RS In our opinion Setting up a business in Russia. Where to start?

Setting up a business in Russia. Where to start?

September 2013

To set up your own business in Russia, you must first register with the tax authorities. This is something you need to do regardless of whether you intend to carry out your activity as an organization or on your own. It is nonetheless very important to make the right decision when it comes to the form your business is going to take. As for the subtle nuances that need to be taken into account - read on.

Individual entrepreneurs: is there any money in it?

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Russian legislation provides potential entrepreneurs with two options when it comes to setting up their business. The first is to create a legal entity. The second is to start up as an individual entrepreneur. Let's have a look at the pros and cons of each option.

The first, most obvious and unquestionable advantage of not setting up a legal entity (i.e. working as an individual entrepreneur, or IE for short) is that you are not required to establish share capital - i.e. the amount of initial investment in the business is reduced by at least 10,000 roubles. Secondly, individual entrepreneurs are not required to maintain accountancy records - a simple profit and loss book suffices, and this also helps to reduce costs. Moreover, entrepreneurs are not obliged to open bank accounts specifically for their activity - they can continue to use accounts they have opened in the past, as long as the agreement they have with their bank allows them to do so. Another advantage of setting up a business as an individual entrepreneur that must be mentioned is the vastly smaller amount of reporting that needs to be done to the various state bodies, compared with legal entities. The fifth advantage of operating as an IE is that in most cases the administrative penalties imposed on entrepreneurs, for breaches of the legislation, are significantly lower than those imposed on legal entities. And last but not least, it is much simpler to register as an entrepreneur than to set up a legal entity - the number of documents that need to be provided is far smaller. And the fees charged by the state are just 800 RUR, as opposed to 4000 RUR for legal entities.

But being an IE has its drawbacks, too. There aren't many of them, but they mustn't be taken lightly. The main one is probably the fact that entrepreneurs must assume responsibility with all their property, including property that is not part of their entrepreneurial activity, even if it was acquired before they registered as an entrepreneur. Another serious disadvantage of operating as an IE is that it rules you out of being able to carry out certain types of activity (e.g. retail sales of alcohol). And finally, the third drawback to setting up as an individual entrepreneur is that the legislative basis is seriously under-developed. Specifically, entrepreneurs often face situations when the legislation only applies to organizations, leaving entrepreneurs unable to apply them without going through the courts (e.g. the application of certain VAT exemptions, records of costs for income tax, etc.).

Legal entities: they come in all shapes and sizes

Experience shows that after weighing up the pros and cons set out above, new entrepreneurs often decide not to put all their property at risk, opting instead to set up their own firm. And it is then that the next major question arises: what form their organization should take precisely.

Russian legislation provides a fairly broad range of options. If we examine the relevant section of the RF Civil Code, we see that in terms of commercial activity it allows for administrative cooperatives and associations, manufacturing associations, and state, municipal or unitary enterprises. So what is the best solution? Let's examine the issue.

Let's start with the last ones mentioned above: SUEs and MUEs, as the names suggest, bear no relation to private business whatsoever. So let's throw those ones out.

Next up are cooperatives. These, although suitable for private business, are so beset by difficulties in terms of setting them up and conducting activity that they have not become widely used in practice. We would not recommend them to entrepreneurs who are just starting out.

Administrative cooperatives and associations are catch-all terms for the following types of legal entities: full cooperatives, trust-based cooperatives, private limited companies, companies with additional limitations, and joint-stock companies. Of these five forms, however, those best-suited to life have trumped the others in practice - just as in Darwin's law of natural selection. And there are just two in that bracket: limited liability companies (LLCs) and joint-stock companies (JSC). It is in these forms that most companies in Russia operate at present.

It is not hard to see why this has happened. The key thing is that neither at an LLC, nor at a JSC are the shareholders responsible for these associations' liabilities, nor do they bear the risk of losses related to their activities - only to the value of the shares of portion of the company owned by them. Whereas at other forms of company and association, the situation is rather different.

At LLCs and JSCs, the shareholders are not responsible for these companies' liabilities, nor do they bear the risk of losses related to their activities - only to the value of the shares of portion of the company owned by them

Thus, shareholders at full cooperatives bear joint additional liability for their property, in accordance with the cooperative's liabilities. At a trust-based cooperative, only the shareholders (full co-owners) carry out entrepreneurial activity on behalf of the cooperative, and are responsible for its obligations with all their property, whilst the other shareholders bear the risk of losses incurred as a result of the cooperative's activity, up to a maximum of the amounts paid by them as contributions, but do not take part in the entrepreneurial activity. As for companies with additional liability, the shareholders are jointly liable, with their property, for the company's obligations, to an identical amount with regard to the cost of shares determined by the association's charter. That's one side of the picture.

On the other hand, there is no compensation for bearing the risk, with their property, of the cooperative's obligations, whilst members of cooperatives and companies with additional liability have no particular advantages over members of shareholders of LLCs or JSCs. So it turns out that LLCs and JSCs offer the ideal balance of risks and freedom to conduct activity.

Let's take a more detailed look at these two forms.

LLC or JSC?

So, in practice, anyone deciding to do business in Russia, after setting up their firm, needs to choose between these two types of company - an LLC or a JSC. And in order to make this choice, you have to have a clear understanding of the pluses and minuses.

A common feature of both LLCs and JSCs is that you need to have share capital which is divided up between the company's shareholders. This share capital determines the minimum size of the company's property, which acts as a guarantee for lenders. As you would expect, it falls on those who set up the organization to transfer the sums required to this share capital. Share capital can be paid for either in cash or in property. It's worth noting that this property is transferred to the organization, which then becomes its owner.

A common feature of both LLCs and JSCs is that you need to have share capital which is divided up between the company's shareholders

Another significant aspect regarding share capital is that any property received in exchange for payment of it does not necessarily need to be held for the duration of the organization's operations. It can be sold, rented, recycled and so on. Equally, there is no need to keep the money that comes in to the share capital in a reserve bank account of any kind. Having said that, it's important that the value of the company's shares does not fall below that of its share capital.

Share capital is not, therefore, capital or property in the original sense of these words, but something abstract, which determines, on the one hand, the amount of liability of the shareholders or members with regard to creditors and, on the other hand, the rights of these shareholders or members with regard to managing the business and receiving dividends and part of the company's property in the event of insolvency. When the organization is being set up, however, this abstract concept has a very real quality to it: the founder (or founders) are obliged to hand over to the organization some form of property or money.

Now for the differences. The most marked difference between a shareholder company and a limited liability company is in the way the rights that the shareholders have in the organization are established. Shareholders in joint-stock companies obtain bonds - shares. It is these bonds that determine their rights with regard to the organization (the right to take part in management, the right to receive dividends or property in the event of insolvency, etc.). Of course, the more shares a shareholder has, the more influence he or she can exert on the way the business is run. Russian legislation also allows for shares to be issued in a paperless form, i.e. the shareholders' rights are certified not by a piece of paper, but by an entry in the relevant shareholder registers.

Accordingly, choosing a JSC as the form your organization takes will mean you are required to record the share issue, register it, and maintain a log of shareholders

Accordingly, choosing a JSC as the form your organization takes will mean you are required to record the share issue, register it, and maintain a log of shareholders (at small JSCs this can either be done without external help, or by outsourcing the task to a special organization). But in any event this all involves extra costs.

An advantage of having shares is that you are able to disposal of them freely and rapidly - shares can change owner several times a day - without needing to make any changes to the charter documents or to the state register of legal entities. It is sufficient to enter into an agreement and introduce relevant changes to the shareholder register.

Things are a little different when it comes to the proportion of share capital at companies with limited liability. In this case, no bonds are issued. The rights of the company's shareholders are set out in the Unified State Register of Legal Entities - this reflects who owns what share, and how big their share is. Accordingly, if the shareholder decides to sell its shares or dispose of them in some other way, changes will need to be made to the official register. But that's not the only difficulty that presents itself. Unlike share sale-and-purchase agreements, transactions aimed at transferring a portion or part of a portion of the company's share capital are subject to mandatory notarial certification. In other words, you have to spend a bit of money in order to get your money.

Alexey Kraynev,
Tax lawyer
Exclusively for Russian Survey RS

In summary

LLCs have a more simple and transparent structure. All the information regarding its shareholders is contained in the state register. This significantly reduces the risk of disputes about whether a particular portion of share capital is owned by one individual or another. And the fact that transactions related to the transfer of the rights to a portion of share capital must go through notarial certification means that the risk of raids on the organization are greatly reduced. The flip-side of this is that there is a more complex procedure for disposing of your portion of capital, which costs time and money, and this makes it more difficult to obtain financing by selling your share.

In a shareholder company, by contrast, the simplicity with which shares can be disposed of enables you to attract capital quickly if necessary. But at the same time, the structure itself is less transparent. Moreover, the activity of JSCs is more complex from a legal point of view, and in most cases requires that a lawyer be brought in, to ensure everything is properly managed and documented: appointing new directors, holding AGMs, maintaining a register of shareholders and so on.