Faced with a need to shore up tax revenue, stagnation in GDP growth and economic sanctions as a result of the Ukraine crisis, President Vladimir Putin has implemented his first measure in order to bring major companies back into the Russian taxman's orbit. As Russia's state expenditure grows, Putin believes that "de-offshorisation" is the key to balancing the state budget, as was done in 2013 by raiding the country's oil industry's piggybanks. These proposed rules are under public discussion and are anticipated to come into force on 1 January 2015.
The proposed new rules have focus on three key aspects, aiming to combat tax avoidance when profits are transferred from countries where they are generated to tax havens:
- foreign entities being classified as Russian Tax residents;
- taxation of controlled foreign companies ("CFCs"); and
- taxation of indirect Russian real estate sales.
As they stand, these new rules will require Russian tax residents (either individuals or entities) to pay tax in Russia on retained earnings that are directly or indirectly controlled by the given individual or entity having their management and control in a 'blacklisted' jurisdiction. The current list only contains certain offshore jurisdictions, but this could be expanded to include jurisdictions that have double tax treaties with Russia (such as Cyprus). This threshold of control has been placed at a mere 10% of direct or indirect equity participation.
Russian individuals and entities will soon be required to notify the tax authorities on two occasions: (1) on any direct or indirect ownership exceeding 1% of interests held in foreign corporations; and (2) if an entity falls under the CFC classification. Failure to notify the tax authorities on such matters will result in financial penalties.
The new rules will also recognise foreign entities as Russian tax residents if they are managed from Russia. Entities whose corporate governance or board meetings that are conducted in Russia will therefore be subject to Russian tax rules.
Entities in which over 50% of its assets are directly or indirectly composed of Russian real estate will also be subject to corporate income tax in Russia if such foreign companies earn income from sales of shares or interests.
A number of exceptions to the above rules have come to light. If such entity is listed on a reputable and recognised market, or if the CFC is currently under a jurisdiction where it has a corporate tax rate of more than 15% or if the CFC is a non-profit organization which does not distribute profits, then such entity would not fall under the onus imposed by the proposed rules.
Even with these exemptions, the new rules will undoubtedly impact all market players, in particular individuals who use offshore vehicles which consist of controlling assets in both Russia and abroad, Russian entities with overseas subsidiaries and Russian strategic investors with minority interests in foreign companies. The 10% control threshold is very low as this would not give the shareholder any material influence on the corporate policies regarding the distribution of assets or other corporate operations. If these rules remain unchanged, they will likely lead to an increase in the reorganisation of complex corporate structures and the migration of companies back to the Russian jurisdiction which can be expensive and time consuming. Once done so, the company's tax burden is likely to increase substantially, falling under Russia's 20%corporate tax rate on profit, and capitalisation may fall as a result.
Please note that the proposed changes are not expected to take effect until 1 January 2015 and that the draft legislation is currently under public discussion and could be significantly altered before it comes into force.