia, i.e. to redomicile the foreign company. The legal entity that has been redomiciled must obtain the status of an international company.
A foreign company may redomicile if:
- it is of a commercial type and has one or more participants;
- it is incorporated in a FATF/MONEYVAL member state (including Switzerland, Luxembourg, Netherlands, Ireland, Cyprus, the Isle of Man, Jersey, Guernsey, Gibraltar, Malta; yet, the BVI, for instance, is a member of a FATF-associated organisation, rather than of the FATF itself);
- it has independently (through standalone subdivisions) or through another entity of the same group conducted activities in several countries, including Russia, no later than as at 1 January 2018.
The new location for a foreign legal entity must be in one of special administrative districts on the islands Oktyabrsky (Kaliningrad Region) and Russky (Primorye Territory).
Once it is redomiciled, the international company or a person of the same group must invest at least RUB 50 million in Russia by way of:
1) contributing to the issued capital or authorised fund or to the assets of commercial companies that are Russian legal entities;
2) making capital investments.
After it is redomiciled, the international company main retain certain attributes of a foreign company:
- corporate relationships involving the international company may be subject to foreign law and rules of foreign stock exchanges (provided that under the international company’s articles of association corporate disputes are referred to a permanent arbitration institution), taking account of amendments after the company has been redomiciled;
- for the purposes of Russian foreign currency legislation, the international company is regarded as a non-resident, meaning that it will not have the same obligations as residents, such as compulsory use of accounts in Russian banks and repatriation of funds payable by non-residents.
If the international company ceases to operate through a reorganisation and a legal entity without the status of an international company is merged into it, then the company in question loses its status. The status does not pass under the procedure of succession to another legal entity in the event of a spin-off or merger. A change of the organisational and legal form or an absorption of an international company within the same special administrative district does not lead to the status being lost. In the event of a spin-off only the party making the spin-off retains its status.
The termination of the status means that the company becomes a standard limited liability company or joint stock company.
Tax advantages of redomiciling
The status of an international company may be supplemented by the use of tax advantages, such as international holding company (IHC) treatment, which is close to the preferential treatment of holding companies known in foreign practice.
At the level of an IHC dividends are subject to a zero tax rate, provided that certain conditions are met, which are similar to the general conditions under which the 0% rate is applied to dividends:
1) the IHC must have a participatory interest in a ‘lower-level’ company for at least a year;
2) there is a 15% threshold for the IHC’s participation in a “lower-level” company (this is a softer rule as compared with the general rules for applying the 0% rate for dividends, whereby a 50% participation is required);
3) the “lower-level” company’s country of incorporation must not be among the jurisdictions blacklisted by the Finance Ministry.
The zero rate does not apply to the profit from disposing of a participatory interest if:
1) the interest (shares) in a “lower-level” company are contributed to the IHC’s capital or received at the time of the IHC’s reorganisation within a year before or after the company is redomiciled;
2) more than half the value of the “lower-level” company’s assets are attributable to real estate in Russia.
IHCs that were public companies as at 1 January 2018 will be able to apply the 5% withholding tax rate until 2029.A foreign person receiving income from an IHC in the form of dividends must provide to the IHC confirmation that it is the beneficial owner of income.
The rule regarding the application of the 5% withholding tax rate is aimed at softening the implications faced by international companies being redomiciled in terms of payments to foreign persons. Prior to being redomiciled, an IHC could lawfully use the tax benefits in the former country of incorporation when distributing profits to third countries.
At the level of an IHC, the profit of “lower-level” CFCs in the participation structure is exempted from taxation until 2029.
Redomiciling allows for marketable bonds to be exempted from withholding tax thereby making an IHC treated on the same footing as a Russian company.
To apply the tax treatment of an IHC, persons holding a substantial participatory interest in controlling a group must have received such participatory interest before 1 January 2017. If a new person with a substantial participatory interest appears in the IHC within a year, the advantages are lost. The restrictions are not applicable to public companies that had this status at the start of 2018 and to international companies with 100% direct or indirect participation in the specified international public companies. In relation to such companies there is a requirement that they should be initially incorporated before 2018.
In terms of participation in control over a group (for individuals, jointly with spouses and children of minority age), the materiality threshold has been determined as more than 15%.
To apply the tax treatment an IHC needs to file with the tax authority, within 15 days after the international company is registered as a Russian company, a report containing an auditor’s opinion and information about the controlling persons.
The Russian Tax Code sets out the rules for determining the value of a redomiciled foreign company’s property. As a rule, such value is determined based on the data from the foreign company's accounting records. The value of participatory interests is determined based on the actual expenses on their acquisition as confirmed by documents.
If companies are redomiciled before 31 December 2019, they are eligible for special terms: participatory interests and securities are applied at the market value, even if no costs in the relevant amount have been incurred. We note that the same rules apply to a foreign company recognised as a tax resident of Russia (which is relevant if this way is chosen for terminating the foreign legal entity’s status of a CFC).