On February 15, 2016 the Russian President signed Federal Law N 25-FZ, which revises the existing thin capitalization rules and expands the scope of their application (the "Law"). A new favorable exemption for loans from unrelated banks can be applied as of January 1, 2016. Other changes become effective as of January 1, 2017.
Implications for taxpayers
The Law follows from existing court practice and extends the application of the thin capitalization rules to loans from foreign companies which are not direct or indirect participants of the borrower. The Law also introduces a number of favorable exemptions e.g., (i) for loans from related Russian companies if such companies do not further pay such interest abroad or (ii) for loans from unrelated banks guaranteed by group companies in the absence of payments under such guarantees.
What the law says
Timely closing the "foreign sister company" loophole
The Law has revised the scope of debts to which the Russian 3-to-1 thin capitalization ratio1 applies ("controlled debt") to include loans from:
- A foreign related party, i.e. an individual or a company (previously only loans from corporations counted) (i) which owns directly or indirectly (via other companies) 25% or more of a Russian borrower (previously 20%) or (ii) which owns more than 50% consecutively in each preceding company in a direct holding chain of a Russian borrower2 ("Foreign Participant");
- A person (either foreign or Russian) related to the Foreign Participant (including direct or indirect participants, subsidiaries and sister companies) ("Related Person");
The reference to the foreign related company officially eliminates the so-called "foreign sister company" loophole, where loans from related foreign companies which do not have direct or indirect participation were not technically considered as "controlled debt". The "foreign sister company" loophole was effectively closed by Russian court practice after the North Kuzbass and Naryanmarneftegas cases in 2011-2012.
- Any other persons if the debt is guaranteed or otherwise secured by any person mentioned under the previous two categories.
The court may also consider other debts as "controlled debts" if it is proven that the payment was effectively transferred to persons covered by one of the above categories.
New exemptions from thin capitalization rules
The Law exempts the following categories from being recognized as "controlled debt":
- Debts to Russian Related Persons not having a "comparable" (based on the amount and term) debt to the Foreign Participant (i.e., where loans are provided from the lenders' own funds and there is no backto-back financing where interest income is effectively transferred abroad);
- Debts to an unrelated bank guaranteed or otherwise secured by a Foreign Participant or a Related Person if there has been no payment on such guarantee or security;
- Debts to foreign SPVs - issuers of Eurobonds that are residents in the tax treaty countries.
The exemption for bank loans guaranteed by group companies will apply as of January 1, 2016.
Actions to consider
- Review the debt-equity position of Russian borrowers in view of the extension of the Russian thin capitalization rules (if not previously done in view of the court practice) to include "foreign sister company" loans;
- Review the thin capitalization position on loans that may benefit from new exemptions (review comparable loans);
- Plan accordingly for new borrowings in view of the new exemptions from the thin capitalization rules.
We will continue to provide timely information on expected amendments to the Russian tax legislation and will be happy to answer, on an individual basis, any questions you may have with respect to Russian taxation.