Deoffshorisation: Controlled Foreign Companies Law
On November 24, 2014, the Russian President signed into law the federal bill “On Making Amendments to Parts One and Two of the Russian Tax Code (Regarding Taxation of Controlled Foreign Companies’ Profits and Foreign Organizations’ Income)” (the “Law”).
The Law, effective from January 1, 2015, will introduce major changes to the taxation process applicable to foreign companies in the Russian Federation.
1. CFC Rules
1.1 Definition of CFC
According to the Law, to be treated as a controlled foreign company (CFC), a foreign organization must meet all of the following criteria: (i) it cannot be a Russian tax resident; and (ii) it must be controlled by Russian residents, whether individuals or legal entities.
Foreign organizations that do not have separate legal personality (such as partnerships, trusts, or other collective investment schemes) will also be treated as CFCs, provided that controlling persons of such organization are Russian residents.
A Russian resident will be treated as a person controlling a CFC if:
- his interest in the foreign organization exceeds 50% in 2015, or 25% (or 10%, where the aggregate interest of all Russian residents in such organization exceeds 50%) in 2016 onwards; or
- though the Russian resident does not satisfy the shareholding test, he effectively controls the foreign organization (or the entity that does not have separate legal personality). For these purposes, control, in particular, means the capability to have influence on the decision-making on profits distribution.
1.2. Notification of Interest in a CFC or Other Foreign Organizations
The Law requires that a Russian tax resident give notice to tax authorities of:
the existence of a CFC;
his interest in any other foreign organizations, where such interest exceeds 10%; and
the establishment of a foreign entity that does not have separate legal personality, and his control over such entity or his beneficial ownership of income generated by such entity.
The deadline for notification of the existence of a CFC is March 20 of the year following the tax period. The first deadline for such notification will, therefore, be March 20, 2016.
Interest in a foreign organization (including interest in a foreign entity that does not have separate legal personality) must be notified to the tax authorities within one month after the ground for such notification has arisen. The first deadline for notification of interest in a foreign company will be April 1, 2015, provided that a ground for such notification arose before the effective date of the Law.
Failure to notify the tax authorities of the existence of a CFC or interest in a foreign organization will result in a penalty of RUB 100,000 or RUB 50,000, respectively, for non-disclosure of each organization.
1.3. Taxation of CFC’s Income
1.3.1. Tax Base Calculation
Income of a CFC incorporated in a jurisdiction that has a double taxation treaty with Russia will be assessed on the basis of the CFC’s audited financial statements prepared in accordance with the laws of the jurisdiction of its incorporation. In all other cases, the provisions of Chapter 25 of the Russian Tax Code will apply.
A CFC’s income will be taken into account for the purpose of calculating the tax base in the Russian Federation, provided that such income exceeds:
- RUB 50 mln in 2015;
- RUB 30 mln in 2016; and
- RUB 10 mln in 2017 onwards.
1.3.2. Tax Exemptions and Credits
According to the Law, income of certain CFCs may be exempt from Russian tax. In particular, such exemption applies to:
- active companies with passive income not exceeding 20% of their total income;
- companies with an effective tax rate equivalent to at least 75% of the weighted average Russian income tax rate calculated for two types of income: (i) CFC’s income less distributable dividends and dividends received by the CFC (currently taxable at the rate of 20%); and (ii) dividends received by the CFC (taxable at the current rate applicable to dividends);
- foreign entities that do not distribute profits (including entities that do not have separate legal personality and nonprofit organizations), provided that certain other conditions are met;
- banks and insurance companies;
- issuers of certain types of Eurobonds, provided that certain conditions are met; and
- offshore project operators, and companies involved in overseas oil production projects.
According to the Law, it is allowed to carry forward CFC’s losses without any time limits, as well as to claim credit for taxes paid on CFC’s income under the laws of a foreign jurisdiction and/or the Russian Federation.
Until January 1, 2017, upon liquidation of a CFC, it will also be allowed to claim exemption from tax on income in the form of the value of received assets (property rights) for Russian income tax purposes.
Failure to pay, or pay in full, tax due to failure to add the relevant portion of CFC’s income to the Russian income tax base will result in a penalty equivalent to 20% of the unpaid tax, but no less than RUB 100,000.
1.3.4. Criminal Liability
At the moment, the State Duma of the Russian Federation has a bill on the table, the authors of which suggest making certain amendments to the Russian Criminal Code. According to the proposed amendments, tax evasion through the use of CFCs will result in criminal liability, with the maximum punishment being imprisonment for a term of up to 6 years. We believe that it is highly likely that the Russian Parliament will pass the bill this year.
It should be said that the Law provides that, during the period of 2015 to 2017, those found guilty in failing to increase their Russian income tax base by the relevant portion of CFC’s income will not face criminal charges, provided that they fully make good the resulting losses incurred by the Russian Federation.
2. Tax Residency of Foreign Legal Entities Managed in the Russian Federation
A foreign organization effectively managed in the Russian Federation may be treated as a Russian tax resident. An organization will be found to be effectively managed in the Russian Federation if:
- most of the meetings of its Board of Directors are convened in the Russian Federation;
- its executive body (bodies), on a regular basis, discharge(s) their functions to manage such organization in the Russian Federation;
- its senior executives mainly discharge their functions to manage such organization in the Russian Federation.
The Law sets out a list of organizations that can voluntarily apply to be treated as a Russian tax resident (e.g., foreign organizations that are tax residents of any jurisdiction with which the Russian Federation has a double taxation treaty).
The Law also sets out a list of activity types, engagement in which may not be treated as “effective management” of a foreign organization in the Russian Federation.
3. Beneficial Owner Concept
The Law has introduced the concept of beneficial owner of income. According to the Law, a person receiving income will be able to apply reduced tax rates (or to claim tax exemption) under a double taxation treaty, provided that such person is the beneficial owner of such income (i.e., he is able to determine the ‘economic fate’ of such income). For this purpose, it will be required to look into such person’s functions and authority, the risks borne by such person, and the fact of income payment (in full or in part) to third parties.
According to the Law, withholding agents will have the right to request that the foreign organization confirm its beneficial ownership of income. However, the Law does not specifically stipulate any steps that can be taken by a withholding agent for this purpose, which would allow the withholding agent to avoid potential penalty for failure to withhold, or withhold in full, tax.
4. Changes in Taxation of Income from the Sale of Shares (Participatory Interest) in a Company
The Law provides that income from the sale of shares or participatory interest in a company (either Russian, or foreign) directly or indirectly holding assets, more than 50% of which comprise immovable property located in the Russian Federation, or income from the sale of financial instruments derivative from such shares (participatory interest), will be subject to taxation in the Russian Federation.
Currently, Russian tax laws provide for taxation of income from the sale of shares or participatory interest in Russian companies only, and only provided that immovable property is held directly.
What Steps to Take Now?
Audit of the current cross-border corporate structure:
Assessment of the current economic and tax advantages of having foreign companies in the group structure.
Identification of foreign group companies that will be treated as CFCs to be notified to tax authorities.
Risk assessment, and assessment of additional tax and administrative burden resulting from compliance with the CFC rules.
Analysis of potential risks in connection with the application of new tax residency rules and beneficial owner concept.
To be submitted: a map of functions and risks for the current cross-border corporate structure.
Risk and adverse effect mitigation:
For the current corporate structure:
Application of the Law provisions allowing taxpayers to claim tax exemption (or apply reduced tax rates) with respect to CFCs’ income (see 1.3.2 above).
Considering various options to change the Russian residency status of group beneficiaries.
Extension of the ‘economic presence’ in any particular jurisdiction.
Proposal of a new corporate structure:
Making amendments to intragroup contracts and cash flow restructuring.
Changing the legal forms of entities holding assets.
Liquidation of foreign group companies the existence of which is unjustified.
Redomiciliation of existing foreign group companies.
 For individuals, together with their spouses and minor children
 Domiciled in a jurisdiction with which the Russian Federation has a double taxation treaty, other than any jurisdiction that does not participate in tax information exchange with the Russian Federation.