RS Brief news Taxes to threaten offshore companies

Taxes to threaten offshore companies

June 2012

The Russian authorities continue their “crusade” against offshore-declared income. In early March then-Prime Minister Vladimir Putin demanded lawmakers to consider a motion by which Russian residents would have to declare and pay income tax on their overseas-based assets. The Federal Tax Service has fulfilled this directive, developing a draft amendment to the Tax Code, according to which special rules will apply to sums transferred by Russian organisations to companies registered in offshore zones.

In particular, it was proposed that Russian taxpayers be forbidden from counting sums transferred to offshore companies among costs, therefore reducing their taxable income. This ban applies to all kinds of costs, including for works, services, interest on loans, etc.

Russian companies will be able to avoid this by presenting documentation to the Tax Service proving that they have no control over the beneficiaries of these payments; i.e. the organisations are in no way interdependent. However, even in this case, taxes paid in offshore zones must be no less than 50% of the amount the organisation involved would otherwise have to pay in Russia; if the difference is greater, then the Russian organisation would have to pay the amount saved in the form of a tax to the Russian Federation.

Another way to reduce the tax burden on such payments is to recognise that the offshore company involved is interdependent. This way, payments in favour of the said company would be considered separately and taxed at 9%, as opposed to 20%.

These are, as we can see, rather tough measures, and could have a significant effect on the level of foreign investments into the Russian economy. Issuers of Eurobonds placed through foreign stock exchanges have particularly suffered in connection with this. In order to exempt the coupon payments on said bonds from taxation, they would need to begin very complex negotiations with foreign stock exchanges to disclose information. Also, according to experts, were this amendment to come into force, it would be an additional burden on businesses larger than half a billion dollars in size.

According to experts, were this amendment to come into force, it would be an additional burden on businesses larger than half a billion dollars in size

All of these points were discussed in the State Duma, where the government introduced the draft amendment. As a result, by the second reading the amendment became far more friendly to foreign investors. The requirement to disclose information on coupon payments on Eurobonds has disappeared entirely. This means that if this version of the amendment comes into force, Russian companies paying coupon payments would not be obliged to withhold taxes on profits from these payments.

However, not all issuers can expect such relief; there are two conditions. First of all, the company who issued the securities must be registered in a country with an agreement in place with Russia. Secondly, the exchange where the bond is held, along with the depository and clearing-house, must be among those recognised by Russian regulators, namely the Federal Service for Financial Markets and the Ministry of Finance.

Thus, the lawmakers listened to the negative assessment of the new tax rules given by many experts upon the amendment's introduction to the State Duma.

Please note that one more, intermediate, option for taxing coupon payments was also introduced in the State Duma, providing for their tax exemption from only until 2013. As of 1 January 2013, only those payments that do not go to an offshore jurisdiction would remain tax-exempt. However, deputies did not approve this option. Furthermore, as a result of the discussion of the full exemption from tax of coupon payments, it was proposed to extend the ruling to all payments made after 1 January 2007. This means that legislators intend to protect foreign investors from any possible claims from tax authorities on any previous payments made within the time limits of tax audits.

Alexey Krainev
Exclusively for Russian Survey RS