Introduction
The de-offshorization law came into force on January 01, 2015.
What the law says (in summary)
1) Disclosure of foreign assets
The Law provides for two types of disclosure notices:
A) ASSET NOTICE: notification of an interest in any foreign organization if such a participation interest exceeds 10%;
B) CFC NOTICE: this notice must be filed by Russian tax residents deemed ‘controlling persons’ of CFCs. A CFC is a foreign company or structure which is not a Russian tax resident and is controlled by a Russian tax resident. A Russian tax resident will be deemed to be a controlling person falling with-in the ambit of the Law if such person’s participation interest is at least 50% during 2015 and 25% thereafter (with the threshold falling to 10% if the Russian resident’s total shareholding accumulated with that of other Russian tax residents, whether or not related persons, is at least 50% of the CFC).
Exemptions to CFC rules
Among others, CFC rules provide that the profit of the following are exempted from taxation:
-A structure which is not legal entity (including, but not limited to, trusts, partnerships, associations and other forms of collective investments) and the following conditions are met:
1. The settlor is unable to acquire ownership rights to the assets of the structure once it has been established,
2. The settlor cannot directly or indirectly receive profits/income of the structure,
3. The settlor cannot transfer personal rights exercised in connection with his status in the structure (such as rights to dispose of property, determine beneficiaries, and others) to other persons.
-The profit of companies which produce active income in over 80 per cent of their activities;
-The profit of companies registered in a jurisdiction where the effective tax rate applicable to the CFC is at least 75 per cent of the weighted average Russian profits tax rate (calculated on a predetermined formula).
Note: Threshold exemptions apply to including the profits of CFCs in a Russian tax resident’s tax base, the threshold for inclusion being set at 50 million RUB in 2015, 30 million RUB in 2016 and 10 million RUB from 1 January 2017 onwards.
2) Russian tax residency rules for foreign companies based on an effective management and control test
Regardless where a company has been incorporated, Russia will be recognized as the place of effective management if at least one of the following terms and conditions (main criteria) is met:
Α) Most of the meetings of the board of directors (or another analogous body of the organization, other than the executive body) are convened in Russia (more meetings are convened in Russia than in another country).
Β) The executive (strategic/operating management) function is performed on a regular basis from Russia (the performance of activities in Russia in a scope that is significantly less than in any other country is not recognized as the regular performance of such activities).
C) The management of a foreign company is performed primarily in Russia by the senior management of the company. While not specifically defined, the term management is understood to mean the adoption of decisions or other actions in respect of issues pertaining to the day-to-day operations of the organization, which fall within the competence of the executive management function.
Additional Criteria: (1) whether the company’s financial accounting or management accounting is performed in Russia; (2) whether the company’s documents are generated and processed in Russia; (3) whether the HR function at an operational level is performed in Russia.
3) The beneficial ownership concept
The new law introduces the concept of beneficial ownership of the passive income paid from Russia to foreign entities in conjunction with the applicability of the double tax treaties in such situations.
If the direct recipient of the income, i.e. the Cyprus Company, has limited powers regarding its disposal and basically acts as an intermediary which will directly or indirectly transfer substantially all of this income to another person, i.e. a BVI company, then there is a risk that the double tax treaty between Cyprus and Russia will not apply.
4) Rules on taxation of the indirect sale of Russian real property
In accordance with the Law, companies which derive capital gains from the disposal of shares in Russian and foreign companies whose assets consist, directly or indirectly, 50 per cent or more, in immoveable property situated in Russia, will be subject to withholding tax in Russia at a rate of 20 per cent (irrespective of the level where the sale takes place).
Up to now, the shares of companies that owned immovable property in Russia regarded as “movable property” and therefore taxed at the jurisdiction of the seller. For example, if a Cyprus company sold the shares of a Russian Company that held immovable property in Russia, then under the treaty the right to tax this transaction was with Cyprus which was the jurisdiction of the seller (effectively no tax arose).
Foreign companies and foreign structures (not legal entities) that have property in Russia are obliged to provide the Russian tax authorities with information on the foreign company’s participants (the founders, beneficiaries of the structure), including disclosure of the indirect share interest of any individual or public company whose direct (indirect) interest exceeds 5%.
It is worth mentioning that both the Cyprus legislation as well as Russian Tax Code and the double tax treaty between Cyprus and Russia exempts the sale of shares of listed property-rich companies in a recognized stock exchange from the above provisions (such as the Cyprus Stock Exchange from now on referred to as CSE). The great advantage of being listed at the CSE is the tax regime. In particular, there is a tax exemption on profits from the sale of shares listed on the Emerging Company Market of the Cyprus Stock exchange (i.e. exemption from capital gains tax). This is also safeguard in the Double Tax Treaty between Cyprus and Russia (Article VII which amends article 13 (5) of the Treaty). As a result, no capital gains tax is payable in Russia and or Cyprus. The procedure for listing at the emerging market of CSE is about 2-3 weeks and the fees associated with such listing are minimal.
Liability for Non-Compliance under the New Rules
(1) Non-payment of Russian tax as a result of the non-inclusion of CFC profits in the tax base – 20% fine of the amount of the unpaid tax, but no less than RUB 100,000 (starting from 2018);
(2) Failure to submit a notification as to shareholdings in CFCs (inter alia, the submission of incorrect data) – fine of RUB 100,000 for each CFC;
(3) Failure to submit an asset notice i.e. notification as to participation in a foreign organization (inter alia, submission of incorrect data) – fine of RUB 50,000 for each foreign organization.
Note: Non-payment or partial payment of tax arising from omission to include a CFC’s profits in a tax resident’s tax declaration will not entail criminal liability until 2017, provided that the tax resulting from the omission is paid in full to the tax authorities.
Significant deadlines to consider
• 1 April 2015 – notification on participations in any foreign entity and/or structures set up prior to 1 January 2015.
• 20 March 2016 – first CFC reporting date.
Actions to consider
a) Establish a Cyprus International Trust and or review existing trust structures to determine whether they meet CFC criteria.
b) List a Cyprus company (which primarily owns immovable property in Russia) at the Emerging Companies Market of the Cyprus Stock Exchange. According to the Cyprus tax law, and Russian Tax Code and the double tax treaty between Cyprus and Russia, there is an exemption to capital gains tax if the company is listed for example at the Emerging Companies Market of the Cyprus Stock Exchange.
c) Obtain a Permanent residence in a foreign jurisdiction (i.e. Cyprus etc.) and become a tax resident of that jurisdiction.
d) Obtain Citizenship in a foreign jurisdiction (i.e. Cyprus) and become a tax resident of that jurisdiction
e) Have stronger substance in Cyprus in order to mitigate the risk for the Cyprus company of being considered as a tax resident of Russia by executing the following actions among others: rent an office in Cyprus, employ people in Cyprus, avoid using general power of attorneys, use persons residing in Cyprus to operate and manage the company’s bank accounts in Cyprus or abroad and outsource the accounting function to firms in Cyprus that provide accounting services. As a result of the above you will be able to prove that the company is “active and alive” in Cyprus.
f) Avoid multi-layered structures so that the recipient of the income to be also regarded as the beneficial owner of the income.
How we can assist you
• Tax review and evaluation of the current structures in relation to CFC issues
• Implementing any of the possible strategies mentioned above such as establishment of Cyprus International Trusts
• Assist in creating better substance including the provision of office facilities, knowledgeable directors and bank signatories
• Review of the current holding, financing and royalty structures to evaluate the beneficial ownership issues that might be faced and provide and implement possible solutions.
• Assisting in listing companies in the Emerging Companies Market of the Cyprus Stock exchange.