10 Strategic Russian Tax Tips when Going Into a Joint Venture with a Russian.
1. Do tax due diligence carefully
Russian tax law is relatively new (with a history of just 20 years), prone to differing interpretations, and with very limited power of court precedents. In this environment proper understanding of tax risks is paramount. This is especially important if you invest under Russian law, since Russian law does not recognise
most of the English-law-type tax indemnities and warranties.
2. Tax risks may have a significant impact on the valuation
It is common for Russian small and medium sized businesses to tolerate higher levels of tax risks as compared to a foreign investor. Factoring in these risks may have a significant negative impact on the valuation of the company by the foreign investor as compared to the Russian partner’s expectations.
3. Factor in increased tax burden if investing into a business that currently uses simplified tax regime
In addition to different tolerance of tax risks, Russian small and medium sized business often use a simplified tax regime, which provides significant tax benefits as compared to a regular tax regime. This regime, however, is available only to companies at least 75% owned by individuals. As a result, purchasing a significant stake in such business by a corporate entity will result in additional taxes going forward, with resulting reduced cash flow and lower valuation.
4. Put a lot of emphasis on actual tax litigation precedents when assessing tax risks
Unlike many other jurisdictions, tax litigation in Russia is a common occurrence, with approximately 100,000 tax-related cases decided annually. Russian tax authorities cannot issue a binding ruling or interpretation, or agree to a reduced settlement with the taxpayer. As a result, tax litigation is often the only possibility to resolve a dispute over conflicting interpretations of the tax law of fill the gaps in the tax legislation. Although technically, court precedents
are not the source of law, they provide a helpful indication of sustainability of a tax position, especially, if the court ruling is made at the Supreme Arbitrazh Court level. Also, given the importance of proper evaluation of tax risks for valuation, it is important to have a realistic (rather than academic) assessment of tax risks in order to avoid unnecessary disputes with the Russian partner about risks that are purely hypothetical.
5. Plan for pre-sale restructuring
One of the ways to reduce the impact of historic tax risks on the transaction is to request that your Russian partner moves the business to a new legal entity prior to the transaction. Such pre-sale restructuring, however, may be subject to regulatory approvals and, therefore, additional time needs to be factored in.
6. Try to ask from the Russian partner at least a 4 year tax indemnity
Tax limitation period in Russia is 3 years preceding the year of the audit. Therefore, if you ask for a tax indemnity, try to ensure it covers 4 years (an additional year to handle formalities). This is not always practically achievable, however, if you buy a stake in a small or medium sized business, as the Russian partners typically try to push for a 1 to 2 years indemnity period instead.
7. Debt push-down can work in a limited number of circumstances
As a general rule, pure debt-push-down (ie establishing a Russian SPV to purchase a business with subsequent
merger or tax consolidation) does not work in the Russian environment.
There are two main reasons for that:
(a) Russian statutory accounting does not recognise goodwill upon merger, which generally results
in a technical insolvency (negative net assets) upon merger of the purchased entity into an SPV;
(b) tax consolidation currently is available only for the largest taxpayers, and cannot be used by medium sized businesses.
However, there may be situations where debt push-down is possible. One possibility is if you invest into a business that contains several Russian entities.In this case one of the Russian operating entities can take an intercompany loan from an affiliated foreign company to purchase the other Russian operating entities, effectively achieving a partial debt-push down. Russian thin capitalisation rules will need, however,to be monitored in this case.
8. Properly drafted tax indemnities under foreign law are enforceable in Russian courts
Until recently there have been doubts to which extent tax indemnities and tax-related personal guarantees granted under foreign law are enforceable in Russian courts, since Russian law generally does not have the concept of a tax indemnity. However, there has been a recent case at the Supreme Court level that enforced such tax indemnity (awarded by a foreign court in a Russia-related transactions) against a Russian individual.
9. Be prepared to structure a transaction through a foreign SPV
A significant portion of Russia-related transactions is done via foreign jurisdiction SPVs. This is driven both by legal reasons (English law typically providing more flexibility as compared to Russian law), as well as by common desire of Russian sellers to obtain deferral of their personal income tax liability through use of a foreign selling entity. The most common jurisdictions are Cyprus and the Netherlands (Luxembourg will likely also become a favourite once the changes to the Luxembourg- Russia double tax treaty are ratified by the Russian parliament). However, it is also becoming more and more common for Russian owners to sell their stake directly to the foreign investor as individuals, immediately paying their taxes, but at the same time benefiting from the use of Russian law in a transaction (that typically favours the seller).
10. Recent changes in the tax law make use of a Russian holding company more efficient
Domestic dividends between two Russian entities are currently exempt from taxation, provided the parent owns at least 50% of the subsidiary and holds the shares in the subsidiary at least 365 calendar days. If Russian subsidiaries are in the form of a OOO (limited liability company) then capital gains on sale of such shares realised by a Russian holding company are exempt from Russian tax as long as the shares are held for at least 5 years.
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