Russian Federation: Tax Alert 18/95 - 8 November 1995

Last Updated: 20 November 1995

1. In this Tax Alert we summarize:

- tax implications applicable to lease arrangements as they are currently developing in Russia

- the rules for the deductibility of interest on loans payable by Russian companies, and

- amendments to the property tax rules for foreign companies

- possible changes in official attitudes to the tax status of sales out of customs (bonded) warehouses.


2. In Russia two major types of lease arrangements are recognized: `short-term' and `long-term', although they are not primarily distinguished by length of lease period. They are defined in accounting regulations, mainly in the Chart of Accounts, and their differing tax implications are greatly influenced by the accounting treatment.

3. A long-term lease is defined as a lease under which the lessee has the right to purchase the leased asset on expiry of the lease, or the right to pay the balance of outstanding lease payments during the course of the lease and thereby acquire ownership of the asset. This concept is therefore close to the concept of finance lease or hire-purchase, as generally understood, although there may be cases where such arrangements would not qualify as a Russian long-term lease.

4. A short-term lease, on the other hand, is a lease which does not confer on the lessee a right to acquire ownership of the leased assets, and is broadly similar to an operating lease.

5. A recent clarification of the tax authorities, effective from 1 January 1996 (sic), which specifically considers `leasing activity' suggests that `leasing' is to be treated on the basis hitherto applicable to `short-term' leases for accounting purposes, notwithstanding any purchase option, although there remain some differences in tax treatment.

6. Based on the Temporary Leasing Provisions of 29 June 1995, our understanding is that the term `leasing activity' or `finance lease' refers to specialised leasing activity, specifically, where an asset is purchased by leasing company at the behest of the lessee and is subsequently leased. `Leasing activity' does not refer to lease arrangements for terms substantially shorter than the prescribed useful life of the asset.

7. In this Tax Alert we do not examine the tax implications of `leasing activity' in detail, as these are likely to affect mainly specialised leasing companies, however, we would be pleased to provide further information if required. The treatment of the two principal kinds of lease as applicable to companies, other than specialised leasing companies, is summarized below.

`Long-term' leases

8. An asset subject to a long-term lease leaves the balance sheet of the lessor and is booked to the balance sheet of the lessee. Consequently, the lessee depreciates the asset and the depreciation may be deducted for tax purposes if the leased asset is used in production. The lease rental payments will not be tax deductible. The taxable income of the lessor is the excess of lease rentals receivable over the net book value of the asset at the time of transfer, recognised over the term of the lease on the basis of actual receipts.

9. While the asset remains on the balance sheet of the lessee, the lessee will be liable to property tax on the net book value of the asset. Any expenses incurred by the lessee on the leased asset should be either deducted or capitalised by the lessee, as appropriate.

10. Under current value added tax and special tax (together `VAT') legislation, a lease constitutes a service and is therefore subject to tax at the rates of 20% and 1.5%. VAT charged by the lessor would be treated as normal output VAT, and as input VAT of the lessee. However, because of the special treatment of input VAT on fixed assets the input tax would be creditable only after title to the leased asset passes to the lessee; that is, it would generally be recoverable over a six month period from the expiry of the lease.

11. This treatment contrasts with that under a sale by instalment or financed by commercial debt, for example, under which title to the asset would pass on commencement of the arrangement and the purchaser would be able to offset VAT from that point. Moreover, the accounting treatment of an instalment sale would normally permit a qualifying purchaser to claim an investment credit deduction for such instalment payments, which would not be possible under a long-term lease.

12. Currently lease rental income is not subject to turnover taxes.

`Short-term' leases

13. An asset subject to short-term lease remains on the balance sheet of the lessor, who is entitled to depreciation on the asset. The lessee is entitled to deduct lease rentals for profits tax purposes if the asset is used in production. Under this treatment, all VAT invoiced by the lessor is recoverable as input tax on payment by the lessee.

14. Since the asset remains on the balance sheet of the lessor, property tax is payable by the lessor. Expenses incurred by the lessor in relation to the leased asset may be deducted or capitalised, as appropriate. The lessor should seek to establish lease rentals at a level exceeding depreciation, otherwise the tax authorities may seek to adjust rentals for profits tax and VAT purposes to their conception of `market value'.

15. As with long-term leases, short-term lease rentals are not subject to turnover taxes.


16. Only a brief summary of the tax implications applicable to various lease arrangements can be provided here. A range of tax-efficient structuring possibilities may be available, subject to commercial and contractual constraints. Where a foreign entity is involved in the transaction, additional complexities would arise.

17. When considering the use of leasing arrangements in Russia, therefore, we recommend that professional tax and legal advice are obtained at an early stage.


18. New rules for interest deductibility were introduced with effect from 1 January 1995. Currently interest incurred by Russian companies may be deducted for profits tax purposes in the following circumstances:

- bank interest limited to the Central Bank rate plus 3% for Rouble loans or LIBOR plus 3% for loans taken in hard currency, except interest paid on

- overdue loans

- loans received for the purchase of fixed assets, tangible or intangible, which should be capitalised as part of the value of the relative fixed asset within the limits applicable to the bank loans, or

- interest on loans funding non-production expenses, although often it is impossible in practice to identify convincingly such a purpose

- interest on debt granted by suppliers of goods, works or services, with the exception of interest paid on overdue debt.

19. There is as yet no official clarification as to the LIBOR rate to be used in calculating the limit, especially where no LIBOR rate corresponds with the term of the actual debt. Informal advice from within the State Tax Service has suggested that, given the variety of LIBOR rates and the absence of any clarification, taxpayers are entitled to apply the rule previously applicable, which referred only to the Central Bank of Russia Rouble rate. This approach should be defendable in the circumstances, but is also aggressive.

20. The more conservative approach that we would recommend would be to apply the limitation by reference to the most closely analogous LIBOR rate or, if there is no such rate, a rate generally obtainable in a major financial market for similar financing.

21. We have information that consideration is being given to changing the rules on the deductibility of interest on hard currency debt retroactively from 1 January 1995.

22. It should be noted that some recent double tax treaties, and the protocols and exchanges of letters forming part of them, purport to secure for entities entitled to benefit much broader deductibility of interest than is available under Russian domestic legislation. It should be noted, however, that the effect of such provisions is relatively untested and requires careful consideration before reliance is placed on them.


23. The new Instruction No. 38 on property tax payable by foreign legal entities in Russia (`FLEs') has been issued and registered with the Ministry of Justice, although not yet officially published. We expect it, however, to be in force in time for, and to apply to, 1995 calculations, at least for the final quarter. We summarise below the main differences between the old and new Instructions.

Definition of taxpayers

24. Under the old Instruction, property tax was payable only by an FLE which had a representation or division on the territory of Russia. The new instruction expands the definition to FLEs include those which own assets located in Russia.

25. FLEs having representations are now required to maintain registers of fixed assets in a standard format, including the date of purchase or receipt of property from the head office, initial value, current value on the first date of each quarter, depreciation rates, etc.

26. FLEs with no presence in Russia are required to report to the State Tax Service and to the local authorities responsible for the region in which assets are located.

Taxable property

27. The new instruction provides that taxable property shall include:

- leased property under a long-term lease (see above)

- property belonging to the FLE under any Joint Activity Agreement

- notional work in progress calculated by reference to a formula, where its actual value cannot be determined.

28. Tax is not due on property brought into Russia under foreign trade contracts until ownership passes to the importer, or to the ultimate customer for goods consigned for sale through commission agents, when the importer or purchaser becomes liable to the tax.

Depreciation limits and property valuation

29. Under the old Instruction FLEs were allowed to use the depreciation rates established at head office level in their country of origin, whereas the new instruction introduces the following maximum limits:
-    Category A: buildings                              5%

-    Category B: cars, office furniture and equipment   25%

-    Category C: other property                         15%
30. These rates are applied to the Rouble written down value of property bought for Roubles. If it was acquired for foreign currency (including funds from head office), the property is to be accounted for in the currency of purchase, with yearly recalculation of its value into Roubles at the exchange rate at the end of the reporting period.

31. The value of equipment for property tax should include transportation and installation costs, customs duties and similar costs. If there are no documents confirming the value of property, the market value shall be taken.

Taxable event

32. The following definitions of the time at which property first becomes taxable is provided in the new Instruction:

- for property received from head office, the date of the customs declaration on import

- for property purchased, the time title of ownership is acquired

- for property under long-term lease, the date the lease commences.


33. FLEs having a presence in Russia are required by the new Instruction to pay property tax from an account with a bank in Russia. This requirement is similar to that introduced by the new profits tax instruction this summer, although it is at present unclear how the tax authorities would seek to enforce this requirement. We would, however, recommend that taxpayers comply where possible. Where compliance would create significant difficulties, we would be pleased to discuss possible solutions.

34. The Instruction recognises that exemptions may be provided from property tax under double tax treaties and confirms that treaties have priority over any conflicting Russian tax legislation. It may be noted, however, that the form of application for treaty exemption annexed to the Instruction requires confirmation by the tax authorities in the country of residence of the FLE, as is the case for profits tax. We recommend those eligible for exemption commence application procedures as soon as possible, where the amount of tax in question justifies the time and effort involved.


35. The explanations set out above demonstrate that the tax authorities are becoming more precise and sophisticated in their regulations, whilst not necessarily recognizing the extent of the compliance burden placed on taxpayers relative to the revenue in question. Taxpayers are expected to maintain high levels of tax knowledge and compliance, in a penalty environment that remains highly adverse.

36. If you have any doubts about the property tax status of your company in Russia, or need help with compliance, please call or fax your usual contact in our tax department.


37. A foreign legal entity ('FLE') importing goods into Russia on terms under which ownership title passes to the customer in Russia before the goods enter Russian territory has long been exempt from tax on such profits, even if the FLE maintains a place of business or affiliated agency in Russia. Sales out of a warehouse situated on Russian territory are, however, specifically subject to profits tax.

38. Under a 1992 Finance Ministry ruling, for profits tax purposes a customs (bonded) warehouse was not to be treated as being on Russian territory, so that sales out of such warehouses might also be treated as profits tax exempt. In addition, such sales were in practice generally treated as not subject to VAT, since the VAT would be paid by the customer when clearing the goods out of the customs warehouse.

39. Recently there have been indications that the attitude of tax inspectors on this issue is beginning to change, and that sales out of customs warehouses may in future be treated as taxable. Although arguably in conformity with the law, this would represent a significant change in approach and, in relation to VAT especially, could produce some illogical results. We are seeking clarification, but in the meantime, any client who is relying on previous practice is invited to contact us to discuss how any exposures might be limited.

This publication is intended for general guidance only and should not form the basis of specific decisions.

For further information contact the firm on +7 503 232 5511, or enter a text search "Coopers and Lybrand" and "Business Monitor".

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