RS In our opinion Should you buy a turnkey business in Russia?

Should you buy a turnkey business in Russia?

June 2013

Even though the Russian tax authorities are constantly hard at work trying to streamline and automate the process of registering new businesses, getting state registration for a new company still remains a major hassle. Especially for someone doing it for the first time: it’s one hidden catch after another. And if you happen to be a foreigner who’s not particularly proficient in Russian and who’s accustomed to the simple business registration procedures found in Europe, then buying a turnkey business in Russia sounds like the most natural course of action. And such services are actually on offer, just google for it and you’ll find a couple dozen offers. However, how safe is this option?

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An old Russian saying states that cheap people end up paying twice. The same principle applies to our situation as well. Having decided to save the time and hassle of the business registration procedure, you may well find yourself in a situation where you might end up spending a lot more time and dealing with a lot more hassle, because buying a turnkey business can often be a very risky proposition. And all of the risks stem from the shoddiness of the characters that created and ‘sold’ you the business. So if you have really decided to buy a business in Russia, the first rule is to steer clear of unverified ‘sellers.’ That will significantly reduce your risks.

Unfortunately, though, some risks will still remain so when deciding to buy a business you wanna look at all the pros and cons and assess all possible risks. We have identified four categories of risks you’ll be facing if you decide to buy a company in Russia: taxation, incorporation, Financial and time. Let’s take a closer look at each one of them.

Taxation risks

I suppose no special explanation is needed for what taxation risks are all about: these basically mean all the problems that the company you just bought may have had with tax authorities before it was sold to you. Naturally, some things can be easily checked before the purchase because for them records and documents are kept. For example, if the company was registered last quarter or before that but it hasn’t done any business it still should have submitted ‘blank’ financial statements and tax returns to the authorities. Consequently, the ‘seller’ must be able to produce documents confirming that all blank financial statements and tax returns have been submitted for all the past periods as required, such as copies of the financial statements and tax returns with the stamp of the appropriate tax agency confirming their receipt, postal receipts, or documents confirming all the necessary statements and returns have been submitted via computer telecommunications channels.

One recommendation that can be made here is to go and talk to a qualified accountant or a tax advisor and ask them to make a list of the documents which the company you’re fixing to buy should have submitted to state authorities in past periods. Once you have a list like that you can check the documents the seller gives you against it. Remember, if you fail to notice an omission it’s now going to be the failure of your company to have submitted the required financial statements or tax returns to appropriate authorities in due time. And such failure may result not just in a conflict with a tax inspector but may serve as grounds for a fine or even for the freezing of your new company’s accounts. And if this happens after you make the purchase it will be your legal entity that will be facing these problems and your money that will have to be paid.

And it should be noted that fines can be quite large. Thus, under Article 119 of the Tax Code of the Russian Federation the fine for failure to submit a tax declaration on time starts at RUR 1000 ($33) and under Article 126 of the Tax Code the fine for submitting tax returns is RUR 200 ($6.6) for each document that wasn’t submitted in due time.

Fines for failure to submit tax returns is not the only taxation risk

But fines for failure to submit tax returns are not the only risk. If you plan to use the simplified taxation/accounting system you need to check that an application to use the simplified system was submitted in time, because under clause 2 of Article 346.13 of the Tax Code a newly established company wishing to use the simplified taxation system from the time of its registration must submit an application to the local taxation inspectorate within five days of the date of registration with the local tax agency specified in the state registration certificate. If an application wasn’t submitted in time the company will have to abide by the standard taxation and accounting rules until at least January 1st of next year. And to use simplified taxation and accounting from next year an application must be submitted between October 1st and November 30th of this year. Also you need to check that the simplified taxation/account application specifies the taxable base that you need *, because the taxable base can also only be changed from January 1st of next year.

Incorporation risks

The next category of risks to consider is incorporation risks. Organisational risks mean various violations or omissions that may have been committed by the person who set up the company you are thinking of buying. It has to be remembered here that the state registration procedure for legal entities does not require tax authorities to verify the correctness of the incorporation documents and completion of all pre-registration formalities. The problem is, however, if any such violations or omissions were committed during the incorporation of the company, it can be liquidated by a court ruling regardless of how long it may have been in existence.

A bad address can create lots of problems for a company

Perhaps the worst type of such violations is when non-existent property is recorded as making up part of the share capital or when the company is registered at a bogus or ‘bad’ legal address. A bad address may create lots of problems, such as difficulties with getting VAT refunds, problems during audits and complications in relations with customers, suppliers and banks. Non-existent property in the share capital can also cause a host of problems, because in this case once you buy a stake (shares) in the company you’re going to need to identify such non-existent property and replace it with your own assets. But even if all these issues are taken care of ASAP there’s still the risk that a court of law may find your company is null and void if it was incorporated with violations of the law.

Financial risks

But the worst downside to buying an existing company is the fact that it may be head over heels in debt. And the real problem is that unlike the risks mentioned above there are no real mechanism to check all the obligations of an existing company. Think about it: the seal of the company you’re fixing to buy has been held for quite some time (often for quite a long time) by people you essentially know nothing about. They could have taken out a huge loan or entered into some contract or other on behalf of the company.

And these actions may not be recorded in any of the company’s official accounting or other documents and even if there are records of such transactions, the sellers may choose not to show them to you until the purchase is finalised. What this means in effect is that you can never be 100% certain sure how many and what types of contracts the company you’re buying may have entered into, in fact you may eventually only learn about them when the other parties show up and demand your company perform its obligations under them.

Lost time risks

And finally, even if you’re buying a turnkey company from super honest people that you have every confidence in, you have to remember that after the purchase goes through time will have to be spent on officially handing over the stake you bought from the founders you bought the company from to you. You can hardly conduct business using an organisation whose unknown founder may show up at any time and appoint himself CEO, interfere in your business or just take away your money. This means that the Articles of Association have to be amended following all applicable corporate governance procedures and that takes time.

In addition, you’re going to have to get all the amendments to the incorporation documents state-registered. And it should be noted there is no point to having the sellers do all this work for you because you’re going to have to recheck and verify everything yourself and then get an excerpt from the national register of legal entities to make sure that everything is legal and by the book. So one way or another, time will have to get spent on these things as well as on talking with registration authorities.

Alexey Kraynev,
Tax lawyer
Exclusively for Russian Survey RS

* Under Russian law the taxable base in simplified taxation/account can be either revenue or revenue less expenses

Resume

So to sum it up: on the one hand buying a turnkey business can really simplify and expedite the process of opening an operation in Russia. On the other hand, you still have to carefully (and probably even more carefully than in the event of setting up a new company from scratch) check and recheck all the documents of the company you’re fixing to buy. And you’re still going to have to go through registration formalities, plus there are some risks that the buy simply cannot eliminate complete.

Therefore, it is our opinion that the most reliable and hassle-free way to establish an operation in Russia is to register a new company here from scratch and if you have some cash to spare, instead of spending it on a ‘turnkey’ company, it would be better spent on consultancy services to help you set up a new company of your own. And in our next issue we’ll have an article with plenty of hints on how to minimise the amount of time needed for registering a new company in Russia.