On February 15, 2016, the President of the Russian Federation signed Federal Law No. 32-FZ "On Amendments to the First and Second Parts of the Russian Tax Code (with Respect to the Taxation of Controlled Foreign Companies and the Income of Foreign Organizations)", introducing a new set of amendments to Russia's controlled foreign companies (the "CFC") and beneficial ownership rules (the "New Law").
Implications for taxpayers
The New Law is generally positive for taxpayers: it allows use of financial statements for determining the CFC profits of offshore companies, and it introduces certain clarifications on the avoidance of double taxation as well as a number of technical changes that may affect the application of CFC rules.
What the New Law says
1. Financial Statements for CFC Profits
The New Law provides for a much-anticipated expansion of the use of financial statements when determining the CFC profits of a controlled company registered in an offshore jurisdiction (previously this was available only to companies required to prepare audited financial statements according to domestic law, e.g. EU companies). Financial statements can now be used for calculating CFC profits in the following cases:
- Financial statements (audit is not required): the CFC is registered in a tax treaty jurisdiction that exchanges information with Russia1;
- Financial statements confirmed by an audit: the CFC is not registered in a tax treaty jurisdiction that exchanges information with Russia, but it voluntary prepares and files audited financial statements (e.g. in accordance with IFRS or any other international standards) with no negative auditor’s comments (or refusal to give comment).
CFC profits should be determined in a local currency and then transferred into rubles based on the annual average exchange rate (there is no requirement for per-transaction conversions).
These rules may effectively allow offshore companies to be retained in cross-border structures without the need to calculate the CFC tax base under rules set in Chapter 25 of the Russian Tax Code, and without the risk of the Russian tax authorities challenging such calculations.
2. Potential Increase in CFC Profits
Since CFC profits could be calculated based on foreign companies' financial statements, the New Law provides that all income (not only passive income, e.g. dividends, interest, capital gains) should be taken into account, which may in certain cases increase the CFC's tax base (unless the active companies' exemption applies).
3. Improvements for Trusts and Foundations
The new rules allow Russian settlors, their close relatives or their CFCs to contribute property, including monetary funds, and property rights to foreign trusts and foundations without creating taxable CFC profits (e.g., to the beneficiaries). The return of funds not being profit distributions (and provided that the foreign structure has no retained earnings) to the same persons/beneficiaries is also tax exempt, which may eliminate a long-existing tax inefficiency in the use of trusts (of foundations) as succession planning instruments.
The New Law requires only Russian settlors to notify on establishment of foreign structures. The beneficiaries are no longer required to notify the Russian tax authorities on holding beneficial rights in foreign structures.
The New Law further specifies rules for determining participation of a controlling person in foreign unincorporated structures (i) pro rata to contributions or, if this method is unavailable, (ii) in proportion to the number of controlling persons.
4. Avoidance of CFC Profit Double Taxation
The New Law clarifies provisions eliminating the double taxation of CFC profits, e.g. where a Russian controlling person receives dividends previously taxed as CFC profits.
5. "Tax Exempt" CFC Liquidation
The New Law extends the period when Russian controlling persons and shareholders (individuals and companies) can receive liquidation proceeds (except for money for individuals) from their CFCs free from taxation in Russia and create a “tax basis” for the future sale of these assets from January 1, 2017 until January 1, 2018, allowing more time for efficient cross-border restructurings.
6. Changes to the Reporting Procedure Regarding Participation in Foreign Companies
The period for filing notifications on participation in foreign companies has been extended from one month to three months. Individuals becoming Russian tax residents only as of the end of a calendar year have to report until March 1 of the following year.
The New Law exempts Russian persons participating in foreign companies through Russian public companies from the requirement to file notifications on participation in foreign companies and notifications on participation in CFCs with the Russian tax authorities.
7. Amendments to the Beneficial Owner Rules
Previously, Russian tax agents had the right to ask foreign recipients of Russian-source income to confirm their beneficial ownership of income. The New Law makes it obligatory for income recipients to provide such confirmation. So this will likely increase the burden on foreign recipients of income to provide the required documentary support. Clear rules have yet to be established by the Russian tax authorities on what information should be sufficient.
8. Tax Residency of Foreign Companies
Foreign companies that become Russian residents under the self- declaring mechanism are entitled to apply the 0% dividends tax rate under the "strategic participation" exemption. The New Law further clarifies several procedural issues for such companies, and extends the term for liquidation of foreign companies for the purpose of avoiding the risk of being declared Russian tax residents from January 1, 2017 till January 1, 2018.
Actions to consider
The following actions are suggested:
- reconsider use of offshore companies in cross-border structures due to new possibility for determining CFC profits based on audited financial statements; prepare for audits of existing offshore companies;
- revise the holding structure to determine CFCs that may be liquidated within the extended “tax exempt” liquidation period;
- consider the approach of supporting the beneficial ownership status of foreign companies that are recipients of Russian-source income.