REPRESENTATIVE OFFICES AND INTERCOMPANY LOANS
1. In this Tax Alert we cover a variety of topical issues which have been mentioned in previous publications but which deserve further comment.
Hard currency salaries for employees of representative offices
2. A Russian citizen who only has one place of work and who has no other source of income does not usually have to file a personal tax declaration since all income tax is withheld by the employer. Individuals with several sources of income have to file a separate tax declaration with their local tax inspectorate.
3. One exception to this general practice is where foreign legal entities pay remuneration to their Russian representative office employees in hard currency, in which case the employee is required to file a personal tax declaration and pay the income tax on assessment. A letter of the Moscow Tax Inspectorate issued late last year implied that a foreign legal entity in this situation had to withhold personal income tax, but the authorities have commented verbally that this is not required if the employee provides a certificate of registration with the tax inspectorate where he lives.
4. Another recently issued letter of the Moscow Tax Inspectorate states that where remuneration has been paid during 1995 from abroad to a Russian employee working in a representative office , an analysis must be provided of the amount of income paid, taxes withheld and the residential address of each employee. There is a form for this purpose in Appendix 3 to Instruction 35 of the State Tax Service "On personal income tax". The list should include not only staff employed directly by the head office company under a labour agreement but also seconded Rusian staff who are employed by other companies but who physically work in the representative office. According to the letter, these declarations have to be filed by 1 March 1995, presumably intended to be 1 March 1996.
5. The representative office must also report on which foreign staff have worked in the representative office, including "specialists" working in Moscow to carry out contracts that are concluded by the foreign legal entity. The number of days each foreigner has spent in Russia during1995 should be indicated, but not the remuneration nor the address. Typically, a foreign citizen staying 183 days or more in Russia in a calendar year is taxable on his worldwide income.
6. The extension of this requirement to Russian employees not employed directly by the representative office, and also the obligation to disclose the addresses of these individuals, are not required by the Law, and employers may wish to consider the extent of compliance with the letter in this respect.
Intercompany loans, deductibility of interest and VAT
7. Under Russian tax regulations applicable to the 1995 fiscal year, interest paid to banks on loans in foreign currency (other than those financing fixed asset purchases) was deductible up to a limit of LIBOR + 3%. In a recent joint letter of the State Tax Service, the Central Bank and the Ministries of Finance and Economy, it has been announced that the limit to be adopted when filing final profits tax returns for 1995 is 15% per year, with no reference to LIBOR .
8. Under the protocol to the US-Russia double tax treaty, different deductibility criteria may apply. For Russian companies with no less than 30% US shareholding and a charter capital of at least $100,000 (or the equivalent in roubles), interest would be deductible up to a limit of LIBOR plus a reasonable risk premium. Interest on loans to purchase fixed assets is not excluded. Interest on intercompany loans is also potentially deductible, as the protocol mentions "interest paid to a bank or another person". The new Ireland-Russia double tax treaty which entered into force on 1 January 1996, contains a similar provision.
8. Russian tax authorities have in the past considered intercompany loans to be "financial assistance" and accordingly levied VAT on the loan principal. The new VAT law, still awaiting signature, can be interpreted as removing this liability and indeed we understand that both the State Tax Service and the Ministry of Finance have agreed in principle that VAT should no longer be levied on intercompany loans. The usual solution to this problem - the back-to-back bank loan - may not be necessary for much longer. In the meantime, however, a prudent approach continues to be recommended.
9. Intercompany loans outstanding for longer than 180 days still require a Central Bank licence, and without this the loan agreement is considered to be void in addition to being subject to sanctions under the currency legislation. Licences are however difficult to obtain.
New profits tax law entered into force
10. The Profits Tax Law amendments described in Tax Alert 20/95 have now entered into force as of 1 January 1996. The final law does not differ in any material respect compared to the draft law already discussed.
11. The law implies that interest on bank loans used to finance capital investment may be deducted for profits tax purposes. The means by which this is achieved is that the interest is capitalised - added to the cost of the asset - and it is the total amount which may qualify for capital investment allowance under the usual rules. Where the lender is resident in the US or Ireland, there is a question over which provision prevails.
This publication is intended for general guidance only and should not form the basis of specific decisions.
For further information please contact the firm on +007 503 232 5511 or enter text search 'Coopers and Lybrand' and 'Business Monitor'.
Russian Federation: Tax Alert 1/96 - 8 February 1996
Last Updated: 20 February 1996
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