New Tax Rules Remove RUB 500 Million Equity Investment Requirement for Parent Companies to Claim 0% Substantial Shareholding Exemption Tax Rate on Dividends; Proposed Amendments Contemplate Introduction of Consolidated Tax Filings and Abolition of Capital Gains Tax on Long Term Investments
Several amendments to Russian tax law were introduced at the end of 2009 and the first half of 2010, with some interesting reforms also planned for 2011. This article summarizes the new developments.
Removal of the RUB 500 million Equity Investment Qualification Requirement for the Substantial Shareholding Exemption on the Taxation of Dividend Payments
The Tax Code of the Russian Federation (the “Tax Code”) was recently amended (at Article 284.3(1)) to remove one of the qualification requirements for the so-called “substantial shareholding exemption,” which, when triggered, sets a 0% tax rate on dividends distributed by subsidiaries to parent companies. It is no longer required that to qualify for the exemption the company receiving the dividend must have made an equity investment of at least RUB 500 million in the company paying the dividend. This amendment brings shareholders which had previously fallen beneath this threshold into the scope of the substantial shareholding exemption and will likely encourage the further use of Russian holding companies in corporate groups. The substantial shareholding exemption qualification requirement of an equity investment of RUB500 million had previously been criticized for a number of ambiguities: for example, it was unclear whether the threshold value of an equity investment of RUB 500 million could be reached through the purchase of shares at different times or only through a single purchase of shares. The following two criteria for the exemption are still retained: (1) the company receiving the dividend must hold at least a 50% shareholding in the company distributing the dividend; and (2) the company receiving the dividend must have owned the relevant shares in the company distributing the dividend for a minimum of 365 days. This provision will come into force from January 1, 2011, but will apply to the
payment of corporate income tax on dividends for 2010 and subsequent periods.
New Rate of Income Tax for “Highly Qualified Foreign Professionals”
As set out in detail in this DechertOnPoint Russian Legal Update in the article titled “Russia Welcomes Highly Qualified Professionals,” a new streamlined work permit program for “highly qualified foreign professionals” became effective on July 1, 2010. A 13% personal income tax rate will apply to remuneration received from the professional activities of such highly qualified foreign professionals, even if they are not tax resident in Russia (a tax resident must spend 183 calendar days or more in Russia over a period of 12 consecutive months). Previously, foreign employees who were not tax resident were taxed at 30% on their Russian-source income.
Reinstatement of the Pre-Crisis Rate for Deducting Interest on Ruble Debt Obligations
The previous procedure for calculating the deduction of interest on Ruble debt obligations was reinstated from July 1, 2010, for all Ruble debt obligations that arose before November 1, 2009. From July 1, 2010, interest on Ruble debts may be deducted at the refinancing rate of the Central Bank of Russia multiplied by 1.1. Until June 30, 2010, interest on debt obligations that arose before November 1, 2009 could have been deducted at double the refinancing rate (for Ruble debts). This was a temporary measure that was introduced in 2009 as part of the Russian Government’s anti-crisis program. The deduction of interest on Ruble debt obligations arising after November 1, 2009, was not affected by the temporary measures and remained at the refinancing rate of the Central Bank of Russia multiplied by 1.1. For debt obligations in a foreign currency the current limit for interest deduction is 15% per annum.
Since January 1, 2010, the following amendments to the Tax Code in relation to VAT have taken effect:
- Assignments under loan agreements or credit agreements and the fulfillment of obligations by borrowers to creditors which have been assigned the benefit of such loan or credit agreements are now VAT exempt. Previously, the Ministry of Finance of the Russian Federation had interpreted the provisions of Article 149 of the Tax Code in such a way so that only assignments from initial creditors (who signed the original agreement) and the fulfillment of obligations to such initial creditors were VAT exempt. These VAT exemptions are now available to all creditors.
In order for a buyer to deduct VAT paid to a seller, the invoice for the purchase should meet certain criteria provided in Article 160 of the Tax Code. In practice there have been many disputes related to violations of these criteria which have led the tax authorities to reject the deduction of VAT. The new amendments provide that non-material errors in an invoice shall not constitute grounds for the rejection by the tax authorities of a VAT deduction. A non-material error is one which does not impair the identification of the buyer, purchaser, price, goods, works or services, applicable tax rate or the amount of tax payable. Most Arbitrazh Courts have supported this approach in various tax disputes relating to VAT.
REPO transactions (including funds which should be paid by providing securities under such transactions), as well as loans in the form of securities (including interest on such loans) are now VAT exempt. The Ministry of Finance has stated with respect to this provision that in the event that securities have been transferred under the relevant loan agreements before 2010 and the termination date of such agreements is after January 1, 2010, then interest under such loan agreements should be subject to VAT.
Those taxpayers who have paid more than RUB 10 billion in tax over the past three years (including profits tax, excise tax, mineral extraction tax and VAT, but excluding import/export VAT and VAT withheld by tax agents) will be able to offset VAT input tax recorded in their tax returns before the mandatory audit of such tax returns. In order to qualify, the taxpayer must provide a bank guarantee in the amount of the refund in the event that it is later challenged. This new procedure can be applied to tax declarations submitted for the first quarter of 2010.
Abolition of the Unified Social Tax
New rules related to the calculation and payment of social security contributions were effective as of January 1, 2010. Thus, the unified social tax no longer exists and instead separate contributions to the Russian social funds (i.e., state pension, medical insurance and social insurance funds) have been introduced. These contributions are payable by employers in conjunction with employee salaries. From 2011, higher tariffs for these contributions will be introduced. Employers’ reports must now be submitted to the relevant social fund instead of to the tax authorities.
Projected Future Amendments
Russian law does not currently provide for consolidated tax filings for companies under common control in a group structure. However, a draft law is currently under consideration which would allow for consolidated group profits and losses, if the participants of the group agree. The group would be recognized only for the purposes of the profits tax. Under the draft law, the profits and losses of different group companies could be offset against each other and transactions between group companies would be ignored for tax purposes. These measures would allow corporate groups to reduce their overall tax burden. However, companies which already enjoy certain tax advantages would be excluded from such groups for tax purposes and there is a requirement in the draft law that all group companies would need to be in the same industry sector.
Transfer Pricing Rules
A proposed draft law on transfer pricing is also under consideration, which, if adopted, would be effective from January 1, 2011. The key changes would include the introduction of: “advance pricing agreements” with tax authorities (to resolve key issues early); new pricing methods (derived from widely-used international practice); the “arm’s length” concept (as opposed to looking at 20% deviations from market prices); further documentation and reporting rules; and making further sources of data available for the calculation of market prices.
Transfer pricing controls would cover transactions between related parties, transactions with third parties in low tax jurisdictions or with other third parties which enjoy tax advantages, and a number of other cross-border transactions.
Capital Gains Tax Exemption For Long Term Investments
In his speech to the St Petersburg Economic Forum on June 18, 2010, President Dmitry Medvedev announced that in 2011 “Russia will completely abolish capital gains tax on long-term direct investment.” However, further details concerning this measure have yet to be published. Since many companies transact business through offshore structures, it is difficult to determine the true impact of the abolition of this tax.
Ratification of the Protocol to the Russia/Cyprus Double Tax Treaty
On April 16, 2009, a Protocol (the “Protocol”) to the Russia/Cyprus Double Tax Treaty (the “Double Tax Treaty”) was signed in Nicosia. 10 articles of the Double Tax Treaty were amended by the Protocol and one new article was added. The main changes will affect revenues from the sale of real estate, the taxation of dividends, the definition of a permanent establishment (which has been broadened) and provisions relating to the exchange of information. The Protocol provides that it will come into effect on January of the year following the date of its ratification by the last of the two parties to do so. An article relating to revenues from the sale of real estate will come into effect four years from the date the Protocol comes into force.