Setting up and operating a joint venture


Are there any particular drivers in your jurisdiction that will determine how a joint venture is structured?

As with any jurisdiction, a number of factors drive joint venture structuring. Typical factors include:

  • increasingly complex regulation;
  • marrying the requirements of Russian mandatory rules with the governing law of the transaction;
  • international sanctions;
  • the rapidly evolving tax regime;
  • the lack of established market practice to benchmark transactions against;
  • the availability of recourse to international arbitration with a seat outside of Russia; and
  • satisfying the requirements of Russian regulators, particularly if the transaction concerns a strategic business sector.

As mentioned in question 1, concerns about the enforceability of certain provisions of SHAs under Russian law have historically resulted in offshore joint venture structures.

Tax considerations

When establishing a joint venture, what tax considerations arise for the joint venture parties and the joint venture entity? How can tax charges be lawfully mitigated?

Russian legislation dealing with controlled foreign corporations (CFCs), which came into force in 2015, has continued to develop. Although broadly consistent with the approach of the EU and the Organisation for Economic Cooperation and Development, these rules remain widely untested in the Russian legal framework, especially in the courts.

The Russian legislation concerning CFCs sets out rules in four areas of tax structuring. First, it addresses the taxation of profits received by CFCs owned by Russian residents but not yet received by the Russian residents themselves. Second, it requires Russian residents holding shares in, or controlling, foreign companies or non-corporate entities to notify the Russian tax authorities of such a shareholding or such control. Third, it lays down the test for determining the tax residency of legal entities. Lastly, it introduces the concept of beneficial ownership of income for the purposes of DTTs.

The Russian government’s aim is to restrict the availability of DTT benefits for recipients of passive income from Russian sources where offshore structures are deliberately established to obtain tax treaty benefits for the ultimate beneficial owners of such income.

Within the same trend, interest taxation rules have been heavily amended, with specific transfer pricing regulations introduced concerning interest in 2016 and thin capitalisation rules revised with effect from 2017. Amendments to thin capitalisation rules restrict the deductibility of interest under loans extended by foreign sister companies. However, according to the most recent amendments to these rules, there are certain exceptions to the rules in respect of the deductibility of interest payments under loans relating to investment projects. It is not yet clear, however, to what extent these exceptions will be available to foreign investors.

In addition, changes to certain obligations have been imposed on the members of international groups of companies. These companies are obliged to notify tax authorities that they are part of such groups. If the consolidated revenue of a group exceeds certain limits, its members are obliged to disclose various information, such as the structure of ownership and control of the group, main indicators of activity, profits gained and losses incurred, and taxes paid. Currently, a breach of these obligations is punishable by fines.

Apart from this, the Russian government has shown a trend towards increasing the tax burden on business. The value added tax (VAT) rate was increased from 18 to 20 per cent on 1 January 2019, and amendments to the profit tax regime (which are mostly disadvantageous for taxpayers) were introduced in 2017 and 2018. The ability of the Russian regions to introduce tax incentives on profits is gradually being limited. Loss carry-forward was amended so that only half of losses carried forward can be deducted in a given year (although the carry-forward itself is now unlimited by time).

These developments illustrate the continuing trend of Russian tax legislation becoming significantly more complex and nuanced. In tandem, Russian tax authorities are adopting increasingly sophisticated and rigorous approaches to assessing applications for relief under DTTs. In the past couple of years, there has been a closer examination of the substance of ownership structures and the nature of the relationship between, and the functions of, the different entities in these structures. Where foreign companies or non-corporate entities are found to be acting as mere conduits or agents for the true beneficial owners of income, they may be disregarded for tax treaty purposes. Investors need to be aware of this issue and seek detailed legal advice accordingly. It is also quite common for foreign partners to request indemnities regarding tax matters when buying into Russian joint venture companies.

Asset contribution restriction

Are there any restrictions on the contribution of assets to a joint venture entity?

Russian law establishes minimum charter capital requirements for LLCs and JSCs, and provides that their net asset value must be equal to or exceed their charter capital. Non-cash consideration for shares or participatory interests may be satisfied by, among other things, securities, property, shares, participatory interests, state or municipal bonds, and intellectual property.

Certain restrictions apply on how contributions of proprietary rights can be made. Restrictions on non-cash consideration may be imposed by a company’s charter. The value of non-cash contributions paid for shares or participatory interests at the incorporation of a company must be determined by an independent appraiser. Contributions of assets from shareholders are tax-free for the receiving Russian company.

Interaction between constitution and agreement

What is the interaction between the constitution of the joint venture entity and the agreement between the joint venture parties?

Shareholders of LLCs and JSCs are permitted under Russian law to enter into SHAs to regulate the exercise of their corporate rights. Creditors and other third parties (such as lenders granting a convertible loan to the joint venture or option holders) may also be party to such SHAs. As a general rule, the provisions of an SHA are valid and enforceable between the parties even if they conflict with the company’s charter. That said, this rule has not been extensively tested in the Russian courts.

Decisions of a company’s management bodies may be invalidated if they breach the SHA, provided that all shareholders were party to the SHA at the relevant time. Further, transactions by a party or the company’s management that breach the SHA or the company’s charter (respectively) may be invalidated if the other party to the transaction was, or should have been, aware of the relevant restrictions in the SHA or charter (as applicable).

Russian law requires that any disproportionate voting or profit distribution arrangements be disclosed in the state register (although due to certain technical limitations of the register, the effectiveness of disclosure is limited). If the SHA contains restrictions on the disposal of shares (participatory interests), the existence of the SHA must be disclosed in the state register. Otherwise, there is no requirement to register or publish SHAs relating to LLCs and non-public JSCs (save for a requirement to notify the company itself).

Party interaction

How may the joint venture parties interact with the joint venture entity? Are there any restrictions?

The traditional governance arrangement between joint venture parties is that the directors of the offshore holding company take all principal decisions regarding the joint venture, except for those decisions reserved to the shareholders by the SHA or the company’s constitutional documents. This arrangement is traditionally mirrored at the level of the Russian operating company through equivalent provisions in the company’s charter. Recent reforms to Russian law have increasingly enabled parties to replicate such governance arrangements in relation to Russian companies. For instance, in relation to non-public companies, there is now greater flexibility in allocating matters between different management bodies, regulating quorum or majority requirements, and other procedural matters.

Governance arrangements usually include an information-sharing regime. In addition, public disclosure rules apply to public JSCs, and other companies must disclose prescribed information to shareholders upon request (eg, general meeting minutes and statutory audit reports). That said, these statutory information rights were significantly narrowed in 2017, making it increasingly important that minority shareholders negotiate contractual rights to company information. Under Russian law, Russian businesses and individuals affected by international sanctions are exempt from certain disclosure requirements.

Exercising control

How may the joint venture parties exercise control over the joint venture entity’s decision-making?

As with any jurisdiction, the SHA and the company’s constitutional documents may contain provisions protecting minority investors and regulating joint venture decision-making.

Decision-making can be regulated at shareholder level (eg, requiring unanimous shareholder consent for certain decisions) or board level (eg, giving minority shareholders the right to appoint directors with specified veto rights). Limits may also be placed on the authority of the joint venture’s corporate officers. While these provisions are typically included in an English law SHA, it is increasingly viable to place such restrictions in the charter of a Russian company and a Russian law SHA. At the same time, while it is now possible in a Russian company to appoint several general directors, each with executive powers, there are still certain technical restrictions under Russian law that affect the enforceability of the exercise of joint signatory powers by several general directors.

As stated above, information rights are commonly negotiated to support minority investor participation in decision-making. Representation on company committees can also be an effective tool to ensure access to information.

Governance issues

What are the most common governance issues that arise in connection with joint ventures? How are these dealt with?

The most common governance issues arising in Russian joint ventures are broadly the same as with any jurisdiction - for example, dividend policy, approval of business plans and budgets, board appointments, veto rights, deadlock provisions, financing provisions and exit rights. These matters are generally dealt with in the SHA or the company’s constitutional documents. Other current areas of focus include compliance with sanctions, the rapidly evolving tax regime, and anti-money laundering and bribery standards. Recently, Russian law was amended to reduce the scope of statutory shareholder information rights and to abolish an absolute requirement for prior approval of interested-party transactions, and so foreign investors are increasingly seeking additional contractual protection on these matters.

Nominee directors

With an incorporated joint venture, what controls exist in your jurisdiction in relation to nominee directors? How should a nominee director balance the potentially conflicting interests of the joint venture company and the appointing shareholder?

Russian law requires directors of Russian companies to act in the company’s best interests and to exercise their rights and discharge their duties reasonably and in good faith. Directors may also be liable for damage they cause to the company by acting outside the ordinary course of business. Russian law also regulates interested-party transactions and conflicts of interest.

Russian law does not recognise nominee directors, and directors are not considered representatives of a particular shareholder, even if appointed at their request. It is quite common in Russian joint ventures for shareholder procurement obligations to include actions by their nominated directors subject to directors’ legal duties. Where there is a concern that directors’ abilities to exercise their rights may be limited by their legal duties, this is often addressed by:

  • giving such rights to the shareholders instead of the directors; or
  • the concept of necessary duties, which may include the re-election of directors.

It is quite common for shareholders to indemnify directors or require that a portfolio company obtain directors’ and officers’ liability insurance.

Competition law

What competition law considerations are engaged by the formation and operation of the joint venture? Is approval needed?

Subject to certain exemptions, the acquisition of control of Russian companies operating in strategic business sectors by foreign investors requires governmental consent. Strategic business sectors include the development of significant subsoil fields, major telecommunications and print media, and the nuclear, military and aviation industries. Companies incorporated in Russia and operating in any of these sectors are within the remit of the Strategic Investment Law. ‘Control’ is broadly defined and includes controlling the majority of votes at a shareholders’ meeting, having the power to appoint a majority of the directors, and being entitled to appoint the CEO. The control thresholds for companies engaged in the development of subsoil fields of federal importance are stricter than those applicable to other strategic companies. Foreign sovereign investors are generally prohibited from acquiring control of strategic companies. In June 2018, the restrictions applicable to foreign sovereign investors were extended to any foreign investor who does not disclose information on its controlling shareholders and beneficiaries to the relevant Russian regulators as required by Russian law (a non-disclosing investor). In certain cases, the Federal Antimonopoly Service (FAS) may aggregate stakes held by several unaffiliated non-disclosing investors and sovereign investors, so that it may treat several such unaffiliated investors as if they were a single party and apply the strictest set of restrictions as if that party were a foreign state. The scope of contractual rights may also be relevant for determining whether control is being acquired.

In July 2017, Russian law was amended to provide that the Russian government may escalate any transaction involving a foreign investor to a lengthy and complicated strategic review process, not merely those where the target is a strategic business. At the time of writing, we are aware of only one instance where this procedure was followed in a sensitive yet not strategic business sector.

Separately, the consent of the FAS is required for the acquisition of control (including the acquisition of pre-determined equity thresholds in the event investment is made into Russian entities directly) over Russian businesses or businesses active in Russia subject to asset and turnover thresholds. As the thresholds are relatively low, it is often necessary to approach the FAS for its consent to transactions, including, among other things, the formation of joint ventures and the purchase of a joint venture partner’s stake. Arrangements between competitors regarding their joint activities in Russia are also subject to control from the FAS.

Non-compete arrangements in the M&A context may generally be more problematic in Russia than in the EU or other developed jurisdictions. Non-compete arrangements may be enforceable in Russia if they are placed in proper joint venture agreements and meet a number of criteria.

Subject to certain thresholds, the approval of the Central Bank of Russia may be required to acquire an equity interest in a Russian bank or insurance company.

The merger-control regime and the regime under the Strategic Investment Law is suspensory, meaning that closing cannot proceed unless the clearance is in place. Gun-jumping is penalised. It is possible to sign transactions and make them conditional upon the receipt of FAS consent or approval under the Strategic Investment Law. Because the regulator is entitled to impose remedies, it is quite common to require, as a condition precedent to a merger, the receipt of regulatory approvals to the reasonable satisfaction of the buyer or parties jointly.

Provision of services

What are the key considerations in your jurisdiction in structuring the provision of services to the joint venture entity by joint venture parties?

Separation issues are often important when structuring the provision of services and are particularly relevant when dealing with Russian majors that remain controlling shareholders. For instance, major energy companies commonly use their subsidiaries to provide operatorship and other services to a number of entities. The underlying service contracts may contain provisions that would be common for intragroup arrangements, but these may not necessarily work in a joint venture context. Joint venture documents commonly stipulate that services must satisfy arm’s-length criteria and provide an order of priority to the parties’ interests in case of any conflicts of interest between the parties (eg, as a service provider) and the joint venture. Interested-party transaction rules must also be considered.

Employment rights

What impact do statutory employment rights have in joint ventures?

Since 1 January 2016, Russian law prohibits secondment arrangements. There is, however, an exemption for secondment arrangements between parties to SHAs in respect of JSCs that are implemented in accordance with (yet to be adopted) regulations, provided that the secondees have consented.

Intellectual property rights

How are intellectual property rights generally dealt with on the creation, operation and termination of a joint venture in your jurisdiction?

Russian law specifies which intellectual property (IP) rights are recognised and protected in Russia and any applicable registration requirements. For example, the protection of inventions, utility models, industrial designs and trademarks depends on registration with the Russian Federal Service for Intellectual Property (Rospatent). Russia is also a signatory to several international IP treaties.

As a general rule, Russian law provides that the author of IP (or the employer, if the IP is created by employees during their employment) owns all of the associated IP rights. The owner of IP rights can assign, encumber or license such rights to third parties, provided that this is only effective for trademarks, patents and certain other IP once registered with Rospatent.