Key changes to Russian tax law in 2011.

05.04.2011

The AEB guide to theory and practical advice for making an investment in Russia in 2011.

Numerous changes were introduced to the Russian tax legislation recently, which become effective in 2011. We selected the key 5 changes that may be relevant to making deals or an investment in Russia.

1. Capital gains on some types of shares exempt from Russian tax

Capital gains on shares in Russian companies that have been held for more than 5 years are now exempt from Russian tax provided that shares

a) have not been publicly traded during the holding period; or
b) are publicly traded and the company being sold was operating in the high technology sector during the holding period; or
c) were not publicly traded when acquired, but at the moment of sale are publicly traded and the company being sold operates in the high technology sector.

This provides new and interesting opportunities for structuring Russian investments through Russian holding companies (given the domestic dividend participation exemption that was significantly expanded in 2010), especially, in the high-technology sectors.

2. Interest deductibility limit significantly reduced for loans in foreign currency

Historically, Russia has been relatively generous when establishing limitations on deductibility of interest – the interest deductibility cap on foreign loans for more than 15 years has never been below 15%.

This was very useful in planning acquisition structures, and with proper planning, allowed to get substantial tax shield on taxation of your investment in Russia once it was properly leveraged.

However, from 1 January, 2011, the interest deductibility cap was reduced from 15% per annum (pa) to 0.8 multiple of the Central Bank of Russia rate – i.e. based on the current Central Bank rate, effectively to 6.2% pa.

If your existing loans (or the loans you plan to attract to finance or acquire the Russian business) are denominated in foreign currency and bear an interest higher than the above threshold, you will be affected.

There two key possible solutions to the issue are

a) replacing loans in foreign currency to loans denominated in Russian Roubles, where the interest cap is retained at the level of 1.8 of the Central Bank of Russia (CBR) rate ie based on the current CBR rate, effectively at 13.95% pa; and 

b) rely on provisions of some of the double tax treaties that allow allows for full deduction of armslength interest, if the Russian borrower is owned by a parent resident in the treaty country (such benefits are granted by the treaties with Netherlands, UK, Germany, Belgium, New Zealand, Canada and France).

3. Protocol to the Cyprus-Russia double tax treaty signed, potentially decreasing the attractiveness of Cyprus as a holding location

On 7 October, 2010, the governments of Russia and Cyprus signed a protocol to the Russia – Cyprus double tax treaty. As of the time of this publication the protocol has not come into force, but its provisions will apply from 1 January of the year in which all formal approval processes are completed.

The most significant changes introduced by the Protocol include:
1. Taxation of capital gains on sale of shares deriving more than 50% of their value from immovable property;
2. Admissibility of thin capitalisation rules;
3. Withholding taxes that apply to income from mutual investment funds;
4. Broader opportunities for information exchange and tax collection assistance;
5. The required investment threshold for a reduced tax rate for dividends, which is now is set at Euro 100,000;
6. More extensive procedure for the determination of the place of effective management;
7. New limitation of benefits article;
8. New, extended permanent establishment criterion for services provided through individuals.
The new provisions, once they come into force, will require exercising greater care to the structuring and management of Cyprus holding companies, if you intend to use them in your acquisition/holding structure for Russian investment

4. Skolkovo area tax benefits to innovation companies clarified

The law now clarifies the tax benefits for Skolkovo innovation project participants – which should be Russian legal entities, established exclusively for the activities referred to in these laws and included in the special participants’ register for 10 years.

The benefits include:

a) the choice of not having to keep Russian statutory accounting records, unless their annual
sales proceeds exceed 1 billion (bln) Roubles, provided the company maintains records in line with the requirements of the Russian Tax Code;
b) no profits tax until their annual proceeds exceed 1 million (mln) Roubles, and after that – profits tax of 0% until the year in which their profits top 300 mln Roubles;
c) no value added tax (VAT) – except on goods imports into Russia – or property tax, until their aggregate profits exceed 300 mln Roubles from the beginning of the year in which their sales proceeds top 1 bln Roubles;
d) to the option of paying insurance contributions only to the Pension Fund of the Russian Federation at a 14% rate (from 1 January, 2011) until the 300 mln Roubles profits mark is reached.

This may be relevant if you consider performing Research and Development (R&D) activities in Russia that also target the Russian market.

5. Profits tax exemption for contribution of assets aimed at increasing net assets

The contribution of assets or property rights by shareholders with the specific aim of increasing the net assets of a Russian company (even if this does not result in a formal increase of charter capital) is no longer subject to Russian profits tax. This should help eliminate some of the historic tax difficulties which foreign investors faced when devising structures aimed at improving the statutory net assets of their Russian subsidiaries (this, for example, can be an issue for leveraged subsidiaries in case of abrupt Rouble devaluation, as was the case in 2008), where tax-exempt charter capital contribution had not been available in some cases for regulatory reasons.

For example, previously, in similar circumstances, profits tax exemption applied solely to transfer of property by a controlling (more than 50%) shareholder.

Also, there were doubts as to whether forgiveness of interest qualifies for a profits tax exemption. The new provisions should allow one to avoid these issues.

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