Tax Flash Report from PwC experts Draft law with CFC rules submitted to State Duma October 2014 / Issue No. 31 In brief A draft law on deoffshorisation, including Controlled Foreign Company (CFC) rules and other new developments, has been presented to the Russian State Duma. ( http://asozd2.duma.gov.ru/main.nsf/(Spravka)?OpenAgent&RN=630365-6). The wording of this draft law has again been substantially modified. Without delay, we would like to inform you of the most significant amendments compared to the version we commented on in September. We would like to note a reduction in the administrative burden for business with respect to a CFC's auditable statements in treaty jurisdictions (such companies will not have to recalculate their profits under Russian tax rules). The new draft law also clarifies the rules for applying a foreign company liquidation benefit and clarifies many other clarifications, including a comparison of the effective tax rate of a foreign company to an average weighted tax rate, rather than a 20% tax rate. The draft law may still go through further changes. Draft laws are often amended after the first readings in the State Duma. In detail Who is recognised as a CFC? The following changes were made to the list of institutions not subject to Russian profits tax under CFC rules: The provision on public companies and participation through public companies has been removed. Now, participation through public companies is not a recourse for avoiding CFC rules; The "white" list was again replaced by a "black" list. However, this is not the same list currently used for the purposes of Article 284.3.1 of the Russian Tax Code. The Russian Federal Tax Service (FTS) will have to develop another list of territories that do not exchange information with Russia; The effective tax rate now is compared to a specified rate instead of a 20% rate. This approach helps to avoid a lot of confusion and narrows down the list of companies subject to the CFC rules; Companies that derive predominantly active income are no longer under the scope of the CFC rules. A company is not subject to profits tax if it is from a treaty state (except for those states that do not exchange information with the Russian tax authorities) and if the effective tax rate is at least 75% of the average weighted rate [1], or if the company’s share of income from passive activities is not more than 20%; In order to exempt a CFC’s profits from Russian tax, the share of income from production sharing agreements (PSA) (for respective companies) must come to at least 90% of the organisation's total income. Operators of newly developed sea-based hydrocarbon [1] So the application of different tax rates will be accounted for in a special formula. www.pwc.com deposits and their direct shareholders shall not be deemed as CFCs; The draft law clarifies the rules for not deeming structures as CFCs (the previous version was contradictory in regards to the possibility to distribute profit). A CFC's controlling party does not necessarily have to meet the participation share criteria, yet it may control over the CFC for its own benefit or for the benefit of his/her spouse and underage children. Deeming a company or a person carrying out managerial functions of an investment fund, as a Russian tax resident is not a reason for classifying such a fund as the CFC or a Russian tax resident. CFC notifications If the tax authorities become aware of a CFC that was not reported by a Russian tax resident, a relatively "soft" procedure will take place. The tax authorities will require submission of a clarification within 20 days or issue a notification within the prescribed deadline. In its request, the authorities shall provide detailed information on the company and describe the grounds for deeming it as a CFC. Disputes over whether a company can be qualified as a CFC may be forwarded to court. If CFC status is not challenged in three months, the tax authorities will then rule that the resident agree that it has CFC. Thus, taxpayers who fail to collect information on their CFCs in time can enjoy a short respite. Calculation of CFC profits A CFC’s profits are determined: in accordance with its financial statements subject to audit (provided the CFC is located in a treaty jurisdiction); according to Chapter 25 of the Russian Tax Code for all other instances. If CFC does not distribute profits due to an increase in its charter capital, such profits shall not be taxed in Russia. A CFC’s profits may be reduced by the dividends (distributions in case of structures) paid from such profits. Losses incurred by a CFC during the three financial years prior to 1 January 2015 and after this date (as determined on the basis of its financial statements) can be carried forward and accounted for. The draft law also proposes an instrument in regards to the sale of securities and property rights by a CFC to a controlling party (or its Russian related party). By using this instrument, the CFC’s income is not taxable in Russia, while the assets obtained by the Russian buyer will be registered for tax accounting purposes at the value they were earlier recorded by the seller (without an increase in the assets' tax base). Tax residence criteria The draft law clarifies residence criteria and expands on concepts such as "majority" and "regularity". It provides examples of activities performed in Russia that would not result in Russian tax residency (budgeting, preparation of consolidated statements, and adoption of standards and methods for all companies in a group) [2]. The draft law also describes situations when company may obtain status of the Russian tax resident by its own choice only: (1) a company is located in a treaty country; (2) it is a party to a PSA; (3) it is a holding structure (over 95% of its income is dividends subject to certain conditions); (4) it is an operator or a direct shareholder of a new sea-based hydrocarbon deposit. In order to obtain tax resident status, a company must notify the tax authorities at the place of registration of its separate Russian subdivision (the existence of a subdivision is mandatory to comply with the procedure) in accordance with the form developed by the FTS. Issuers of tradable bonds and other types of companies may not be deemed as Russian tax residents. Concept of beneficial owner of income If a Russian tax agent is actually aware of the party acting as the real beneficial owner of income originating in Russia, then: (1) if the beneficial owner is a Russian resident, the tax agent shall not withhold tax but inform the tax authorities about payment [3]; (2) if the beneficial owner is a non-resident, the agent may apply a respective DTT (with a state where the beneficial owner is located). At the same time, it remains unclear as to how to identify a beneficial owner and which documents may substantiate this fact. Please note that the draft law uses the following wording: "if the payment source is aware of..." [2] There is some inconsistency in the wording with regards to the application of basic and additional conditions (i.e. the use of such conditions as "at least one" and "only one"). Thus, we expect the draft law to be correctly adjusted or specified in future. [3] Following this concept, a Russian tax resident (beneficiary owner) must settle its tax payment obligations on an individual basis. Tax exempt transfer of property within a group Instead of relying on the exemption set in Article 251.1.11 of the Russian Tax Code, the draft law proposes a new version with additional conditions. It clarifies that in order to be exempt, the company transferring property should not have residence in a country on the Russian Finance Ministry’s blacklist (this list is drawn up and approved in order for the proper application of Article 284.3.1 of the Russian Tax Code). This version is more preferable for taxpayers in comparison with the earlier aforementioned exemption. Thin capitalisation rules Amendments to clauses 2-4 of Article 269 of the Russian Tax Code were removed from the draft law. The earlier amendments did not change the existing rules. However, lawmakers may return to this issue in the future. Indirect sales of real estate The new version of the draft law excludes benefits that were earlier proposed in regards to sales of shares (participatory interest) in companies with over 50% of assets represented as property held in Russia. The earlier version proposed taxation of such shares (participatory interest) depending on the number of shareholders, their respective stakes and periods of ownership over five years. Contacts We will be happy to answer any of your questions or enquiries. 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