CFC rules: towards the deoffshorisation of the Russian economy?
March 2015 | EXPERT BRIEFING | CORPORATE TAX
The use of offshore corporate and private wealth structures by Russian companies and individuals is extremely prevalent. The introduction of the controlled foreign companies (CFC) rules, part of a package of so-called ‘deoffshorisation’ amendments to the Russian tax code that came into force on 1 January 2015, has therefore ruffled more than a few feathers.
So what’s changed? Essentially, Russian tax residents are now required to report a direct or indirect interest in any foreign (non-Russian) structure, be it a company, trust, partnership, foundation, or any other foreign profit-generating relationship, to the Russian tax authorities. The first reporting date, which has been designed to record the ownership of over 10 percent in any such entity by a Russian tax resident, falls on 1 April 2015. Beyond that, the undistributed profits of any foreign entity in which a Russian tax resident is deemed to have a controlling interest will be liable to Russian tax, regardless of whether or not it is a company. Tax is due in proportion to the participation in such entity attributable to the Russian tax resident, at the rate of 13 percent for an individual or 20 percent for a corporate.
However, what constitutes a controlling interest is not always apparent. For companies the rules are relatively clear: a direct or indirect ownership stake (together with close family members) of at least 50 percent will be required to trigger the CFC rules in 2015. From the 2016 financial year onwards the threshold falls to over 25 percent (or over 10 percent, if, when aggregated with the participation of any other Russian tax residents in the same entity, the collective Russian tax residents’ stake exceed 50 percent). As far as a trust or similar structure is concerned, Russian tax authorities will most likely look to the overall substance of control test set out in the new rules. This test considers the ability of the relevant Russian tax resident to exercise a ‘controlling influence’ on the decisions relating to profit distribution of the offshore entity. However, applying this criterion in the context of a discretionary trust or pension arrangement, for example, would not necessarily be clear cut. Does the settlor retain ‘control’ for these purposes, where any distribution arrangements are hard-wired in at the outset, or where the trustee is given full discretion? The rules as they currently stand offer little substantive guidance. Even if a Russian tax resident finds that he is caught by the control test, there are a number of exemptions that may apply.
Perhaps most notably in the more general context, there is an exemption for active trading companies (though the rules around what constitutes active versus passive income are not, in all circumstances, clear and leave much to the discretion of the tax authorities) and for certain non-corporate foreign structures, such as a trust or fund. Certainly, much will turn on the interpretation of the Russian tax authorities once the new regime comes fully into play. Rather more broad exemptions seen in various drafts of the rules during the public consultation process (including, most noticeably, that exempting companies or other entities with a technical stock exchange listing) did not make the final cut.
The CFC rules introduce a sliding scale of profit thresholds, below which profits will not be taxed, ranging from RUB50m in 2015 to RUB10m from 2017. There will be no fines for non-payment of tax until 2018.
In addition to the CFC provisions, the new rules have codified the ‘place of effective management’ concept into the Russian tax code. In broad terms, if the place of actual or effective management of a company – by reference to criteria such as where the majority of board meetings are held, where executive management is undertaken or, in certain circumstances, where records are kept or managed, or accounting, administration or hiring take places – is Russia, then the profits of that company are liable to Russian corporate profit tax at 20 percent.
The tax code amendments also define, for the first time in a broad context, what is meant by a ‘beneficial owner of income’ for double tax treaty purposes. Although there are exemptions in the tax code connected to the issue of Eurobonds and certain other structured finance transactions which make use of offshore SPVs, the new rules otherwise attempt to restrict the availability of certain double tax treaty benefits. The rules aim to reduce or eliminate withholding tax payable on payments of interest or dividends to circumstances where the immediate non-Russian party receiving the funds (and the party seeking to take advantage of beneficial owner of income status from a double tax treaty perspective) is actually able to determine the ‘further economic destiny of income received’ (and is not, for example, simply a pass-through SPV).
It has been strongly suggested that the Ministry of Finance will issue clarifications or actual amendments to these rules ahead of the first reporting deadline in April of this year. Certainly, the lack of clarity, in addition to the phasing in of the full regime over the next couple of years, is encouraging a ‘wait and see’ approach to the new regime at present.
So what does all this ultimately mean for the Russian user of offshore structures? It should first be noted that, despite the initial concerns raised, the real substance of these rules does not go any further than analogous regimes in place in most western countries. If anything, Russia is actually catching up with modern tax practice. Indeed, the oft-heard concern of significant new reporting obligations should not amount to substantially more work than the prudent administrator, service provider or trust company undertakes as a matter of course, and often to meet the standards required by other taxing jurisdictions. Yes, there is a significant amount of documentation to be filed at the outset – and, as with everything concerning the Russian bureaucratic machine, notarised and apostilled Russian language transactions will be required. But this is an obligation that ultimately falls on the Russian tax resident, and Russians are certainly used to the volume of documentation, and officious requirements, required in dealing with the Russian authorities.
For many, the key driver of offshore structuring remains asset protection rather than tax efficiency, not least given the relatively low, and flat, rates of tax charged in Russia. Nothing in the new rules is likely to change that. Added to the mix is the challenging economic and geopolitical landscape Russia currently finds herself in – perhaps an unlikely environment for a significant repatriation of capital to Russia. As such, it is highly unlikely that we will see a significant decrease in the use of offshore structures by Russian tax residents going forward.
There will be those, whether individuals or companies, who consider the relevant income or profit tax rate to be a reasonable price to pay for the continued security their offshore structuring brings. Others, perhaps in view not only of the tax implications but also the creeping push of ever-more invasive legislation (including notification of dual citizenships or foreign residence, or increased currency regulation – with the threat of potentially more to come), may look to divest themselves of their Russian tax residency.
For many, there will likely be a combination of compliance with the new rules, together with a restructuring and rationalisation of offshore structures, either in an attempt to fall outside the new regime, or else to limit its impact. Of course, there is no one-size-fits-all answer, and much will depend on individual circumstances. What is clear, though, is that the net result is unlikely to be the deoffshorisation of the Russian economy.
Nicholas Davies is a group partner at Collas Crill. He can be contacted on +44 (0)153 460 1650 or by email: firstname.lastname@example.org.
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