This client note is the first in a series of regular briefings providing an update on recent developments relevant to organisations based in the Channel Islands and Cayman Islands who have Russian clients, or have an interest in developing business in Russia and the wider CIS region.
Significant changes to the Russian tax code – purportedly aimed at the "deoffshorisation" of the Russian economy and introducing, among other things, controlled foreign companies (CFCs) and corporate Russian residency taxation rules – have been in force since 1 January of this year (the CFC Rules). See our briefing of January 2015 here: http:// www.collascrill.com/media/138689/9750_ cc_lit_jsy_russian_deoffshorization_d4.pdf
There have been a number of recent amendments made to the CFC Rules (the Amendments), the most significant of which exempt trusts, foundations and similar structures from the CFC Rules regime, provided certain criteria regarding the control and management of the assets of the structure (and related payment flows) are met.
In addition, the basis on which the Russian authorities will be entitled to recognise a foreign corporate entity as Russian tax resident has been refined, and a new exemption from the CFC Rules has been introduced for Russian tax residents investing (directly or indirectly) through Russian listed vehicles.
On 22 June 2015, the European Council formally extended the European Union's economic sanctions against Russia (the Russia Sanctions) by six months. The Russia Sanctions – unless further amended or extended – now expire on 31 January 2016.
THE CFC RULES: A QUICK REFRESHER
From 1 January 2015 a Russian tax resident is liable to profits tax on the undistributed profits of any foreign entity controlled by it, in proportion to such controlling stake or participation, generally at the rate of 13% (if an individual) or 20% (if a corporate entity).
Under the CFC Rules, a foreign entity is a company, organisation or other structure that is not itself Russian tax resident and is controlled (as below) by a Russian tax resident.
A Russian tax resident is deemed to control such foreign entity where such tax resident:
- is deemed a legal participant for CFC Rules purposes in the relevant foreign entity (see below); or
- otherwise has the ability to exercise a decisive influence on the distribution of profit (directly or indirectly) of such foreign entity.
For the purposes of calculating liability to profit tax in 2015 under the CFC Rules, a Russian tax resident will be deemed to control any foreign entity in which its direct or indirect ownership stake or participation (including any participation through structures such as trusts, foundations or funds) exceeds 50%.
From 1 January 2016 the 50% control threshold will reduce to:
- 25%; or
- where the aggregate (direct or indirect) participation of Russian tax residents, including unrelated persons, in the foreign entity is greater than 50%, 10%.
The CFC Rules exempt certain CFCs from Russian profit tax liability (including non-profit organisations; Eurobond issuance vehicles; and certain arrangements in which the ability to receive or control the distribution of profit is limited, or a double tax treaty with certain approved jurisdictions is available).
In addition, a profit floor per CFC of RUB 50 million (2015); RUB 30 million (2016) and RUB 10 million (thereafter) applies, below which no tax will be due.
AMENDMENTS TO THE CFC RULES
The Amendments were signed into law by President Putin on 8 June 2015, and form part of a wider review and discussion with stakeholders on the CFC Rules. It is anticipated that further changes will be forthcoming, with the State Duma due to consider further amendments to be proposed by the Russian Ministry of Finance in the autumn of this year.
New control criteria for non-corporate structures
Under the CFC Rules, a Russian tax resident settlor of any foreign entity other than a corporate structure would generally be assumed to control it (though the CFC Rules contained a loosely worded exemption – removed by the Amendments and replaced with the below – that arguably would have exempted discretionary trusts and similar arrangements).
The Amendments have codified an exemption to the assumption of settlor control, which is available provided the Russian tax resident settlor does not (directly or indirectly):
- retain any right to income or profit from the structure;
- retain the ability to exercise influence over, or manage, the assets or profit-related affairs of the structure;
- retain any right to reclaim assets from the structure (i.e. assets are contributed on an irrevocable basis); or
- otherwise control the structure.
It is anticipated that these control criteria will provide a basis for ensuring that structures such as discretionary trusts – if drafted appropriately – fall outside of the CFC Rules vis-ŕ-vis the settlor. It should be noted that the new Russian tax resident settlor control test is intended to also apply to foreign legal entities in which a Russian tax resident participates other than through an equity interest. As such, structures such as foundations or guarantee companies – assuming structured to avoid Russian settlor control – should also benefit.
What about beneficiaries?
Any Russian tax resident (other than the settlor) will be deemed to control such a non-equity foreign structure, provided it: (a) exercises control over the structure (as determined by the control tests under the CFC Rules); and (b)any of the following three conditions is met:
the Russian tax resident:
- is the "beneficial owner of income" from the structure (as defined in the Russian Tax Code);
- has discretion to manage the structure's assets; or
- has the right to receive assets of the structure upon its termination.
As such, provided any Russian tax resident beneficiary does not control the structure, such beneficiary should, as regards such structure, fall outside the scope of the CFC Rules.
The Amendments make welcome clarifications to other aspects of the CFC Rules. Of particular note:
- structuring participation in a CFC (directly or indirectly) through a Russian listed company or companies exempts a Russian tax resident from the CFC Rules;
- the exemptions for 'active' holding and sub-holding companies have been clarified; and
- with regard to determining Russian tax residency of foreign corporate entities:
- the primary criterion is now solely the effective place of management. The location of board meetings is itself no longer relevant; the test instead focusses on the exercise of executive management;
- where the place of management is not clear – or it is arguably both Russia and the jurisdiction of incorporation of the foreign entity – secondary criteria, such as where accounting and other corporate records are maintained or where day-to-day management of HR functions takes place, come into play.
As noted, it is anticipated that further changes will be made to the CFC Rules as the year progresses.
There are additional disclosure requirements set out in Russian legislation relating to the CFC Rules. Of particular concern has been the requirement to notify the Russian tax authorities on an annual basis of:
- any direct or indirect participation in a foreign corporate structure, provided the share of such participation exceeds 10%;
- the establishment of any foreign non-corporate structure, in addition to the right to manage or receive income from any such structure; and
- any other interest in a CFC in which the relevant Russian tax resident has control.
The first such filing was due to be made on 15 June 2015, with a relatively small fine payable on a per-structure basis for non-declaration. Initial reports in Russia suggest that, as at 15 June, just over 1000 declarations by Russian corporate tax residents have been made, with a further 2000 by individuals1.
On 22 June 2015, the European Council formally extended the Russia Sanctions, which now expire on 31 January 2016. The Russia Sanctions apply directly in Jersey and Guernsey by virtue of local implementing legislation, and in the Cayman Islands, British Virgin Islands and other British Overseas Territories through statutory instrument.
The Russia Sanctions restrict economic activity with Russia in three broad areas:
- financial: buying, selling, dealing with or providing assistance in relation to debt or equity – of greater than 30 days maturity – issued by five Russian state owned banks, three energy companies and three defence companies (and, in each case, their non-EU subsidiaries and other entities under their control);
- oil production and exploration: prohibition of certain services (and de facto involvement in) deep water, offshore Arctic or shale oil exploration or production in Russia, with a licence required to provide certain equipment relating to other oil exploration or production projects;
- military: prohibition of provision of 'dual-use' goods and technology for military or mixed defence use.
In addition, there are freezing orders in force concerning certain named individuals and corporations and their assets, and effectively a prohibition on any economic activity with Crimea (other than as permitted by the Ukrainian government).
On 24 June 2015, Russia responded by extending its 'special economic measures', which prohibit the import of certain agricultural and other products from countries including the EU member states, the United States, Canada, Australia and Norway, to August 6 2016.
In addition, other countries – most notably the United States, but also including Canada, Australia and Switzerland – have imposed their own sanctions on certain economic activity with Russia. Even where there is no direct jurisdictional nexus, these sanctions might still be applicable to certain arrangements, the most common being payments due to be made in US dollars through a US correspondent bank.
Although in many cases it will be clear whether a proposed activity is sanctioned, there are a number of 'grey areas' in which detailed analysis is required and other activities that (perhaps unintentionally) fall within the broad drafting of the Russia Sanctions.
The Amendments have added welcome clarification to the CFC Rules in a number of key areas; most particularly with regard to the establishment of discretionary trust, foundations, guarantee and cell companies, and similar arrangements. We anticipate that there will be an uptick in the establishment of such structures for Russian tax residents.
Although tax efficiency is clearly important, it should be noted that the key driver in the use of offshore structures by Russian tax residents (both corporate and individual) remains asset or investor protection. As such, the CFC Rules will likely be by another push towards a refinement of offshore structures and a flight to both quality and substance: 'reoffshorisation' rather than 'deoffshorisation'.
Russia is of course a difficult place in which to do business in the current climate, with the Russian Sanctions an important consideration in evaluating any potential structure or transactions. We recommend advice is sought in relation to any arrangements which might (even indirectly) relate to individuals, entities or sectors to which Russian Sanctions apply, in relation to structures intended to mitigate the effects of the CFC Rules, or involving Russian interests more generally. Collas Crill has been engaged by a number of clients to undertake such evaluations, or to provide insight into doing business with Russia more generally, and is uniquely positioned to offer such advice through our combination of significant Russian experience and on-island technical expertise.
1 Source: RBC.ru; 4 July 2015
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