Tax aspects of crossborder leasing in Russia

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Tax aspects of cross-border leasing in Russia

• Vladimir Gidirim, Tax Manager, Ernst Young
• February 10, 2004

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Tax attributes of cross-border leasing

• Available structures
• Balance sheet choice
• Options for tax presence for foreign lessor
• Withholding tax for lessee
• 20 WHT is applicable to the lessors margin
• 0 under most double-tax treaties
• Customs duty
• Rates vary upon type of assets
• Customs VAT
• 18 on the customs value inclusive of duty
• Reverse charge VAT for lessee
• 18 on income of foreign lessor without Russian
  tax registration

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Available lease structures
Structures
Domestic leasing
Cross-border leasing

• A foreign lessor without presence in Russia
• A foreign lessor with a registered presence but
  no Permanent establishment (PE)
• A foreign lessor with a PE

• Lessor is a Russian legal entity

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Balance sheet choice

• By default lessor accounts for an asset
• However, lessee accounts on his balance sheet if
  provided by the leasing agreement
• BSC affects
• Deductibility of depreciation/lease payments
• Asset tax
• Potentially, input VAT

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Tax presence of a foreign lessor in Russia

• Tax registration with no PE
• Profit tax - NO
• VAT administration - YES
• Asset tax
• if movable property NO (Chapter 30 of TC)
• If immovable YES (no treaty exemption)
• PE risk exists since Russian tax authorities may
  try to challenge the non-PE status

• Leasing activity is performed via PE
• Profit tax - YES
• VAT - YES
• Asset tax - YES (no treaty protection usually
  available for movable property of a PE)

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Taxation of lease payments
VAT issues
WHT issues

• 20 WHT is applicable to the
• lessors margin
• Difficulty to prove the margin
• Under treaty WHT rates reduction to 0
• Advance treaty clearance available

Domestic legislation

• In most cases 18 reverse charge VAT is
  applicable to payments to a foreign lessor
  without Russian tax registration (exceptions
  ground vehicles and arguably ships)
• Payments need to be grossed-up in order to
  eliminate VAT cost to lessor

Treaty Protection
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Customs issues

• Determination of customs value
• Lessors acquisition cost?
• Summation of lease payments?
• What about inclusion of interest?
• Timing of customs payments (customs duties and
  VAT)
• A) Regime of free circulation (immediate payment)
• B) Temporary import regime (deferrals available
  but difficult to obtain)

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Timing of customs payments

• Law on leasing (art. 34)
• Historical controversy of application of
  deferral option
• Arbitration Court decision in favour of a
  taxpayer
• New Customs Code effective 2004 simplifies
  customs VAT and duties deferral (can be used for
  leasing)
• Assets are declared under the temporary import
  regime for 34 months
• Customs VAT and duties paid in 3 installments
  during 34 months until the full amount is paid
  off
• If assets are cleared into free circulation, no
  additional interest for deferral of payments
  applies
• Conditions foreign-owned property fixed
  production assets
• Detailed procedures not yet established hence
  practical application yet to be tested

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Example

• Cost 10,000
• Customs duty 15
• Customs VAT 20
• Time period 34 months
• Partial instalment 3 monthly
• Customs duty to be paid 10,000 x 15 1,500
• Customs VAT to be paid ((10,000 1,500) x
  20) 2,300
• Computation of customs VAT and duty deferral
• 1 year VAT 2,300/3412m 812
• Duty 1,500/3412m 529
• 2 year VAT 2,300/3412m 812
• Duty 1,500/3412m 529
• 3 year VAT 2,300/3410m 676
• Duty 1,500/3410m 442
• No interest for deferral applies

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Customs taxes on imported assets
Customs VAT
Customs duty

• Who pays customs VAT according to the lease
  agreement?
• If lessee pays, VAT offset problem may arise
• If lessor pays, tax registration in Russia may be
  a solution

• Who pays customs duties according to the lease
  agreement?
• If lessee pays, deduction of customs duties may
  be a problem
• If lessor pays, it needs to be factored into the
  lease payments

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Customs VAT

• VAT paid to Customs by lessee
• Formal requirement for input VAT credit is not
  met (e.g. acquisition of the asset by the
  lessee Art. 171.2 of the Tax Code)
• Acquisition may or may not take place in the end
  of the lease depending on the existence of the
  purchase option in the leasing agreement. If
  purchase option is exercised, the customs VAT is
  offset only at this moment
• Balance sheet accounting enhances chances for VAT
  credit for lessee, but does not solve the
  acquisition problem as such (formally, no
  acquisition occurs at the moment of importation)
• Interpretative letters of Minfin and Mintax
  contradict each other. A private clarification
  could be sought to avoid tax penalties in case of
  a dispute with tax authorities
• We are not aware of any court practice on this
  issue yet

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Customs VAT

• VAT paid to Customs by lessor
• Payment of customs VAT by the Russian lessee may
  result in inability of the lessee to offset
  customs VAT
• A possible solution is that the foreign lessor
  pays customs VAT and applies for VAT offset of
  customs VAT
• This is only possible if the foreign lessor
  registers for tax purposes with Russian tax
  authorities. Once foreign lessor is registered,
  it could administer VAT in a manner similar to
  domestic lessor (collect output VAT and offset
  customs VAT)

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Tax (incl. VAT) registration

• In order to obtain VAT offset, the foreign lessor
  needs to apply for a full tax registration. No
  VAT-only registration exists. Grounds for a
  full Russian tax registration include
• activity in Russia via otdelenie for more than
  30 days in a calendar year
• immovable property located in Russia
• transportation vehicles located in Russia -
  registration in whose name?
• The only practical way to tax register is to
  proceed with the registration of an otdelenie,
  which triggers a PE risk

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Further VAT issues

• Further VAT issues for tax-registered lessors
• Time gap between incurring and recovery of input
  (customs) VAT
• VAT refund difficult to obtain
• Devaluation costs
• Non- VAT issues may arise for the lessor from
  Russian tax registration
• need for monthly VAT filing to tax authorities
• Need for annual/quarterly filing of various other
  returns to tax authorities
• need to defend the non-taxable status (absence
  of a PE)
• certain other compliance requirements and costs
• However, practical and working examples exist

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PE issue

• No PE arguments for foreign lessors
• Existence of an otdelenie does not mean a PE
• Existence of a PE should be assessed on the basis
  of the article 306 and the applicable double tax
  treaty
• OECD commentary denies existence of a lessors PE
  if the major decisions on entering into lease
  transactions are met abroad
• The otdelenie may maintain auxiliary
  functions, e.g. administration (filing VAT
  returns). If this activity is outsourced, PE risk
  is further reduced

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Assets tax

• Balance sheet holder pays the tax
• Under Chapter 30 of the Tax Code, no tax is paid
  on movable property unless it belongs to assets
  of a PE
• So, if balance sheet holder is the foreign lessor
  and no PE arises, no Russian asset tax is paid
  for movable assets. No treaty protection needed.

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Suggested EBC action

• EBC has already applied to MNS for clarification
  on VAT/PE issue which proved unsuccessful
• Therefore, it is suggested to apply to Duma Tax
  Committee for Tax Code changes which would
• Remove the uncertainty regarding possibility for
  lessees to offset customs VAT in full, and/or
• Allow VAT-only registration for foreign lessors
  to ease the administration of VAT

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Contact details
Vladimir Gidirim Manager International Tax
Services Phone [phone]Fax [phone]
9293vladimir.gidirim_at_ru.ey.com