The regulatory framework of the newly formulated industrial policy in Russia, as set out in Federal Law No. 488-FZ of 31 December 2014 (the “Law”), will come into force on 1 July 2015. In line with the shift towards an import substitution model for the Russian economy, the Law sets out the main principles that will govern new incentivising mechanisms intended to support the development of industrial production in Russia. It also prioritises regional development and favours Russian-based manufacturers.
Despite the fact that the full implementation of the industrial policy will require the adoption of complex secondary legislation and the amendment of other legislative acts (such as the Tax and Budgetary Codes), it is highly advisable to start considering what new mechanisms will be available and take them into account when elaborating on business development plans in the context of changing market conditions in Russia. To this end, we have outlined below key aspects of these incentivising mechanisms for investors who may be considering localising production in Russia.
All industrial companies are faced with the issue of long added value creation process. For example, the timeframe between ordering materials at the initial stage of the production cycle and the final delivery of goods (machines, equipment, etc.) can be in the region of two to three years, depending on the industrial sector. Therefore, manufacturers are forced to resort to the use of circulating funds obtained on the local financial market, which in Russia can be accessed only at extremely high interest rates. This causes goods produced in Russia to become over-priced and non-competitive in the local market (compared with imported goods) and even more so in international markets.
In order to alleviate this problem, the Law establishes the following incentives for the industrial sector:
- Financial support in the form of various subsidies (for R&D expenditures and for the development of industrial infrastructure) to be granted on the basis of tenders, with priority being given to projects involving the use of so-called ‘best available technologies’ (“BATs”).
The concept of BATs is relatively new in Russian environmental law. It was introduced by Federal Law No. 219-FZ of 21 July 2014. Manufacturers who implement BATs can offset the amount that they spend on improving environmental efficiency at their facilities against environmental fees;
- Refinancing of loans by the regions and access to long-term loan financing on competitive terms;
- Various types of tax incentives, such as special incentives for projects that are to be implemented before 2025 and have been duly approved by the Russian Government;
- Creation of dedicated state funds to stimulate industrial development (by way of loans, grants, equity participation in project companies, leasing, etc.).
Special investment contracts
The Law creates a new contractual framework for projects in the industrial sector by introducing the concept of special investment contracts which may be concluded for a period of up to ten years. Under such contracts, investing companies that undertake to modernise existing industrial production facilities or set up new ones, will be guaranteed long-term incentives by the Russian State.
What mainly distinguishes special investment contracts from other contractual arrangements formalising public-private partnerships is that the state does not contribute budgetary funds or state-owned property to the relevant project. The purpose of special investment contracts is therefore to create favourable stable conditions for investors in terms of the applicable legal regime and tax burden, and not for the state to obtain title or any rights to property. The cost of these state incentives is expected to be offset by the anticipated positive economic effect for the state in the form of new infrastructure, jobs, as well as tax payments from new businesses.
Given the nature of this new Law, particularly the need to amend other legislation and adopt complex secondary legislation (in particular, more than ten Decrees are to be adopted by the Government), implementation of the regulatory framework may prove to be less straightforward in practice.
The intention of the Law is clearly to prioritise local production over import and this will likely force international investors into changing their business models by favouring industrial production within Russia. At the same time, Russia’s potential industrial capacity does in itself necessitate that domestic production sites evolve and become more self-sufficient and in this sense, the legislative changes do represent an interesting opportunity for business development through local production.