24 November 2015 Global Tax Alert Russia releases new version of bill amending De-offshorization Law EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: www.ey.com/taxalerts Executive summary On 29 October 2015, the Russian Government posted the latest version of the bill proposing a number of amendments to the De-offshorization legislation (the Bill) on the federal portal of draft normative legal acts. The new version of the Bill has been substantially modified in comparison with 21 May 2015 version. The Bill is designed to address a number of controversial issues in connection with the practical application of the legislation. Not all issues are resolved in the Bill, but the attempt to address the concerns of the business community is a positive development. This Alert provides a summary of the key amendments proposed in the Bill. Detailed discussion Procedure for submission of notifications of participation in foreign organizations (foreign structures without corporate identity) The Bill proposes to maintain the obligation to submit notifications on the basis of the criterion of the foundation of foreign structures without corporate identity, but abolishes the obligation to provide notifications on the basis of the criterion of an actual right to income or control over foreign structures without corporate identity. The Bill does not address the issue of what to do about previously submitted notifications if they were made on the basis of the actual right to income or control criteria.
Global Tax Alert 2 Persons whose participation in foreign companies exists solely through direct and/or indirect participation in Russian public companies are to be exempted from the obligation to submit notifications of participation. If the Bill is adopted in its current form, these amendments would apply to legal relations arising on or after 1 January 2015. It is also proposed that Russian tax residents engaging in the fiduciary management of assets should be required to submit notifications of participation and notifications of controlled foreign companies (CFCs) if they have contributed those assets to the capital of a foreign company or transferred them to foreign structures without corporate identity founded by them. Procedure for calculating the share of a participating interest in a foreign company The Bill proposes setting forth in the Tax Code a procedure for the calculation of the size of the participating interest which a person holds in a company through a foreign structure without corporate identity or a foreign legal entity whose laws of the country of the CFC does not provide for participation (there is no charter capital or fund). In particular: Such participation would be taken into account in determining the size of a person s interest in a company only if that person is a controlling person of the structure without corporate identity or the legal entity without participants through which participation in the company is exercised Where a structure/legal entity without participants through which the interest of particular persons in a company is held has a number of controlling persons, the size of that interest should be determined as follows: In proportion to each controlling person s contribution to the assets of the structure/legal entity without participants, or, if it cannot be calculated in this way In proportion to the number of controlling persons of the structure/legal entity without participants The Bill also proposes the insertion in the Tax Code of a provision governing the procedure for determining the participating interest in companies for which shares/ interests held therein form part of the assets of a Russian investment fund or a non-state pension fund: the size of a direct participating interest in such companies would be determined in proportion to a person s participating interest in (share of assets contributed to) that investment fund (non-state pension fund), or, if that interest cannot be determined, in proportion to the number of participants in the fund. Recognition of a foreign company as a CFC by the tax authorities Under the proposed new provisions, if the Russian tax authorities receive information from foreign tax authorities indicating control over CFCs in a situation where the controlling person has not submitted CFC notifications, depending on the grounds on which the person in question is recognized as a controlling person, the tax authorities have a right to send a notification declaring the person to be a controlling person of a CFC. In this case the controlling person would be exempt from the liability set forth in Articles 129.5 and 129.6 of the Tax Code. It is important to note that it is not specified that the information on potential control must be received in the context of the exchange of tax information under international taxation agreements. Tax exemption for profit of CFCs The range of exceptions would be extended to include Eurobond SPVs where the proceeds from the issue of circulated bonds by the SPV are used as debt financing for foreign borrowers. Previously, such an exception applied only in cases where debt financing was used by Russian borrowers. It is proposed that exchange rate differences and income which is not taken into account in calculating the profit of a CFC (such as income from the revaluation of securities, participating interests and derivative financial instruments, income from the restoration of reserves, etc.) should not be taken into account in determining the proportion of passive income. Calculating profit of a CFC The Bill proposes the exclusion of the requirement for financial statements to have undergone a compulsory audit in accordance with the laws of the country of a CFC in order for the profit of a CFC to be calculated on the basis of data in those financial statements.
3 Global Tax Alert The Bill sets out conditions which must be met by a CFC in order for profit which is taxable at the level of Russian controlling persons to be calculated on the basis of financial statement data. At least one of the conditions specified below must be met: The CFC is a resident of a foreign state with which Russia has an international taxation treaty and which provides for the exchange of tax information with Russia (a draft order of the Federal Tax Service, which differs from the blacklist of the Ministry of Finance) OR An auditor s report not containing an adverse opinion or waiver of opinion has been provided in relation to the CFC s financial statements The Bill sets out requirements relating to financial statements: non-consolidated statements based on standards established by the personal law of the CFC (if no standard is established by that personal law, IFRS or standards recognized by exchanges or depositary and clearing companies should be used). Where the profit of a CFC is calculated on the basis of financial statement data, it is proposed to allow that profit to be adjusted only for revaluations of securities and derivative financial instruments which are recorded from 2015 onwards. If a controlling person independently chooses the option whereby profit of a CFC is calculated according to the rules of Chapter 25 of the Tax Code (i.e., according to the rules prescribed for Russian legal entities), even though there are grounds for it to be calculated on the basis of financial statement data, that decision must be laid down in the person s accounting policies, and the taxpayer would be obliged to use the chosen approach for five consecutive years. It is proposed to allow the profit of a structure without corporate identity which is a CFC to be reduced by the amount of distributed profit (thus, the law would not limit profit distribution solely to controlling persons). Taxation of profit of a CFC for a controlling person The date on which profit of a CFC is recognized for a controlling person where no profit distribution decision has been made would be changed to 31 December of the year following the tax period in which the last day of the financial year falls. Thus, if no profit distribution decision is made by the end of 2015, the date on which profit of a CFC is recognized would be 31 December 2016. The proposed amendments would, among other things, align the date on which the profit of a CFC is recognized with the standard rules establishing the date of receipt of income in the form of profit of a CFC (Articles 223 and 271 of the Tax Code). It is specified that where the participating interest of a controlling person in a CFC differs from the profit share to which the controlling person has a right (for example, in the case of preference shares), it is the profit share to which the person in question has a right that is relevant for determining the tax base. The list of items of income of a Russian controlling person which are not taken into account in computing profits tax/ personal income tax is to be extended to include income received by such a controlling person in the form of dividends as a result of the distribution of profit of a CFC, provided that the controlling person in question has already paid the appropriate amount of tax on that CFC profit. The time period for the tax-free liquidation of a CFC may be extended to 1 January 2018, with the possibility of further extension subject to a number of conditions being met. The property-related deduction for personal income tax in the event of the subsequent sale of property received in connection with tax-free liquidation would be determined on the basis of the market or balance sheet value as indicated in the CFC s accounting records as at the date on which the property was acquired rather than as at the liquidation date, as the current wording of Article 220 of the Tax Code states. The Bill proposes to grant individuals a deduction in the form of the value of securities received as a result of the tax-free liquidation of a CFC as indicated in the CFC s accounting records, but not higher than their market value at the time of their sale. The Bill provides that the receipt by individuals of property or property rights at historical cost from a CFC which is to be liquidated before 1 January 2018 would not result in the recognition of income in the form of material gain. An exemption from personal income tax is proposed for any income received from Russian organizations to which an individual has an actual right and on which tax has been withheld at source in Russia (including income from sale, interest, royalties, etc.). At present, clause 58 of Article 217 of the Tax Code provides such an exemption only for dividends. At the same time, in addition to the existing
Global Tax Alert 4 requirement to provide proof that tax was withheld, the Bill introduces a further requirement to provide evidence of the taxpayer s actual right to the income. Therefore, there is a risk that, in order to use the exemption, the taxpayer would have to disclose confidential information (trust declarations, nominee agreements, etc.). If the Bill is adopted, most of the above-mentioned amendments relating to CFCs would apply to legal relations arising on or after 1 January 2015. Rules for determining the tax residence of foreign legal entities Under the Bill, the range of foreign companies which may be classified as Russian tax residents solely on the basis of a statement of self-declaration would be extended to include organizations which carry out activities involving the leasing/subleasing of marine/combined-navigation vessels/aircraft/means of transport and/or activities involving international carriage/the leasing or subleasing of containers used in international carriage, subject to particular conditions being met in relation to the structure of their income. The Bill proposes a provision to the effect that the carrying on by a management company of a foreign investment fund or persons hired by it or by their employees and representatives of activities in Russia involving the preparation and adoption of decisions on matters which fall within the competence of the general meeting of shareholders, involving the holding of a meeting of the board of directors and involving the planning and monitoring of activities, or of other related activities in relation to Russian and foreign organizations in whose capital the fund participates, should not be regarded as executive management of the fund or foreign organizations in which it participates. The Bill clarifies the procedure for determining the first tax period for profits tax for foreign organizations which have independently declared themselves tax residents of Russia: Where a foreign organization independently declared itself a Russian tax resident from 1 January of the calendar year in which the relevant statement was provided: the period from 1 January of the year in which the statement was provided to the end of that calendar year Where a foreign organization independently declared itself a Russian tax resident from the moment when the statement was provided to the tax authorities: the period from the moment when the statement was provided to the end of that calendar year (to the end of the following calendar year if the statement was submitted on or after 1 December) The Bill proposes to clarify the procedure for the application of the 0% rate of profits tax in relation to income in the form of dividends: that tax rate may be applied by a foreign company which is classified as a Russian tax resident only if it classified as such on the company s own initiative If the Bill is passed in its current form, the above-mentioned amendments regarding the tax residency of legal entities would apply to legal relations arising on or after 1 January 2015. The Bill also proposes to extend the deadline for completing the liquidation of a foreign company without it being treated as a Russian tax resident from 1 January 2017 to 1 January 2018, with the possibility of an extension if a number of requirements are met. Concept of a person having an actual right to income Amendments are proposed to Article 7 of the Tax Code which would directly provide for foreign structures without corporate identity (as well as foreign companies) to be treated as persons having an actual right to income. Under another proposed amendment to Article 7 of the Tax Code, a person (a foreign structure without corporate identity) in whose interests another person (a foreign structure without corporate identity) is authorized to dispose of income received by the above-mentioned company (a foreign structure without corporate identity) or directly by that other person (a foreign structure without corporate identity) would also be recognized as a person possessing an actual right to income. Clause 3 of Article 7 of the Tax Code would be amended to state that one of the criteria for recognizing a person as not having an actual right to income is the fact that all or almost all of the income in question (compared with in whole or in part in the current wording) is paid in favor of
5 Global Tax Alert another person who, if the income in question was received directly from sources in the Russian Federation, would not have the right to the application of the relevant provisions of the double taxation agreement. The purpose of the proposed amendment is partly to moderate the current wording of the clause, since a literal interpretation of the provisions as they stand would call into question the majority of foreign structures, given that any structure can be proven to have paid a part of their income to third parties (including in the form of fees for services, charges for financing, etc.), which does not mean, however, that the structure in question may not be recognized as a person possessing an actual right to income. The Bill does not provide any further guidance as to how the phrase all or almost all ought to be interpreted (e.g. 100% or over 75% of income), which may lead to different interpretations in practice if the Bill is passed in its current form. With regard to the look-through approach in relation to dividends, amendments are proposed which would directly provide for the status of a person possessing an actual right to income to be disclaimed in relation to a portion of dividends. The Bill also proposes to remove the clarification that, in such circumstances, the foreign company does not claim the benefits of double taxation treaty concluded by the Russian Federation. The inclusion of this clarification in the current wording may have invited the interpretation that the look-through approach may not be applied by companies located in countries with which Russia does not have a double taxation treaty. The proposed amendments should remove this ambiguity. If the Bill is passed, the amendments described above relating to the concept of a person possessing an actual right to income may enter into force one month after the date of official publication of the Federal Law. For additional information with respect to this alert, please contact the following: Ernst & Young (CIS) B.V., Global Financial Services, Moscow Irina Bykhovskaya +7 495 755 9886 Irina.Bykhovskaya@ru.ey.com Svetlana Berleva +7 495 664 7895 Svetlana.Antonyuk@ru.ey.com Maria Egorova +7 495 641 2922 Maria.Egorova@ru.ey.com Margarita Igelnik +7 495 648 9610 Margarita.Igelnik@ru.ey.com Ernst & Young (CIS) B.V., Personal Taxes Group, Moscow Anton Ionov +7 495 755 9747 Anton.Ionov@ru.ey.com Anna Savon +7 495 660 4860 Anna.Savon@ru.ey.com Ernst & Young LLP, Russian Tax Desk, New York Julia Samoletova +1 212 773 8088 Julia.Samoletova@ey.com
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