Amendments to Russian Thin-Capitalization Rules and Interest Deductibility Caps Address the Devaluation of the Ruble
On 8 March 2015 the President of the Russian Federation signed Federal Law No. 32-FZ “On Amending Part Two of the Russian Tax Code,” establishing a fixed ruble exchange rate to be applied to thin capitalization and extending the use of interest deductibility caps (the “Law”).
Implications for taxpayers
The new amendments should help Russian borrowers obtain interest deductions on the related-party loans denominated in a foreign currency, which had fallen under thin capitalization restrictions due to the drastic devaluation of the ruble, by fixing an artificial exchange rate. The Law fixes ruble exchange rates as of 1 July 2014 for the purposes of calculating the thin capitalization debt-to-equity ratio, thus placing some of the foreign currency loans outside the class of tainted debts.
The Law also extends the application of the new safe harbors for allowed interest rates, currently available only for transactions with banks, to other related party loans for which companies do not want to go through the transfer pricing study. This could help taxpayers reduce costs on the tax administration and save on transfer pricing studies, especially on small loans.
What the Law says
The Law (i) fixes ruble exchange rates for the purposes of applying Russian thin capitalization rules and (ii) extends and revises the new interest deductibility caps.
1. Fixing ruble exchange rates for thin capitalization rules
Because of the drastic ruble devaluation in 2014–2015, many Russian borrowers having foreign currency denominated loans from related parties faced thin capitalization issues, even on loans that were previously within the 3 to 1 debt-to-equity ratio and were extended on the arm’s-length terms. Although this non-deductibility problem suggests that there are more fundamental issues with Russia’s thin capitalization rules, the Russian authorities are aiming for a quick and temporary solution by artificially fixing ruble exchange rate. The fixed ruble exchange rate will apply (and no exchange rate differences will be considered) to calculating deductible interest accrued in the period from 1 July 2014 to 31 December 2015 on loans concluded before 1 October 2014.
The ruble exchange rates for thin capitalization purposes will be based on the Central Bank rates set on 1 July 2014 (USD1 — RUB33.8434; EUR1 — RUB46.1827).
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2 Legal Alert March 2015
2. Extension of safe harbor interest deductibility caps
As of 1 January 2015, historic interest deductibility caps based on the Central Bank refinancing rate (the “CBR”) were eliminated in favor of applying transfer pricing rules, except for loans where one of the parties is a credit institution. Although the transfer pricing rules only apply to the related-party loans in the absence of a safe harbor rule, it is quite costly and impractical for Russian borrowers to prepare transfer pricing studies for small-scale loans.
The Law revises the application of the safe harbor interest rates to all controlled loans as of 1 January 2015. New safe harbor interest rates for ruble loans shall apply, and are mostly based on the Central Bank “key rate” (currently 15%), which is higher than the CBR (which is still fixed at 8.25%).
Finally, the Law introduces a temporary, wider safe harbor range applicable to ruble loans concluded between the related Russian entities for year 2015.
We summarize the safe harbor interest rates as revised by the Law in the table below (including temporary, more beneficial ranges). Currency (period) Safe-Harbor Range for Interest Rates on Debt Obligations between Related Parties Minimum Maximum
RUB (for loans granted from 1st to 31st December 2014)
3.5 CBR (28.875%)
RUB (for 2015)
0%1 of the key rate
180% of the key rate
75%2 of CBR
RUB (as of 2016)
75% of the key rate
125% of the key rate
EURIBOR + 4%
EURIBOR + 7%
SHIBOR + 4%
SHIBOR + 7%
GPB LIBOR + 4%
GPB LIBOR + 7%
CHF LIBOR + 2%
CHF LIBOR + 5%
JPY LIBOR + 2%
JPY LIBOR + 5%
USD and other currencies
USD LIBOR + 4%
USD LIBOR + 7%
1 0% - applicable to ruble loans concluded between the related Russian entities;
2 75% - applicable to ruble loans concluded with related foreign entities or offshore companies;
Note that taxpayers may not rely on or deduct interest under the safe harbor rule when the interest rate on a controlled loan is outside the applicable minimum and maximum thresholds in the range; in such cases they must prepare and use the transfer pricing study.
Actions to consider
review the thin capitalization position of Russian borrowers for 2014–2015 in view of the artificial fixed ruble exchange rate; consider amendments to 2014 tax returns to increase interest deductions;
review and revise the deductible interest amounts on current related-party loans which are not backed by transfer pricing documentation; consider the new safe harbors for future borrowings.
This LEGAL ALERT is issued to inform Baker & McKenzie clients and other interested parties of legal developments that may affect or otherwise be of interest to them. The comments above do not constitute legal or other advice and should not be regarded as a substitute for specific advice in individual cases.