Andrey Tereschenko and Ivan Zelenin
Pepeliaev Group - Taxand
Andrey Tereschenko and Ivan Zelenin of Pepeliaev Group – Taxand round up the latest developments in Russian tax law and outline what the next year will hold for taxpayers.
Russia has finally passed a new transfer pricing law. It will come into force on January 1 2012.
Federal Law No. 227-FZ, which makes extensive amendments to the Russian Tax Code with regard to transfer pricing rules, was officially published on July 22 2011. Such amendments are due to come into force on January 1 2012, so the Russian Federal Tax Authority has already created a new department of transfer pricing and international cooperation. This department's staff will be drawn not only from public officials, but also from private businesses.
After the law comes into force, the Russian tax authority will exercise control over:
- Transactions between affiliated entities (the definition of an affiliate has been significantly broadened and extended), if
• the transactions total more than RUB1 billion ($35 million) during a year;
• one of the affiliated entities is involved in extracting minerals;
• only one of affiliated entities benefits from special tax treatment (i.e. is subject to unified tax on imputed income, or a simplified tax system, or unified agricultural tax, or is a party to a Production Sharing Agreement, or is a resident of a Russian special economic zone), but the other does not;
• at least one of the affiliated entities is not a corporate income tax payer (CIT) or applies a 0% CIT rate to its income.
- Cross-border trade transactions involving commodities traded on a global exchange markets;
- Transactions between entities, if one of such entities is resident or is registered in a country (territory) mentioned in the Russian Finance Ministry's so-called blacklist of offshore territories which can be used unlawfully to a party's tax advantage.
- Transactions involving specific entities or facilities which can be used unlawfully to a party's tax advantage (for example, transactions involving entities which benefit from special tax treatment; those involving off-shore companies).
And after January 1 2012, the Russian tax authority will have no control over:
- Barter transactions; and
- Transactions with a price differing from the market price by more than 20% (this provision has been a significant issue for many taxpayers doing business in Russia).
At the same time, the transactions of domestic affiliated entities are controlled when their volume is more than: RUB3 billion a year in 2012; RUB2 billion a year in 2013; and RUB1 billion a year in 2014 and in subsequent years.
The law provides new methods for determining market price. From 2013 the Russian tax authority will be able to use three old methods:
- Identical or similar goods method;
- Re-sale price method; and
- Cost-plus method.
and two new methods:
- Comparable profitability method; and
- Distribution of profits method.
The procedure for exchanging information is also going to change. Taxpayers should inform the tax authority about every transaction that is subject to control. Documents relating to such transactions should be given after May 20 in the year after the year in which the transaction takes place. These documents will be used in a desk tax audit, which can last for six months (usually a desk tax audit in Russia lasts for three months, though this can be extended). If any violations of the law are revealed, the tax authority draws up a report and the taxpayer has 20 working days to reply (usually a taxpayer has only 10 working days to reply to a tax audit report).
According to the law, so-called major taxpayers (such as those which have been recognised under the relevant legislation) may conclude an agreement with the tax authorities laying down the conditions for assessing prices and selecting the methods to be used in transfer pricing.
Where one party to a transaction is assessed to additional tax, the law requires the tax authority to make the corresponding correction in relation to the other party to the transaction. Such correction should be made pursuant to a notification to the tax office, without tax records and accounting source documents being corrected.
The law also sets out new principles in relation to the tax authority obtaining information to allow it to determine market prices.
The law is very complex, so many issues are expected to arise in practice regarding price formation. For now every taxpayer would be advised to check its pricing policy and make any necessary changes to ensure that the policy complies with the new rules.
Draft law on consolidated tax reporting
The draft law on consolidation of a group of taxpayers for profit tax purposes has been submitted to the State Duma. The document is an integral component of the way the transfer pricing rules are to be implemented. It is anticipated that the draft law will be adopted in time to enter into force from 2012.
For the purposes of the draft law, a consolidated group of taxpayers is a voluntary union of taxpayers based on an agreement created to calculate and pay profit tax on the aggregate financial results of those taxpayers' businesses.
The draft law stipulates the following criteria for creating such groups:
- Only Russian companies may be included;
- No less than 90% of the participatory interests in each company in the group must be owned by other members of the group;
- The companies must not be eligible for special tax treatment, are must not be residents of any special economic zone and must have no standalone subdivisions outside Russia;
- The group members must have a unified accounting policy; and
- The group members must pay more than RUB15 billion in federal taxes in total, they must have aggregate revenues of more than RUB100 billion, while their aggregate assets must be worth more than RUB1 trillion.
All members of such a consolidated group assume joint and several liability. The tax authorities will perform field tax audits of the members simultaneously. At the same time, transactions between the group members are not taken into account for tax calculation purposes. Tax is calculated based on the consolidated tax base (as in the total profits and losses of all members) and only at the general tax rate of 20%.
Changes to tax treatment for foreign investors selling Russian stocks
On June 7 2011, Federal Law No. 132-FZ came into force. One of the amendments it has made to legislation is to add to article 309 Russian Tax Code, establishing particular features for taxing the income from Russian sources of foreign organisations with no permanent establishment in Russia.
Under the old rule of the Russian Tax Code, profits from the sale of stocks and shares in Russian companies were treated as income from sources in Russia and were therefore taxable in Russia. This rule applied to stocks and shares in Russian companies more than 50% of the assets of which consisted of immovable property situated in Russia, and to derivatives based on such stocks (shares).
Now, the profits from the sale of stocks or shares of any Russian companies circulating on securities exchanges or from the sale of derivatives based on such stocks or shares are not treated as income from a source in Russia even if more than 50% of the assets of the company concerned consist of immovable property situated in Russia.
Amendments to the Russian Tax Code to support investment activity and innovation
Federal Law No. 395-FZ dated December 28 2010 introduced a special tax regime for transactions with securities or participation interests in the issued capital of Russian companies when such securities or interests are acquired by taxpayers from January 1 2011 onwards. For individuals, the special tax regime allows them to declare income from the sale of securities and participation interests as non-taxable for income tax purposes. Legal entities are entitled to apply a zero rate for profit tax in relation to amounts of income received in transactions involving a sale or other disposal of participation interests in the issued capital of or securities in Russian companies. The main condition for receiving such tax benefits is that the taxpayer must have owned the participation interest or securities for an uninterrupted period of five years or more. A further condition for securities of Russian companies which are traded on an organised securities market is that the securities must be classed as being securities in the high-tech or innovation sector of the economy under a procedure to be established by the Russian government.
Law enforcement practice
New rules for taxation of investments
On July 11 2011, the Plenum of the Supreme Arbitration Court (SAC) reached two important conclusions in its Resolution No 54 On future real estate. These have completely changed the existing approach to the taxation of construction transactions, and will have a significant impact.
The first conclusion is concerned with determining who has a right of ownership to property under construction. The plenum of the SAC concluded that the right of ownership to real estate is vested in the person who owns the land plot (i.e. the developer).
The second conclusion is that the relations of the parties under the investment agreement should be classified as relations under other agreements, in particular, a sale and purchase agreement, construction agreement and a basic partnership agreement. The court pointed out that the primary agreement to be used to classify the relations is the sale and purchase agreement.
Taking into account the conclusions of the SAC, transactions relating to the transfer of real estate may have these tax implications.
Tax implications for new investment agreements.
If the parties are only just entering into investment relations, the SAC's conclusions change the parties' relations for the better. For example, under the new legal classification of investment relations, the transfer of property under construction from the developer to the investor is treated as sale and is subject to VAT. Therefore, all tax implications will be the same as if a standard sale took place with an advance payment.
Analysing the rights and obligations of the investor and the developer with regard to calculating, deducting and paying VAT to the budget shows that the developer, as previously, will only have to pay to the state budget VAT on its fee. The investor will, in its turn, be able to deduct the whole amount of VAT connected with construction.
The change in the legal classification of investment activity will not result in any additional tax burden on the parties.
Moreover, if under the previous legal classification of relations the investor could only deduct VAT after the construction had been completed, now the investor will be able to deduct VAT immediately after it receives from the developer VAT invoices with regard to the advance payment transferred.
Therefore, the new procedure for taxing investment transactions will be more beneficial for the investor, while the developer will not have any additional tax liabilities (provided that the advance payment received from the investor is paid to its subcontractors in the same period).
Tax implications for existing investment projects.
If investment projects have already been implemented or are at the final stage of completion, the legal position specified in the resolution on future real estate is likely primarily to affect the developer, and to do so in a very negative manner. In fact:
- After the SAC's position, the investment contribution should be classed as an advance payment under the sale and purchase agreement and the transfer of property under construction as a sale. This means the developer being obliged to pay VAT at the rate of 18%, firstly, on the investment contribution and then on the proceeds of sale. The failure to perform this obligation constitutes grounds for the taxpayer to be held liable for a tax offence (a fine of 20% of underpaid taxes) and for default interest to be assessed. In the majority of cases, developers failed to pay the above VAT amounts.
- It is the developer (as seller) which has the right to claim tax deductions. However, there is a three-year time limit on this right. As the developers failed to deduct VAT earlier, under the new classification they may miss the deadline for tax deduction.
To mitigate negative tax implications for those investment contracts that already have been or are being implemented, both the investor and the developer should make changes to bring their tax affairs into line with the legal classification stipulated by the SAC for a sale and purchase agreement or for a partnership agreement.
Procedure for raising electronic VAT invoices approved
On May 25 2011, the Russian Ministry of Justice registered the Ministry of Finance's Order No. 50-n dated April 25 2011. This order approves the procedure for raising and receiving VAT invoices electronically using telecommunications channels and applying digital electronic signatures. The procedure came into force on June 3 2011.
The procedure has been adopted in pursuance of article 169(9) of the Russian Tax Code. It describes the electronic document flow procedure, the requirements which are placed on the main parties involved and the actions to be taken by such parties. This includes the procedure for adjusting or amending VAT invoices.
The introduction of the procedure is a significant step on the path towards creating an automated document flow process in Russia. Obviously, the procedure will allow organisations which do business with a large number of other companies to optimise and speed up the process of raising and receiving VAT invoices.
Adjustment of the laws and regulations is required before the procedure is actually operational in practice: the technical formats used in the electronic flow of documents have to be approved, and amendments also need to be made to the Russian government's Resolution No. 914 On registering VAT invoices and keeping sales and purchase ledgers, dated December 2 2000. Publicly available sources indicate that these amendments are currently being discussed internally within the Ministry of Finance.
Both from a technical and a legal standpoint, those who may be affected by electronic document management also need to prepare, among other things, to determine:
- The extent to which an operator will be liable for VAT invoices being raised and received correctly and on a timely basis, bearing in mind that the operator is the key link in the electronic document flow process;
- Whether the operator will be a party, and if so in what capacity, should there be a court dispute in terms of confirming that a VAT invoice has actually been raised and received.
Andrey Tereschenko (email@example.com), partner and Ivan Zelenin (firstname.lastname@example.org), paralegal, Pepeliaev Group – Taxand