These amendments to Instruction No. 35 were issued further to the Federal Law of 10 January 1997 No. 11-FZ which introduced basic amendments to the taxation of individuals and was discussed in our Tax Alert No. 2/97 dated 30 January 1997. In particular, the amendments provide substantial guidance on the taxation of deposit interest, insurance premiums and payments, beneficial loans and the application of the housing construction exemption.
Interest received on bank deposits is now subject to personal income tax withholding to the extent that it exceeds the Central Bank refinancing rate for rouble deposits or 15% for deposits in hard currency. Taxable income arises on the date when interest is credited to the taxpayer's account.
This applies to deposits concluded, prolonged or amended after 21 January 1997 and to new amounts deposited after 21 January 1997 under existing deposit agreements.
For rouble deposits, non-taxable income is determined having regard to the Central bank refinancing rate effective during the whole of the period for which interest is accrued on the deposit. If the refinancing rate has changed during the period, then each separate refinancing rate effective within the period should be used for the purposes of the calculation. Any new refinancing rate should be used beginning from the month following the month of its change.
Banks are responsible for completing internal tax cards according to Appendix 7 to Instruction 35. These reflect the amount of benefit received by each individual and the personal income tax withheld at source. Banks however are not required to submit to the tax authorities any information about personal income tax withheld from the deposits.
INSURANCE PREMIUMS AND PAYMENTS
In respect of insurance agreements concluded or prolonged after 21 January 1997, insurance premiums made by an employer for the benefit of an individual are subject to personal income tax withholding, unless they relate to state obligatory insurance or voluntary medical insurance under which the individuals enjoy only medical treatment and do not receive any monetary payments.
Only a limited number of insurance payments to individuals, (as mentioned in paragraph 7 of our Tax Alert No. 2/97), may be exempt from personal income tax, regardless of from which sources the respective insurance premiums were made, i.e. whether insurance premiums were made by the individual himself or by the employer for the benefit of the individual. All other insurance payments are subject to personal income tax withholding according to the procedure set out below.
Where Insurance Premiums Are Made By An Individual Himself:
personal income tax should be withheld by the insurance company at the rate of 15% of the difference between the insurance payment and the insurance premiums paid increased by a deemed profitability component established by the insurance company. Insurance companies are not required to file any information with the tax authorities about personal income tax withheld from such insurance payments, although they should complete internal tax cards in respect of each individual according to Appendix No. 7 of Instruction No. 35.
Where Individuals Are Insured At The Expense Of The Employer:
Insurance payments are subject to personal income tax withholding at source at a rate of 15% of the difference between the insurance payment and insurance premiums paid by the employer. In this case insurance companies are required to file information with the tax authorities about insurance payments made and personal income tax withheld according to Appendix No. 3 of Instruction No. 35, unless the insurance agreements provide that insurance payments are first to be transferred to the employer who then pays them out to the individuals. Under these circumstances the employer itself is responsible for personal income tax withholding and filing with the tax authorities.
Personal income tax withholding procedures as mentioned above should also apply in respect of long term (not less than five years) voluntary life insurance agreements, if they are terminated before the five year period expires. Under normal circumstances however insurance payments made under such agreements are exempt from personal income tax.
Interest Free Or Low Interest Loans
It has now been confirmed that individuals receiving beneficial loans (which include cash, bank transfers or goods valued at the market price effective on the date of the loan) shall receive deemed income computed as the positive difference between interest payable computed at two thirds of the Central Bank refinancing rate for the rouble loans or 10% for hard currency loans, and the actual interest paid. For interest free loans, loans without established dates of repayment and loans repayable upon request, the deemed income is imputed at two thirds of the Central Bank refinancing rate for the rouble loans and 10% for hard currency loans. This applies to all loan agreements concluded or prolonged after 21 January 1997.
For rouble loans, the Central bank refinancing rate effective during the whole period of the loan should be used for the purposes of the tax calculation. New refinancing rates should be taken into account from the beginning of the month following the month of its change.
Deemed income must be calculated on a monthly basis for the entire period of the loan based on the interest discount multiplied by the balance of loan outstanding at monthly rests. Personal income tax based on the total amount of deemed income received during the calendar year appears however to be calculated once a year. Thus, if loan is repaid before the end of the year, the deemed income 'earned' during the period of the loan should still be calculated along with personal income tax due.
It is still unclear whether the individual should file a tax declaration to declare the amount of deemed income 'earned' during the calendar year, or the employer (or other company providing the loan) should withhold the tax from other remuneration paid to the individual. Although the tax authorities may argue that the latter approach is supported by legislation (income received from the enterprises, institutions, organisations an other employers is generally subject to personal income tax withholding at source), there might be practical difficulties with this respect, especially where no other remuneration is paid to the individual by the lender.
Where a loan is provided by an entity other than the individual's employer, it appears that a tax declaration should be filed by the individual to reflect non-employment income received during the calendar year. It also appears likely that a tax declaration should be filed by individuals who receive beneficial loans from unregistered foreign companies.
We believe however that the tax declaration should not be filed if a loan is provided by the individual's employer and personal income tax is withheld by the company in full from deemed income 'earned' by the individual.
No Deemed Income Is Calculated In Respect Of The Following Payments:
- loans provided by the employer against upcoming salary payments to the individual if given for less than one month and provided that these do not exceed the amount of the monthly salary;
- loans provided to individuals who have entered into life insurance agreements, unless these exceed the amount of the insurance premium paid;
- housing loans granted to the individuals under special government or municipal programs.
Housing Construction Exemption
It has now been confirmed that the housing construction exemption may be used by an individual only once in a lifetime. The amount of the exemption has been confirmed as 5,000 minimum monthly wages over a three year period but that the total claim may not exceed the individual's total gross income.
Based on the wording of the Instruction however it is not clear if the exemption is available during any three years of construction or consecutive three years. In addition, according to recent Letter of the Moscow State Tax Inspectorate No. 11-13/6091 dated 27 March 1997, it appears that exemption may be exercised during any ( though possibly not consecutive) years.
The new system applies to all purchase or construction contracts which were concluded after 21 January 1997. For individuals who started claiming the housing exemption in 1995, 1996 or before 22 January 1997, the old procedure should be followed and a maximum of 5,000 monthly minimum wages claimed for each year. Individuals who already used the housing deduction before 22 January 1997 may now apply for the exemption according to the new procedure.
The exemption is also available against repayments of bank loans received for the purposes of purchase (construction). The maximum exempt amount is the actual amount of loan principal and interest payable to the bank within the three year period. Loans provided by the enterprises and other credit institutions which are not licensed to such kind of operations do not attract this relief.
If actual housing expenses incurred by an individual during the calendar year exceed gross income received for the year, the excess may be offset against income received during the next two years, always provided that the 5,000 times monthly minimum wages for the three year period limit is not exceeded.
If an individual improperly claims the housing exemption, any benefit incorrectly accrued thereby may be treated as concealed income. This will create an exposure to severe financial or, in certain circumstances, criminal penalties.
The amended Instruction now clearly states that a spouse or other family member(s) of the individual may apply for this exemption only if they are listed as the joint purchasers (constructors) in the purchase (construction) documentation, regardless of whether they are treated as the joint owners of the property according to Russian legislation.
If you feel that any of the issues discussed above affect you or your employees, please contact your usual representative at Coopers & Lybrand in either Moscow or St Petersburg.
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.
For further information contact Alla Shaulina on tel: +7 503 232 5511 fax: +7 503 232 5522 or e-mail directly: Alla_Shaulina@ru.coopers.com or enter a text search 'Coopers & Lybrand' and 'Business Monitor'.