Recent times were difficult for Russian entrepreneurs and Russian businesses with an international presence. The future looks even more uncertain.
Russia has been speculating about introducing anti-offshore measures already for several years. Some measures have already been introduced. However, as the volume of capital flight from Russia to foreign jurisdictions shows no sign of shrinking, the Russian President in his state-of-the-nation address in December 2013 stressed the need for urgent measures to "deoffshorise" the economy. The new legislation may be in force as early as 2015.
It is now the right time to review your existing structures – both corporate and private - so as to assess possible risks and identify future strategies. New structures should be carefully thought through to ensure compliance with the best international practices.
According to the President's address, companies registered in offshore jurisdictions should pay taxes in Russia if they are owned by Russian residents. Also these companies should not be able to access state support mechanisms and state contracts.
As a result, the Russian Finance Ministry and Economics Ministry have been instructed to put forward draft legislation aimed at combating the use of low-tax jurisdictions to minimize tax payments. We set out below a summary of the main tax legislative initiatives.
1. Controlled foreign company legislation
A definition of a controlled foreign company ('CFC') is planned to be introduced into Russian tax legislation together with a regime for taxing CFCs. The introduction of CFC rules would effectively mean that tax is levied on income of foreign companies that are directly or indirectly controlled by Russian resident individuals or Russian resident legal entities if those foreign companies do not distribute their profits to a Russian shareholder.
2. Russian tax residence of companies – "effective management" test
Currently, a company can be a Russian tax resident only if it is registered in Russia. Foreign company is only taxed in Russia if it has a permanent establishment or receives passive income from Russian sources. The current proposal is to introduce the test of effective management as an alternative test to define Russian tax residency of a company. It means that companies which are managed and controlled in Russia will be subject to Russian taxes regardless of the place of their registration.
3. Definition of beneficial ownership
According to the majority of Russian double tax treaties, only beneficial owners can obtain preferential tax rates, for example, the 5% withholding tax rate on dividends paid from a Russian company to its Cypriot parent. Currently, the Russian domestic tax legislation does not have a clear definition of beneficial ownership. As a result, the term "beneficial ownership" is open to interpretation. It is proposed to introduce an unambiguous definition into Russian tax legislation, so to allow the government to tackle tax avoidance and treaty abuse.
4. Exchange of information
Exchange of tax information between states allows the Russian tax authorities to obtain information about foreign operations of Russian taxpayers. Presently, Russia has limited instruments for obtaining tax information from abroad, i.e. only bilateral tax treaties. It is proposed to widen the means of obtaining tax information. One suggested measure is to conclude bilateral tax information exchange agreements with offshore jurisdictions. Another measure is to ratify the international convention on mutual administrative assistance in tax matters.
What to do?
At this stage it is hard to predict how the new legislation will be drafted, and therefore, to make specific recommendations. However, as all the above proposals are in line with current international trends, it is possible to suggest a number of steps which can be taken now.
1. Substance and proper management of international corporate structures
Many Russian companies with international presence often establish subsidiaries in low-tax jurisdictions to enjoy the advantages that this can provide. As a part of the "deoffshorisation" campaign in Russia and also the global fight against tax fraud and 'treaty shopping", companies can be challenged to show their overseas operations are genuine subsidiaries and are run from the host countries.
In practice, many Russian corporate groups might not have an appropriate level of substance in the jurisdictions of incorporation of their holding, trading, financing or licensing structures. This means that companies cannot show that the management, control and day-to-day decisions concerning business activity are taken in the country where such company is based.
Implementation of the proposed "deofshorization" measures will provide the Russian tax authorities with a legal mechanism for taxing structures with insufficient substance. Increased exchange of information will allow the authorities to track down those structures and tax their Russian owners. Consequently, we strongly recommend that as a matter of urgency you should review your international arrangements from a management and control perspective.
2. Trusts and foundations
It is also important to review your trust and foundation structures to ensure compliance with the present day legal environment.
Whether you have a family trust or a trust set up to support your children, a trust which holds only real estate or your businesses - these structures serve various purposes, have different tax implications and should be reviewed and revised in accordance with specifics and planning options available for each of them separately.
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.