Software localization in Russia: challenges and opportunities


The Association of European Businesses

IT is one of the most dynamically growing sectors in Russia. A 2001 meeting with IT business representatives marked the first time the President raised the issue of the need to develop a national IT sector to create healthy competition with foreign IT developers.

In 2015, a law was passed in the Russian Federation establishing the Russian Software Register and excluding foreign software from state procurements, followed by a government resolution specifying the main requirements for inclusion in the register.

In September 2018, Russia’s Ministry of Digital Development issued an Order approving a plan to transition government agencies and major state-owned companies to prioritise the use of Russian software. In December 2018, the Russian Government passed a number of directives confirming the requirements for this transition. Half of the applicable companies’ software must be Russian by 2022. The only exceptions are if companies can prove that there is no suitable Russian equivalent to the software they require.

As a result of these state activities, the share of Russian software in state procurements had reached 65% by the end of 2019 (compared to 20% in 2015). According to calculations by the Ministry of Digital Development, by 2024, this figure will reach 90% in procurements by state authorities and up to 70% in those by state-owned companies.

Legal requirements for localization

The key requirements for software to be included in the Russian Software Register are: (i) exclusive rights to the software throughout the world, and that the rights must belong to a Russian person or entity in which the total direct share of and/or indirect participation by the Russian Federation or a citizen thereof exceeds 50% for the duration of the term of validity, (ii) the software must be a separate subject of exclusive rights, (iii) the software must not be subject to mandatory updates or management from abroad, (iv) the total payments under licencing and other agreements that grant rights to intellectual products, the performance of works or the provision of services in connection with the development, adaptation or modification of software for foreign parties must not exceed 30% of the software owner’s proceeds from its sale during the calendar year, (iv) guaranteed maintenance, technical support and modernisation of the software must performed by an entity without predominantly foreign participation or by a citizen of the Russian Federation.

Point (ii) (the software must be a separate subject of exclusive rights) means that the Russian owner may obtain the software either by: (a) acquiring the full rights to existing software from a Russian or foreign person; (b) developing new software, or (c) technically modifying existing software, thereby creating independent derivative software.

An important aspect of the modification (point (c)) of existing software is that the derivative software must be created by real technical (rather than “cosmetic”) processing.  For instance, the following changes may not be deemed modifications resulting in the creation of independent derivative software: (i) translation of foreign software into Russian, (ii) changes to the software interface, (iii) changes to the name of the software, (iv) the addition to foreign software of modules that do not fundamentally affect the functioning of the basic software as a whole, and which make no changes to the software’s source code. In contrast, modification of basic software by amending its code and adding modules that expand or improve the software overall is highly likely to be deemed a modification of the software resulting in the creation of independent derivative software.

So, if software is created for localization purposes through the modification of foreign software, this must involve real technical and not just “cosmetic” changes; in practice, the addition of individual modules to foreign software or a merger with a Russian product is not recognised as a reworking that creates independent derivative software.

While legislative restrictions are quite stringent, the market suggests that they allow foreign developers to implement (with certain specific features) business models for distributing software. One example is to establish a joint venture with a Russian partner that owns 51% of the shares in the venture, then develop or modify foreign software to be recognised as independent and owned by the joint venture, which is then localized.

IT tax manoeuvre – another step in localization policy?

The following is an explanation of the current tax regime adopted for IT companies in Russia. One of the main tax benefits established for IT businesses is a reduced rate of social security contributions – 14% instead of the basic 30%. The 14% rate is available to Russian legal entities only. It may not be applied by foreign companies operating in Russia through branches or otherwise.

In addition, VAT exemption is granted to IT companies with respect to software supplies made under either an exclusive rights transfer agreement or a licencing agreement. A VAT exemption is also available to foreign companies making cross-border software supplies to Russian customers. Considering that payroll is a major element in an IT business’s cost structure, these two tax preferences add high value to an IT business operating in Russia and increase its overall tax efficiency.

Profits derived by Russian companies are normally taxed at the 20% profit tax rate. That said, in some Russian regions (e.g., Novosibirsk, Chelyabinsk Penza), a reduced profit tax rate may be available to IT companies before 1 January 2023.

Following the introduction of restrictive measures and the digitalisation of the global economy in response to COVID-19, the Russian President announced a tax manoeuvre in the IT sector aimed at making tax legislation in Russia more IT friendly. The law introducing a new tax environment for Russian IT businesses was drafted by the Russian government and passed by Parliament soon after its announcement. It will come into force on 1 January 2021.     

The new tax regime for the IT industry stipulates that the following tax benefits will be granted to IT businesses:

  1. a reduction in the social security contribution rate from the 14% down to 7.6%;
  2. a cut in profit tax from 20% to just 3%.

No time limits have been established for applying these tax benefits. Under the new regime, the eligibility criteria for tax benefits will remain almost the same for applying the reduced 14% social security contribution rate. The criteria are as follows:

  1. the company should be accredited with the Russian Ministry of Digital Development as an IT company;
  2. over 90% of the company’s revenue should come from IT operations related to the development and sale of software or the provision of services related to software development, adaptation, modification, maintenance, testing or installation;
  3. the company’s average headcount in a given tax (reporting) period should be at least seven.

The major difference from the current tax regime is the disqualification of certain types of IT operation-related income for the purposes of the 90% revenue test. Income derived from the following activities of an IT company shall be disregarded:

  1. the dissemination of and access to advertising information on the internet;
  2. the posting of sale or purchase offers for goods, works, services or property rights on the internet;
  3. the search for information about prospective buyers or sellers and/or entry into transactions.

In an attempt to compensate for the loss in state revenues caused by the introduction of such extensive tax benefits, the Russian government has restricted the application of the VAT exemption on software sales. It will now only be available if the following conditions are all met:

      i.        the software has been entered into the Russian Software Register;

     ii.        the software is not used for the operation of aggregator (trading platform) business models or for advertising purposes (please see the specific disqualification conditions established for the 90% revenue test above).

Considering the criteria established for the localization of software in Russia, the fulfilment of condition (i) above is impossible not only for foreign IT companies, but also for their Russian subsidiaries involved in the supply chain of software distributed on the Russian market. In practice, this means that the VAT exemption on software sales will become unavailable to such market players from 1 January 2021. In our opinion, this is a clear sign that the tax manoeuvre in the IT sector could be seen as a continuation of the existing trend in the state’s localization policy.

Following on from the letter of the law, IT companies that operate under aggregator (trading platform) business models or sell software used for advertising purposes will be unable to enjoy the new tax regime preferences. For this reason, foreign investors who fail to qualify for IT tax manoeuvre benefits may consider the tax-saving opportunities provided by other tax regimes available to IT businesses in Russia.

The Skolkovo Innovation Centre (the so-called “Russian Silicon Valley”) is one such preferential regime. The Centre was established in 2010 by the Russian government to encourage R&D and the commercialisation of its products, including in the IT sector of the economy. The following tax benefits are granted to Skolkovo residents:

  1. 14% social security contribution rate;
  2. VAT and profit tax exemption;
  3. refund of customs payments (including import VAT) for goods used for R&D and product commercialisation;
  4. property tax exemption.

The above tax benefits are granted to Skolkovo residents for a period of up to ten years. Skolkovo residents also have the opportunity to seek financial aid from the Skolkovo Foundation for their R&D projects.  

In addition to Skolkovo, Technology & Innovation Special Economic Zones (SEZs) have been established in some Russian regions (i.e., Innopolis in the Republic of Tatarstan, Tomsk, St Petersburg, Zelenograd and Dubna in the Moscow Region). The residents of such SEZs are also entitled to various tax incentives such as a reduced profit tax rate, a 14% social security contribution rate, property tax exemption, etc.

In our view, Skolkovo and SEZ residents should be able to combine the advantages of IT tax manoeuvre benefits with the tax preferences of the Skolkovo and SEZ special tax regimes. In particular, we believe it should be possible for a Skolkovo resident to enjoy the full profit tax and VAT exemption available to Skolkovo residents and, at the same time, the reduced 7.6% social security contribution rate established as a result of the tax manoeuvre in the IT sector.


For foreign IT companies that supply software to Russian government agencies and state-owned companies, software localization in Russia may be the only possible solution for maintaining their market share or gaining access to such a large segment of the Russian market. In light of the upcoming IT tax manoeuvre, such localization may also be seen as an option for ensuring the application of the VAT exemption to software sales and, thus, competitiveness in terms of pricing conditions with domestic market players.

Foreign investors who fail to qualify for IT tax manoeuvre benefitsmay also be encouraged to have a closer look at the tax advantages available to residents of the Skolkovo Innovation Centre and Technology & Innovation Special Economic Zones. They may present another opportunity to increase the overall tax and operational efficiency of an IT business in Russia.  

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