This feature on the tax landscape in Russia is the final report in our series on the BRIC countries. This report covers:
- current developments in Russia’s tax regime;
- a tax adviser’s view on doing business in and with Russia; and
- an overview of the country’s tax regime.
Current developments in tax
- The Russian government is pursuing a ‘de-offshorisation’ initiative and making numerous changes to legislation to raise revenue for the government, including the introduction of ‘luxury taxes’ on the wealthy.
- There are recent changes to the Russian court system.
- For multinationals doing business in Russia, securing deductions for charges from foreign affiliates is a perennial concern.
While all eyes have been on Russia recently with the 2014 Winter Olympics in Sochi and now the growing crisis with Ukraine, less well reported is the number of ongoing Russian tax trends and changes affecting businesses that the government has pushed through in recent years. As Artem Toropov, a senior associate in international tax at Goltsblat BLP (the Russian practice of Berwin Leighton Paisner) says, businesses operating in Russia ‘should keep track of rapid developments better than ever, as they happen both in legislation and court practice at a very fast pace - don’t rely on advice from a few years ago.’
To understand the driving factor behind these changes, it is important to note Russia’s deficit fears: according to Russian news agency RIA Novosti, preliminary data released by the Finance Ministry reported the country ran a budget deficit of 310bn rubles (roughly £5.4bn) for 2013 - about 0.5% of Russia’s GDP. To western economies, this may seem like nothing to worry about, especially with the country’s total income for 2013 being around 13 trillion rubles (or £227.8bn) - until one notes that, according to the budget president Vladimir Putin signed into law last year, Russia is expected to record a budget deficit of 391bn rubles (£6.9bn) for 2014, and 817bn rubles (£14.3bn) in 2015. Coupled with a weakened economy and a need for long-term fiscal planning that does not rely only on the non-renewable resources of oil and gas, it seems policy-makers will either have to curtail public spending - and with the government’s spending plans already set out, this seems unlikely for the foreseeable future - or raise revenue.
The government admits it has limited room for raising tax rates and introducing new taxes in the current economic environment. Instead, it is focusing on increasing the collection of existing taxes from corporations and individuals, eliminating many tax incentives, changing the tax base calculation mechanisms, and fighting tax base erosion with new anti-avoidance mechanisms. It is the latter that is driving the tax changes in the country.
Anti-avoidance and international tax issues
‘The hottest topic at present is the government’s so-called “de-offshorisation” initiative,’ says Maureen O’Donoghue, executive director of tax in EY Russia. ‘This encompasses a number of elements intended to reduce losses to the Russian budget, including the introduction of a controlled foreign companies regime, setting limits to the application of treaty benefits, introducing a basis for taxation of foreign companies based on a residence test, and improved sharing of information with foreign tax authorities. The required legislation is being drafted.’
‘Anti-avoidance practices have been changing especially rapidly,’Toropov agrees. ‘The Russian government loses significant revenue every year with offshore structures being so widely used, so the ongoing de-offshorisation reform aims to increase tax collection and fight abusive tax avoidance. In 2014, we can expect to see further anti-avoidance rules being introduced, as well as the introduction of CFC rules for businesses and individuals - the CFC rules are especially expected to affect large state-owned and privately-owned corporations that typically have extensive networks of subsidiaries in low tax jurisdictions and offshore, as well as high net worth individuals in Russia who structure their affairs through personal offshore holding companies and trusts. The introduction of a “beneficial ownership” concept will make it harder to repatriate income away from Russia, and foreign businesses investing in Russia through SPVs in the Netherlands, Luxembourg, Switzerland and Cyprus could also be affected.’
Russia’s current transfer pricing regime came into effect on 1 January 2012. O’Donoghue explains: ‘The switch from a system with a 20% safe harbour rule, and the burden of proof being placed firmly on the tax authorities, to one more in line with the OECD model has forced companies doing business in Russia to devote considerably more attention and resources to documenting their pricing methods and decisions. Audits of transfer pricing compliance in 2012 have only become possible in the last two months, and it may be some time until sufficient audit decisions will have been issued for any noteworthy patterns in audit practice to be identified.’
One noteworthy feature of the tax system experienced by businesses in Russia is that no binding tax ruling practice exists in the country. Tax authorities very often follow a fiscal-oriented interpretation of the law, while tax litigation and court disputes with the Russian tax authorities are ‘quite common and widespread’, according to Toropov. ‘Many European businesses in Russia typically start off being very cautious, but then they realise that, even if they are super- compliant, they might still find that the tax authorities make a claim against them’.
‘However, it is possible to successfully defend one’s position in court, and once foreign investors obtain positive experiences of successfully disputing tax charges in court, they become braver and more willing to stand up for their rights and to fight the ungrounded and frivolous claims of the tax authorities’,Toropov explains.
‘The recent trend, however, has been for fewer court disputes (due to the successfully developing mandatory pre-trial administrative dispute resolution procedures with the higher tax authorities), but the disputes themselves are getting more complex as the tax authorities have become more experienced and more knowledgeable about business structures, as well as more powerful with new anti-avoidance regulations available for them to use. With Russia’s growing budgetary deficit, the tax authorities have become more aggressive about tax collection, and the courts have found in their favour more often,’ he says.
Court practice in relation to deductions for interest on loans from foreign sister companies also ‘continues to cause concern’, O’Donoghue says: ‘While the wording of the Tax Code excludes such loans from limits on interest deductions under the thin capitalisation rules, there have been a number of cases in which courts, including the Supreme Arbitration Court, have ruled that the limits apply. However, recent changes to legislation in relation to interest are another hot topic, with significant amendments to the profits tax treatment of interest income and expenses being enacted in Federal Law No. 420-FZ of 28 December 2013. The general limits on the deductibility of interest in article 269 of the Tax Code are to be replaced with provisions relevant to controlled transactions only.
‘For multinationals doing business in Russia, a perennial concern is securing deductions for expenses,’ O’Donoghue continues. ‘Significant tax risks may arise in relation to headquarter charges and charges from shared service centres for costs such as management services, shared IP, IT support and other services. Tax inspectors often challenge charges from foreign affiliates based on a perceived lack of substance, an apparent absence of benefits to the Russian taxpayer or inadequate supporting documentation. There have been a number of court cases in which Russian subsidiaries of multinationals have failed to convince the courts to allow deductions for such charges.’
But changes are afoot in the court system too. Toropov explains: ‘One of the ongoing court reforms is the merger of the Supreme Arbitration (Commercial) Court and the Supreme Court. The Supreme Arbitration Court, which was the highest court in Russia for deciding corporate tax disputes, has been quite progressive and has contributed a lot to good court practice. It is effectively being liquidated, and decisions will now be made in the Supreme Court, which is widely seen by many as being pro-government. There is a fear among many tax professionals that, once the courts are merged, the Supreme Court can influence tax disputes in Russia for more pro-government (or pro-tax authority) outcomes.’
Reported by Santhie Goundar, freelance news reporter (firstname.lastname@example.org)
Luxury taxes on the wealthy
The ongoing debate in Russia about a ‘luxury tax’ has also resulted in more changes to come, as Ruslan Vasutin, tax partner at DLA Piper Russia, reports. ‘In its approved Main Directions of the Tax Policy for 2015 and 2016, the government of the Russian Federation announced that it is planning to introduce a series of new laws aimed at the taxation of luxury items,’ he says. ‘There is no such definition as “luxury”, so in practice these laws extend to real estate properties and high value transport vehicles owned by individuals.
‘The Ministry of Finance has been tasked with devising amendments to the Tax Code, introducing a new tax on real estate that should replace the property tax. The discussed plan specifies that for real properties, including land plots, buildings, constructions, residential and non-residential properties owned by individuals, the taxation regime will be introduced based on the “cadastral value” of these assets. The draft law anticipates that real estate assets will be taxed at a rate of 0.1% to 1% of the cadastral value. The new cadastral value will essentially be a new tax base that should be far closer to the real market value of an asset, compared to the existing book (or state inventory) value. For luxury properties, it would effectively mean that the maximum rate of 0.5% to 1% will apply to properties located in Moscow or St Petersburg exceeding the 300m rubles threshold (approximately £5.3m) in their cadastral value, regardless of how many taxpayers keep the asset in freehold or which tax concessions they may have as eligible taxpayers.
‘Further, for the purpose of realising its tax policy, the Russian government has prepared a federal law amending article 362 of the Tax Code. Among various law changes, a new tax regime applicable to luxury transport vehicles has been introduced, covering vehicles with an average value greater than 3m rubles (about £52,600). The new taxation operates by establishing several increasing co-efficients pertinent to the tax.
‘The transport tax is a regional tax that is determined on a progressive tax basis. Its calculation involves a procedure whereby the engine horsepowers are multiplied by an X amount of rubles, then adjusted by the relevant co-efficient. According to the new law, an average value is the one that should be established by the federal state body regulating the functions of state policy for trade (supposedly the Ministry of Industry and Trade) and may differ from the fair market value. In this regard, a list of cars subject to taxation by this “luxury tax” should be determined and published by this authorised state body on its official website not later than by 1 March of the relevant year. Obviously, the motivating driver behind these changes is some political interest to show “fairness” and “objectivity” in the tax system, rather than boosting any budget collections.’
Doing business in and with Russia: a tax adviser’s view
Why invest in Russia? Despite its justified reputation as a challenging market in which to do business, the Russian market is one which is difficult to ignore.
The Russian Federation comprises the largest land mass of any country on earth and contains vast natural resources. Russia contains 32% of the world’s explored reserves of natural gas, 18% of world oil reserves and 23% of world coal reserves, as well as 23% of world forest resources. Russia is also a major producer of gold, diamonds, silver, copper and lead, as well as holding 10% of the world’s uranium resources. Russia has a population of around 140 million people, with a growing middle class and a generally well educated workforce. The domestic consumer
market is still not fully mature. A PwC study showed that in 2010 sales of foreign brands produced in Russia grew by 73% in unit terms and by 100% in terms of monetary value.
I was first asked to go to Russia in early 1995 by one of my then law firm partners, who had recently taken on some Russian clients engaged in the vodka business. (Strangely, this was during a period of vodka shortage in the mid-range market which followed the reduction of capacity resulting from the Gorbachev anti-alcohol campaign in the final days of the Soviet Union.) Whilst I certainly jumped at the opportunity, I had no idea what to expect, having had few previous dealings with the country and never having visited before. After a whistle-stop tour of Red Square and a visit to a recently opened McDonalds, I found myself on a train to the city of Nizhny Novgorod in a compartment bolted from the inside with a wire coat hanger, having been told that this was ‘a necessary precaution against bandits’. Having survived this initial visit, I quickly became fascinated by the country and have now travelled to Russia regularly for the past 18 years, in connection with both inbound and outbound investment projects for corporates and advising ultra-high net worth individuals and families on international wealth planning issues.
If you would like to receive our legal alerts and updates highlighting current legal issues relevant to your areas of interest and providing expert commentary by our lawyers, please click on "Sign Up" and fill out the form.