Russian legal entities, with or without foreign shareholders, branches ('filials') of Russian or foreign companies), and representative offices undertaking activities which are not protected under the terms of the relevant double tax treaty, are subject to profits tax in Russia on profits, including capital gains. A Russian legal entity is taxable on worldwide profits and a foreign legal entity on income and profits from sources in, or from activities performed in, Russia.
BASIS
All Russian legal entities are required to keep accounting records according to the prescribed Russian accounting system. The principal purpose of this system is to establish the tax base - few adjustments are therefore required for tax purposes. Sales income for profits tax purposes may be computed either on a cash or on an accruals basis (subject to an annual election), but from 1 October 1996, most taxpayers will be required to use the accruals basis. Expenditure is generally allowed on an accruals basis. The accounting year runs from 1 January to the following 31 December.
The Russian accounts of a legal entity with foreign shareholders (as well as those with a certain number of shareholders or in excess of a certain turnover) must be independently audited. Generally, where there is a significant overseas shareholding, accounting and audit according to international accounting standards will also often be required.
Representative offices and branches are subject to profits tax on substantially the same basis (but not currently required to follow the Russian accounting system) although where it is not possible to calculate the profit, for example because services are provided without charge to another group company, a deemed profit, usually 25% of costs attributable to such activities, is used as the tax base.
Where a foreign legal entity has no presence in Russia but has a source of income in Russia, a withholding tax will apply instead of profits tax.
RATE
Profits Tax consists of two elements:
- Federal Tax of 13%
- Local Tax of up to 22% (30% for banks and insurance companies)
The maximum combined rate in Moscow is therefore 35%. In St Petersburg, where the local rate is one per cent less, the combined rate is 34%.
Certain types of business, for example gaming, are taxed at much higher rates on the basis of net income rather than profits.
Withholding tax rates where a foreign legal entity has no presence in Russia are as follows:
INCOME SOURCE WITHHOLDING Dividend income and other income from participation in Russian entities, and interest 15% Freight earnings 6% Royalties, rents, lease income, management fees and other income 20%
These rates may be reduced under the terms of the relevant Double Tax Treaty on application to the Russian tax authorities. Treaty protection should be claimed within one year of the period to which it relates.
CALCULATION OF TAX BASE
Most types of expenditure are deductible, including for a branch or representative office those expenses which are attributable to the Russian activities but incurred by the head office company. The following restrictions should however be noted:
- Expenditure on training, entertaining and advertising may only be deducted up to a limit expressed as a percentage of turnover.
- Interest paid to banks, except on overdue loans, is generally deductible subject to a ceiling on the maximum rate of interest. Interest paid to other creditors, except on supplier credit, is not usually deductible. A double tax treaty may improve this position.
- Business travelling expenses are only deductible within specified norms.
Following a recent Presidential decree, the rules concerning the deductibility of these items are likely to be eased.
DEPRECIATION FOR TAX PURPOSES
Depreciation and amortization are calculated under the statutory accounting code, on a straight line basis, and generally with assumed asset lives significantly longer than is generally the case in most jurisdictions (except for some technologically advanced equipment). The cost of acquiring land, mineral and forest rights and other natural resources may be deductible through depletion allowances. Intangible assets, including leases, are amortized over the shorter of the life of the asset and the period of activity of the company. If the useful life of the asset cannot be ascertained, the amortization period is ten years.
Tax depreciation is calculated from the date that the asset is brought into use until the date of its disposal or when it is written off. If the asset is acquired or disposed of during the year, depreciation should be pro-rated accordingly.
Depreciation rates vary considerably depending on the nature of the asset and its use. In practice, it is extremely difficult to account correctly for depreciation due to the complexity of the prescribed rates.
MAIN DEPRECIATION RATES
Buildings Stone/cement structure 0.4 - 1.7%
Wooden structure 2.0 - 5.0%
Impermanent structure 10.0%
Machinery, plant General rate 4.0 - 33.3%
and equipment Computers and technological
equipment 7.1 - 12.5%
Vehicles 6.7 - 20.0%
LOSSES CARRIED FORWARD
Russian entities may carry forward losses for up to five years. Losses may not be carried forward by foreign companies, unless the non-discrimination provisions of an double tax treaty apply. Losses are not indexed to reflect inflation.
Taken together with capital investment allowance (see further below) and other tax incentives, a loss brought forward from an earlier year cannot reduce the tax liability by more than 50%.
Losses cannot be surrendered to related Russian companies - there is no consolidation for tax purposes.
GENERAL RELIEFS
Capital investment allowance
Taxable profit can be reduced by the amount used to finance capital investment (after accumulated depreciation is exhausted). Taken together with loss relief (see above), the tax liability cannot be reduced by more than 50% of taxable income in the year of expenditure. It is deducted in addition to depreciation and amortisation.
Transfers to reserves
In certain circumstances, taxable profit may be reduced by transfers to reserves of an amount up to 50% of taxable profit provided the reserve fund does not exceed 25% of the company's Charter capital. Charter capital is recorded in roubles, therefore to the extent that the rouble devalues, the tax planning value of such transfers is limited.
Tax holiday
There is a two year exemption from profits tax for companies which satisfy the following conditions:
- The average number of workers does not exceed 200 (for industrial and construction companies - fewer for other types of enterprise).
- The company derives more than 70% of turnover from the production or processing foodstuffs, consumer and medical goods, construction of residential, production or social facilities.
Provided that qualifying activities account for at least 90% of the company's turnover in its third and fourth years of operation, profits are taxed respectively at 25% and 50% of the statutory tax rate.
Reliefs for companies with foreign participation
There is currently no tax holiday or relief available in respect of the Federal portion of profits tax for foreign investors, unless the small company exemption described above applies, or the company was registered before 1 January 1992, when a similar exemption for the first two years (25% and 50% of the statutory rate for the third and fourth years) applies. It may be possible, however, to negotiate relief in respect of the local portion with the relevant local authority. There is a limited number of other tax and duty reliefs related to foreign investment in Russia covered elsewhere in this guide.
Anti-avoidance
A company which sells stock or assets at a price less than cost is broadly deemed to sell them at market value. However, there are no general transfer pricing rules.
There are no rules to counter thin capitalization, although there is the current practical disadvantage of inter-company loan finance relating to the general non-deductibility of interest.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.