Russian Federation: Tax Alert 6/96 - Withholding Tax And VAT

Last Updated: 26 July 1996
1. In this issue we will look at the present status of requirements for withholding taxes from payments from Russian companies to foreign recipients.

WITHHOLDING TAX AND VAT

2. Under Russian legislation, Russian source income paid to foreign legal entities ("FLE") is subject to withholding of income tax at the rate of 15% for dividends and interest, 6% for international freight income and 20% for other income, including business income. Generally, Russian legal entities ("RLE") paying these forms of income to FLEs which are not registered with the tax authorities in Russia are required to withhold income tax at these rates, plus any applicable "reverse charge" Value Added Tax ("VAT") at the rate of 16.67%. However, under the provisions of applicable double tax treaties with Russia or the former Soviet Union, these income tax withholding rates can be decreased, or reduced to zero. On the other hand, VAT withholding can only be avoided by the receiving FLE being registered with the Russian tax authorities.

PRESUMPTION OF TAXABILITY

3. The Russian tax authorities usually assume that income tax withholding and VAT apply to every payment to FLEs unless there is documentary evidence to the contrary. Failure to pay over income taxes withheld, or that should have been withheld, will result in confiscation of the tax amount involved from the Russian payer company. The same is true for failure to withhold VAT when applicable to payments to FLEs, except that such omission will also cause the payer to incur penalties. Documentary evidence to support the absence of an obligation to withhold usually consists of forms prescribed by Russian tax regulations. In a few instances, other documentary evidence may be accepted.

TREATY PROTECTION: ADVANCE EXEMPTION OR REIMBURSEMENT OF INCOME TAX WITHHOLDING TO OFFSHORE RECIPIENTS

4. In order to support that a reduced or a zero withholding rate under a double tax treaty applies in advance of payments to a FLE which is not registered with the tax authorities in Russia, i.e. an "offshore" recipient, the Russian payer company and the appropriate tax authorities must receive a properly executed Form 1013DT. This type of exemption can be obtained for a series of payments if the income is paid regularly and is similar in nature. These terms are not defined and interpretation may vary between different locations.

5. For irregular or one-time payments to offshore FLE recipients, the Russian payer company should first withhold and pay the tax to the budget after which the foreign company can apply for reimbursement of the tax using the appropriate Form 1011DT (for passive types of income) or Form 1012 DT (for business income). It should be noted that experience shows that refunds may not obtained quickly from the Russian tax authorities.

6. When income is paid out to a foreign bank under short term operations, treaty protection can be claimed without prior approval if the foreign bank appears in "The bankers' Almanac" or the International bank identifier code (S.W.I.F.T.). This provision has been included to facilitate short term transactions between banks which would otherwise be impossible to accomplish if the procedure described above in paragraph 4 were to be followed for each separate payment. However, the Russian payer bank must file the form 1021 DT quarterly for the foreign bank to obtain treaty protection.

EXEMPTION FROM INCOME TAX WITHHOLDING ON PAYMENTS TO FLES REGISTERED IN RUSSIA

7. If a FLE is registered for tax purposes in Russia, it should report in advance incomes it receives from RLEs on Form 1011FE. On this form, the FLE declares that it has active or passive income, and whether this income is either connected or not connected with its "permanent establishment" in Russia. When the FLE uses this option, Form 1011FE must be filed with both the federal tax authorities and the local tax authorities where the FLE is registered. A copy of the form that has been executed by the tax authorities must then be sent to the Russian payer company.

8. If the income disclosed on Form 1011FE is connected with a permanent establishment, i.e. it is taxable in Russia, then the Russian payer does not need to withhold because the FLE's profits will be reported on its annual Russian Profits tax return (Form 1101FE). Theoretically, the fact that the FLE declared its income as being connected with a permanent establishment on Form 1011FE does not mean that there actually will be a permanent establishment when the yearly tax declaration is filed. However, the FLE will have to present strong evidence that the income in question was not related to its activities in Russia in order to escape Profits taxation.

9. If the income disclosed on Form 1011FE is not connected with the FLE's activities in Russia, then the procedures outlined in paragraph's 4 and 5 above also apply to obtain exemption from withholding or a refund of taxes withheld.

NO VAT WITHHOLDING IF FOREIGN COMPANY IS REGISTERED

10. Withholding (or "reverse charge") VAT applies if a payment which is subject to VAT is made by a Russian payer to a FLE when the latter is not registered in Russia with the tax authorities. In order to avoid VAT withholding, the Russian payer must be provided with either evidence that the transaction is not subject to VAT, or that the FLE is registered with the tax authorities in Russia. In the past, a copy of the tax registration certificate ("spravka") would have been sufficient.

MOSCOW TAX INSPECTORATE: FORM 1011FE REQUIRED FOR EXEMPTION FROM VAT WITHHOLDING

11. However, the Moscow Tax Inspectorate ("MTI") has recently suggested that a RLE, when determining whether a payment to a FLE is subject to VAT withholding, should be guided by the same test which is applied in making the decision on withholding income tax. This means that "exemption" from VAT withholding can only be received if the Russian payer receives a copy of the form 1011FE, and the form indicates that the income subject to VAT is either active or passive income connected with a permanent establishment. Further, the form requires that such income will be declared on the recipient's annual Profits tax return, an indication that the subject FLE is therefore registered with the Russian tax authorities.

12. This requirement of the MTI ignores the fact that income which is subject to VAT is not necessarily income connected with a permanent establishment. With the amendments of 9 April 1996 to the VAT law now in effect, a number of payments for services that are physically performed outside Russia, hence do not lead to a permanent establishment, have become subject to Russian VAT (see paragraphs 13 & 14 below). This would mean that foreign providers of such services would have to file forms to appear as if they would have permanent establishment in order to avoid VAT withholding.

13. Further, the MTI has not clarified whether income subject to VAT but which is not connected with a permanent establishment of an RLE registered with the Russian tax authorities, is eligible for withholding exemption if declare on form 1011FE (such as a registered FLE protected by a double tax treaty which has only real property rental income).

NEW VAT LAW: ONLY ADDITIONAL TAXABLE EVENTS

14. Under the new VAT law, payments to FLEs for certain services or for patent and license agreements, author's rights or similar rights are subject to VAT if the recipient of the services has a "place of economic activity" in Russia. Currently, this principle leads to new economic events subject to VAT such as professional services physically rendered abroad and "consumed" in Russia.

15. Logically, the principle of consumption of services should be applied in the reverse manner as well. For example, if a professional service has been physically performed in Russia but is being consumed outside Russia, no VAT should be due. However, the tax authorities have not yet confirmed this on the basis that the application of the concept "place of economic activity" is not clear. This means that for now Russian suppliers of services need to continue charging VAT to foreign customers who have no possibility to offset Russian VAT paid against VAT collected.

VAT WITHHELD STILL NOT CREDITABLE AS INPUT TAX

16. According to current practice, the tax authorities continue to deny the offset of the VAT withheld by a Russian payer company, thus creating an additional cost for Russian companies that contract for services from foreign companies. We believe, however, that mentioning the VAT in a separate line on the invoice may be helpful in receiving an offset of VAT currently withheld when clarification of this issue is forthcoming in the new VAT instructions from the Russian tax authorities later this year.

CONCLUSION

17. In an effort to assure that VAT and Profits tax is properly collected on payments to FLEs the Russian State Tax Service and the Moscow Tax Inspection have issued regulations which will cause RLEs to withhold tax on all such payments where proper forms are not completed. While this may not seem burdensome in theory, in practice the form approval process is so cumbersome that many FLEs which do not maintain a place of business in Russia may begin to avoid doing business with Russian companies. Further, the new regulations of the Moscow tax authorities may not be in compliance with the VAT law and cause further confusion by Russian payer companies as to when VAT withholding is required.

(Note: The most recent versions of the appropriate forms mentioned in this discussion, along with the instructions for their use, may be obtained from Tax Department of Coopers & Lybrand Russia through the above mentioned phone or facsimile numbers.)

For further information contact Bauke van der Meer on tel: +7 503 232 5511 fax: +7 503 232 5522 or e-mail directly: Click Contact Link or enter a text search 'Coopers & Lybrand' and 'Business Monitor'

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.

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