In March Russia’s deputy economy minister, Andrei Klepach, announced that the country expects up to $70bn of capital to have left Russia for other havens during January/March 2014. In contrast to the total of $63bn which flowed out of Russia in 2013, this is a clear sign of a steeply accelerating trend. Russian president Vladimir Putin identified it in December 2013, when he warned of a drastic need to stem the flow of capital to offshore jurisdictions, and demanded results from his government.
The Russian Ministry of Finance responded with the publication on the 18th of March of a draft law on broad anti-offshore measures which would provide the Russian tax authorities with powerful legal mechanisms for taxing international corporate and private structures. Taking advantage of the increasing international exchange of information, the authorities will be able to track down those structures and tax their Russian owners.
The draft’s key areas of action rest on three concepts:
• Controlled foreign companies rules (CFC);
• Classification of Russian tax residence for foreign companies, based on tests of management and control; and
• New tax rules on the indirect disposal of Russian real estate.
Controlled foreign companies
The draft law takes a broad approach to defining CFCs, including not only companies controlled by Russian tax residents, but also ‘structures’ (including funds, partnerships and other forms of collective investment entities) set up in any “blacklisted” jurisdictions. Russia’s current “blacklist” includes off-shore jurisdictions, but almost none of the jurisdictions with which Russian has a double taxation treaty, though it is not clear if this current list will be the one that is used under the draft law.
Once an entity is defined as a CFC, the controlling persons (defined as both corporate entities and private individuals controlling foreign entities or structures) will be taxed in Russia on the undistributed income of all controlled companies and structures. Other wealth planning vehicles, such as trusts or private foundations are not explicitly listed as a ‘structure’ under the draft rules but, depending on their governance and control, may well be treated as one.
Russian tax residence for companies
Another set of rules in the draft defines Russian tax resident companies not only as companies registered in Russia, but also companies which are considered to be managed and controlled from Russia. Broad criteria will be used to classify foreign companies as Russian tax residents, with corresponding obligations of registration, tax reporting and payment will result. A foreign legal entity will be considered as managed in Russia if one or more of the following conditions are met:
• The board of directors or other management bodies hold meetings in Russia;
• Principal management is usually undertaken from Russia;
• Key officers perform their activities out of Russia;
• Accounting is performed in Russia; or
• Archive records are stored in Russia.
Indirect disposal of property
Russian tax law currently provides that the income of foreign legal entities is subject to Russian taxation if they sell shares in Russian companies in which Russian real estate comprises 50% or more of the assets. The disposal of shares in non-Russian companies with Russian real estate assets has not therefore triggered Russian tax liabilities to date. The draft law aims to tackle this through new rules on taxation of the indirect disposal of Russian real estate. These are aimed at stopping the current use of tax efficient offshore sale and purchase transactions for Russian real estate owned via foreign holding structures.
The draft proposes to treat the disposal of shares in either a foreign or Russian company as Russian income. A number of Russian double tax treaties (including treaties with Cyprus, Switzerland and Luxembourg) allow for this type of income to be taxed in Russia. However, the actual mechanism for the implementation and enforcement of the new rules has not yet been proposed in the Draft.
There appears to be a sense of urgency in the Russian government’s response to capital flight and one might therefore expect these draft rules to be expedited quickly. Should the Ministry proceed with full implementation of the law, the draft states that it should come into force no earlier than the start of the following Russian tax year. If the law is introduced this year, the earliest it should then come into force under the draft rules is 1st of January 2015.
Olga Boltenko is a partner at international law firm Withersworldwide