Russia has recently introduced significant changes to its tax code1 – dubbed the "deoffshorization law"– intended to restrict the use of offshore corporate and trust structures controlled by Russian taxpayers, by taxing profits made through such structures, that have not otherwise been distributed back into Russia.
This note provides a high-level overview of some of the key changes, and is relevant to anyone connected with the structuring, establishment or maintenance of corporate or private wealth arrangements for Russian clients.
SPEED READ: WHAT'S HAPPENED?
From 1 January 2015, undistributed profits deemed made by a foreign company, trust, or other structure controlled by a Russian tax resident will be liable to profit tax in Russia, under new controlled foreign company rules (the CFC Rules). In addition, in certain circumstances foreign entities may themselves be deemed Russian tax resident. The CFC Rules are expected to result in the increased use of foundations, private trust companies, cell companies and the like – and jurisdictions offering same, such as Jersey, Guernsey and the Cayman Islands – in the offshore arrangements of certain Russian tax residents going forward.
THE CFC RULES
From 1 January 2015, a Russian tax resident must pay profits tax on the undistributed profits of any foreign entity controlled by it, in proportion to such controlling stake or participation, at the rate of 13% (if an individual) or 20% (if a corporate entity). A Russian tax resident is deemed to have Control of a foreign entity for the purposes of the CFC Rules if, for the purposes of calculating tax in 2015, its direct or indirect ownership stake or participation exceeds 50%. From 2016 the threshold will be lower, with:
- a direct or indirect stake or participation which exceeds 25%; or
- if the aggregate participation of Russian tax residents in the foreign entity is greater than 50%, a stake or participation which exceeds just 10%,
sufficient to establish control for the purposes of the CFC Rules.
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 above) by a Russian tax resident.
Any tax due under the CFC Rules will be taxed in the Russian tax year immediately following the end of the financial year in which the profit was made.
There are detailed provisions in the CFC Rules regarding the calculation of undistributed profit, and permitted adjustments, which are outside the scope of this note.
EXEMPTIONS TO THE CFC RULES
A number of exemptions to the CFC Rules were proposed as the rules were being developed. Of those that made it into the final version, the following are particularly of note:
- non-profit organisations;
- certain non-corporate foreign entities where the right to receive or control the distribution of profits is limited or prohibited;
- foreign entities that can rely on an applicable double tax treaty with the Russian Federation (provided the relevant country is not on a 'blacklist' to be developed by the Russian authorities), but only in certain circumstances;
- foreign entities established for the issuance of Eurobonds, provided at least 90% of the income of such entity directly relates to such issuance;
- foreign entities that are part of wider profit-sharing, licensing or service arrangements , provided at least 90% of the income of such entity directly relates to such arrangements
DEEMED RUSSIAN TAX RESIDENCY OF A FOREIGN ENTITY
A foreign entity itself may find itself classified as a Russian tax resident if its "place of effective management" is deemed to be Russia. In broad terms, this might be the case where:
- the majority of board meetings;
- senior management executive functions; or
- accounting and/or operational Management
of the foreign entity take place in Russia.
The substance of the arrangements is key and there are a number of exemptions, including, for example, where preparatory work for meetings takes place in Russia but a majority of the actual meetings are held outside the country.
INITIAL NOTIFICATION REQUIREMENTS
Tax residents must generally notify the Russian tax authorities of any existing direct or indirect participation in foreign entities by 1 April 2015.
WHAT DO YOU NEED TO DO NOW?
The Amendments mark a significant change in direction in the approach of the Russian tax authorities to the use of offshore structures by Russian tax residents.
Now is the time for a full root and branch review of existing offshore structures and consideration of potential solutions. Depending on individual circumstances, such solutions might range from exiting structures and repatriating capital to Russia to restructuring and the increased use of corporate and trust vehicles that fall outside of the CFC Rules, and jurisdictions such as Jersey, Guernsey and the Cayman Islands.
1 through the adoption on 24 November 2014 of Federal Law No 376-FZ "On amending Parts I and II of the Russian Federation Tax Code (in respect of the taxation of the profits of controlled foreign companies)"
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.