Don’t Get Clawed by the Russian Bear – Introducing the New CFC Rules
The Russian Federation marked the end of an unpredictable 2014 by tightening its regulations on offshore companies in an attempt to protect its tax base and prevent outflows of capital.
On 24 November 2014, President Vladimir Putin signed Federal Law No. 376-FZ, amending Parts I and II of the Russian Federation Tax Code, introducing significant new rules for controlled foreign companies (CFC). From 1 January 2015, profits of a foreign company, controlled by Russian tax resident individuals or companies, will be subject to income or corporation tax respectively on an arising basis.
The new rules form part of a wider package of reforms dubbed the ‘De-offshorisation’ Law (the Law), that include changes to the test for corporate tax residency, beneficial ownership and the taxation of capital gains from the indirect transfer of Russian real estate. It is perhaps unsurprising that such a far-reaching set of reforms have been enacted in such a short space of time given Russia’s worsening financial and economic position.
The new measures are intended to raise additional tax revenue and act as an information gathering exercise allowing the Federation to gain valuable insight into assets held offshore (assuming of course those affected comply with the reporting obligations). Although these measures are unlikely to solve Russia’s economic woes, the Law could mark a key turning point in Russian tax legislation, with further measures yet to come.
When will a Foreign Company be a CFC?
Similar to most CFC regimes, under the Law a CFC is defined as a foreign company or foreign structure established in any form and is controlled by a Russian tax resident (controlling person). However, it is the definition of control that sets these rules apart.
During the transition period (i.e. from 1 January 2015 until 1 January 2016) a legal entity or an individual is a controlling person only if their share (together with their spouse and minor children for individuals) exceeds 50% of the capital of the CFC. After 1 January 2016, a controlling person is defined as an individual or legal entity whose participation in the company:
- exceeds 25%; or
- exceeds 10% (together with their spouse and minor children in the case of individuals) if more than 50% of the capital of the company is owned by Russian residents.
This means that individuals or companies that hold 25%-49% in a foreign company will have almost 12 months to consider whether to restructure or devolve their shareholdings.
How could the new CFC rules impact you?
CFC profits will be taxed at 13% for individuals and at 20% for Russian legal entities, provided that the CFC’s profit exceeds 10 million rubles (although during the transitional period the threshold is temporarily higher at 50 million rubles in 2015 and 30 million rubles in 2016). Undistributed profits of the CFC should be included in any tax filings of the controlling person, in proportion to their share of the CFC.
As the rules are effective from 1 January 2015, the controlling person must include the profits of the CFC in their 2016 tax return. The Law also introduced an obligation on the taxpayer to provide various documents to the tax authorities including the CFC’s financial statements. Penalties will apply for non-compliance of up to 20% of the unpaid tax.
Can you be exempt from the charge?
The Law does include a number of exemptions from the CFC charge. However, the taxpayer must disclose his interest in the CFC on his tax return and claim the relevant exemption.
The exemptions that are most likely to be availed of are:
- if the CFC is tax resident in a country that has concluded a comprehensive double tax treaty with Russia that includes an exchange of information provision; and
- the effective tax rate of the CFC must be at least 75% of the weighted average tax rate that would apply in Russia (ie the CFC needs to pay tax at 15% or more); or
- the proportion of ‘active income’ is at least 80% of the CFC’s overall profit (dividends, interest, royalties, capital gains are not considered active income).
- if the CFC is a non-profit organisation, which according to local legislation does not distribute profits;
- if the CFC is a tax resident in the Eurasian Economic Union (Armenia, Belarus, Kazakhstan and potentially from 2015 Kyrgyzstan); or
- a bank or insurance company.
If you are concerned that you may be within the new regime, Milestone can provide further detailed information on the rules, exemptions and their implications for you.
Please contact Zoe or Rozi for further information on how we can help.
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