Overview of the key provisions of the draft law on de-offshorization modified by the RF Ministry of Finance
Overview of the key provisions of the new version...
We have learned that based on the results of the public discussion, the RF Ministry of Finance has prepared a new version of the de-offshorization draft law to be submitted to the RF Government (hereinafter the draft law). The draft law introduces into the RF Tax Code rules on the taxation of controlled foreign companies (CFC), tax residency criteria for companies, the taxation of income from the indirect transfer of ownership of Russian companies that own real estate (through the sale of shares in companies, more than 50% of whose assets directly or indirectly consist of real estate located in Russia), and also the concept of “beneficial owner” of income, which was not included in the previous version of the draft law. We present a brief overview of the key provisions of the proposed measures, including the most recent amendments and addenda.
In accordance with CFC Rules, Russian tax residents (companies and individuals) will have to pay corporate profits tax in Russia at the rate of 20% or personal income tax at the rate of 13% on the profits attributed to controlled foreign companies (CFC):
- a foreign company or structure is recognized as a CFC (in particular, a fund, partnership or other form of collective investment vehicle), if it complies with the following terms and conditions:
- the company is not a tax resident of Russia;
- Russian tax residents are deemed to control the companies;
- the shares of this company are not traded on a foreign stock exchange.
The definition of control by Russian tax residents has not changed in the new version of the draft law. Despite the proposals of the Russian business community, the RF Ministry of Finance retained a 10% equity interest (direct or indirect) in a foreign company as the criterion for recognizing it as a CFC.
At the same time, in accordance with the new version of the draft law, foreign organizations will not be deemed CFC in the following instances:
- the Russian tax resident participates in the foreign organization through intermediary company, whose shares are traded on a foreign stock exchange;
- the foreign company is non-profit organization or the participation of the Russian tax resident in the foreign organization is structures through a special-purpose vehicle, which complies with these criteria;
- the foreign company is the resident of a jurisdiction included in the “white list” of the RF Ministry of Finance (should be published separately);
- the foreign company is the resident of a jurisdiction, which exchanges tax information (the list should be approved by the RF Federal Tax Service) and the incomes of this foreign company are subject to an effective tax rate of no less than15%
Consequently, the RF Ministry of Finance rejected the idea of a second “black list”, replacing it with two alternative “white” lists of jurisdictions.
- CFC profits are deemed to be profits calculated according to the rules of the RF Tax Code in respect of any types of activities performed by the CFC (both passive and active) reduced by the total dividends paid from these profits.
The new version of the draft law also introduces the minimum amount of profits to be included in the tax base of the Russian tax resident at RUB 3 million (so-called “de minimis” criterion).
Furthermore, the new version of the draft law establishes separate rules for determining the tax base for CFC, inter alia separate accounting of income and expenses from passive and active activities. At the same time, CFC profits for both types of activity are subject to taxation.
Unlike the previous version, the new draft of the law stipulates directly the possible offset of tax paid in a foreign jurisdiction on CFC income against the tax payable on CFC profits in Russia. In addition, the losses obtained by CFC may be carried forward to future periods.
As in the past the draft law establishes the obligation of tax residents (Russian companies and individuals) to notify the Russian tax authorities on a regular basis of their participation in foreign companies if the equity interest in such companies amounts directly or indirectly to at least 1%, and also in respect of all CFC. Furthermore, in the current version of the draft law the requirement on providing due notification on participation in foreign companies applies not only to foreign companies registered in jurisdictions included in the “black list” of the RF Ministry of Finance, but also to all foreign companies.
As in the previous version, the new draft law establishes fines if the controlling person does not pay or pays incompletely CFC profits tax. At the same time, however, the RF Ministry of Finance eliminated the previous technical error. In the new version the fine has been established as 20% of the unpaid amount of tax, and not CFC profits.
Recognition of foreign companies as Russian tax residents
Foreign companies effectively managed in Russia will be recognized as Russian tax residents and taxed in the Russian Federation.
Furthermore a foreign company is deemed to be effectively managed in Russia if at least one of the following criteria is met:
- the meetings of the board of directors (or another management body of the organization) are convened in Russia;
- the steering management of the company is performed from Russia;
- the top management of the company work in Russia.
In the new version of the draft law, accounting and the storage of the archives of a company in Russia are designated as additional criteria and are only applicable if the aforementioned criteria are not met in full or if such criteria are met in several states.
As in the past the proposed provision does not clarify the term “steering management” and the required nature of the activities of top management in Russia, which could potentially result in different interpretations by the tax authorities.
In accordance with the draft law, foreign companies operating in Russia through separate divisions may independently recognize themselves as Russian tax residents and subsequently refuse Russian tax residency status. At the same time, according to the new version of the draft law, foreign companies registered in jurisdictions included on the “black list” of the RF Ministry of Finance or in jurisdictions that have no existing treaties with Russia, which provide for the exchange of information, will not be able to independently recognize themselves as Russian tax residents.
Introduction of the concept “foreign company entitled to corresponding income” (“beneficial owner” of income)
In accordance with the draft law, a foreign company will be deemed entitled to income if the company is the direct beneficiary of said income, with due account of the performed functions, existing authorities and assumed risks of the foreign company.
At the same time, the draft law does not contain further details on the specific functions, risk and authorities demonstrating that the foreign company is the “beneficial owner” of income, which could result in numerous disputes with the tax authorities.
The draft law also provides tax agents with the right to request from foreign companies documents confirming that the foreign company is the “beneficial owner” of the income (however, this is not an obligation). As a result of these provisions of the draft law, coupled with the position of the RF Ministry of Finance on the definition of a “beneficial owner”, expressed in the letter dated 9 April 2014, in a number of instances, tax agents may adopt a conservative approach and withhold income tax at the maximum rate, in order to avoid penalties for failing to withhold the tax.
In this situation, the draft law stipulates that the foreign company should apply to the Russian tax authorities for a corresponding tax refund (inter alia, submitting supporting documents, which confirm that this foreign company is the “beneficial owner” of the income).
Taxation of indirect transfer of ownership in Russian real estate
Pursuant to the draft law, foreign companies deriving income from the sale of the shares of Russian or foreign companies, more than 50% of whose assets consist directly or indirectly of real estate located in Russia, will be subject to withholding tax in Russia at the rate of 20%.
As in the past, the draft law does not fully regulate withholding tax mechanisms if two foreign companies conclude a transaction involving the alienation of the shares of such companies.
Accordingly, we recommend that our clients take the following action:
- Analyze the Group structure in order to identify the companies – potential CFF and develop strategies aimed at mitigating negative tax consequences.
- Analyze the management structure of the Group for the purpose of identifying companies, which may be recognized as tax residents of Russia. Develop recommendations on how to mitigate risks, inter alia by changing the existing management structure and increasing the Group’s substance in foreign jurisdictions.
- In the event of plans to sell the shares of companies indirectly owning real estate in the Russian Federation, develop alternative options of the Russian real estate ownership structure (including through companies registered in jurisdictions with double tax treaties offering opportunities for tax exemptions on the proceeds from the sale of shares in the Russian Federation).
- Analyze the financing structure or structure for using the intellectual property rights (for example, trademarks) of the Group and develop alternative structures to mitigate risks, in particular in the event of “back-to-back” structures.
We would be glad to assist you with any of the aforementioned issues and also will also keep you up to date about the status of this draft law and other news on legislative activities on de-offshorization.
If you have any questions, please contact us.
© 2024 KPMG Audit LLC, a Mongolian Limited Liability Company and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.
For more detail about the structure of the KPMG global organization please visit https://kpmg.com/governance.