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Tax Implications of Inbound Investments into Russia

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Tax Implications of Inbound Investments into Russia Boris Bruk, Of Counsel, Salans Moscow Contact Tax Implications of Inbound Investments into Russia Boris Bruk, Of ... – PowerPoint PPT presentation

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Title: Tax Implications of Inbound Investments into Russia


1
Tax Implications of Inbound Investments into
Russia
  • Boris Bruk,
  • Of Counsel,
  • Salans Moscow

2
Key questions
  • Form of presence branch vs. subsidiary
  • How to finance your activities in Russia
  • Repatriation of profits
  • Divestment (exit from the project)

3
Branch vs. Subsidiary
SUBSIDIARY
BRANCH
  • Benefits
  • No thin capitalization rules apply
  • No taxation on profits distributable to the head
    office
  • Usually served by specially designated advanced
    tax inspectors
  • Sale of foreign companies having real estate in
    Russia not subject to capital gains tax
  • Benefits
  • Limited exposure of foreign investor to Russian
    commercial and legal risks (although limited
    liability may sometimes be removed)
  • Capital contribution of technological equipment
    free of customs duties available (however, no
    disposal of equipment allowed)
  • Drawbacks
  • Accreditation procedure more expensive
  • No limited liability available
  • Limited rights to clear the imported goods at
    customs
  • Additional currency control formalities for the
    Russian customers dealing with branches
  • Drawbacks
  • Dividend distributions subject to withholding tax
    (minimum treaty withholding tax 5)
  • Additional currency control formalities in
    dealing with foreign suppliers or customers

4
How to finance your activities
  • Capital contribution (including share premium)
  • Contribution to assets
  • Debt financing

5
Capital contribution
  • Tax free (special exemptions for imported
    technological equipment for VAT and customs
    duties) VAT exemption limited to the equipment
    listed by the Government
  • Share premium absorbs losses and provides
    additional cushion against negative net assets
    position
  • BUT the subsidiary may not be able to distribute
    charter capital and share premium at will

6
Contribution to assets
  • Does not trigger increase of charter capital or
    share premium (treated as profits for accounting
    purposes)
  • Tax free (provided the contributor has a more
    than 50 participation in the receiving Russian
    entity or the receiving Russian entity owns more
    than 50 in the capital of the contributor)
  • NB! Under latest legislative amendments
    additional exemption applies to transfer of
    assets and proprietory rights by shareholders to
    subsidiaries starting from January 1, 2007 aimed
    at increase of the net assets of the subsidiary
    (50 participation is no longer required)
  • BUT applies to Russian limited liability
    companies only
  • BUT input VAT recovery and deductibility risks
    (now remote)
  • BUT may be prohibited or may trigger negative tax
    implications in the country of the contributor
    (i.e. Cyprus?)

7
Debt financing
  • Could be rather flexible as profit repatriation
    tool (where properly structured)
  • BUT general limitations on interest deductibility
    (apply on loans from both Russian and foreign
    lenders)
  • - statutory safe harbor (also default interest
    rates) 1.8 CBR refinancing rate (current CBR
    rate is 7.75) for ruble denominated loans 0.8
    CBR refinancing rate - foreign currency
    denominated loans OR
  • - average interest rate on similar loans (same
    currency, similar principal amount, similar
    terms of repayment, similar types of security
    etc.) received by the Russian borrower from
    Russian lenders in the same quarter /- 20
  • BUT thin capitalization rules apply to loans from
    related parties (will discuss in detail in a
    minute)
  • BUT general deductibility requirements economic
    justifiability (connection with income generating
    activities if the borrower has enough equity
    cash unjustified tax benefit) and proper
    documentation

8
Thin capitalization rules
  • Apply where
  • (A) debt financing is provided by a foreign legal
    entity which directly or indirectly owns more
    than 20 of the Russian entity financed
  • OR
  • (B) debt financing is provided by a Russian
    affiliate of such foreign entity
  • OR
  • (C) debt financing is provided by another
    person but repayment of the loan is guaranteed or
    secured in any other way by such foreign entity
    or its Russian affiliate (the "controlled debt)
  • AND
  • The controlled debt/equity (equity net assets
    accrued tax liabilities) ratio of the borrower
    exceeds 31 (12.51 for banks and lease
    companies) as of the last date of each reporting
    (tax) period
  • Excessive interest generally treated as
    dividend non deductible, dividend withholding
    tax applies
  • RF Ministry of Finance treaty dividend rate
    applies to excessive interest

9
Thin capitalization inefficient structure
Shareholder (Cyprus)
Loan
Cyprus
Russia
Russian borrower
10
Thin capitalization inefficient structure
Shareholder (Cyprus)
Guarantee
Bank (Cyprus)
Loan
Cyprus
Russia
Russian borrower
11
Thin capitalization inefficient structure
Shareholder (Cyprus)
Guarantee
Cyprus
Bank (Russia)
Russia
Loan
Russian borrower
12
Thin capitalization current circumvention
structure
Shareholder
Loan
Financial Company
Foreign country
Russia
Loan
100
Operating company
13
Thin capitalization advanced circumvention
structure
Shareholder
Financial company
holding
loans
Sub-holding
Operating company
holding
Foreign countries
Russia
Operating company
Operating company
Operating company
14
Thin capitalization fresh view
  • Positive court practice developed
  • interest paid to a German resident lender
    (Federal Moscow District Arbitration Court, 2005)
  • interest paid to a Dutch resident lender (Federal
    North Western District Arbitration Court, 2007)
  • interest paid to a Finnish resident lender
    (Federal North Western District Arbitration
    Court, 2009)
  • interest paid to a Cyprus resident lender
    (Federal Moscow District Arbitration Court, 2009
    and 2010)
  • interest paid to a Cyprus and a Hundarian
    resident lender (Federal Moscow District
    Arbitration Court, 2010)
  • Courts denied application of thin capitalization
    rules
  • reclassification of interest as dividend income
    for treaty purposes impossible as the treaties
    contain autonomous definitions of dividends and
    interest
  • reclassification of interest as dividend income
    and denial of deductibility of excessive
    interest does not comply with the treaty
    non-discrimination rules (should be deductible as
    if paid to or guaranteed by a Russian parent or
    an affiliate of a Russian parent)
  • Special circumstances both Russia Germany tax
    treaty and Russia Netherlands tax treaty
    contain special unlimited deductibility clause
  • The tax authorities still try to argue with the
    above position of the courts
  • No unlimited deductibility" clauses in Russia
    Cyprus double tax treaty
  • Protocol to the Russia Cyprus double tax
    treaty interest reclassified into dividend
    income to be treated as dividend income for
    treaty purposes non-discrimination rules will
    not change

15
Thin capitalization non-discrimination in action
Shareholder (Cyprus)
Guarantee
Loan
Bank (Cyprus)
Unsecured loan
Cyprus
Russia
Loan
Russian borrower
16
Thin capitalization non-discrimination in action
Bank (Cyprus)
Guarantee
Cyprus
Loan
Shareholder (Russia)
Loan
Unsecured loan
Russia
Russian borrower
17
Thin capitalization non-discrimination trap
Shareholder (outside Russia)
Bank (Cyprus)
Shareholder (Cyprus)
Guarantee
Loan
Foreign countries
Russia
Unsecured loan
Russian borrower
18
Thin capitalization non-discrimination trap in
action
Shareholder (outside Russia)
Bank (Cyprus)
Guarantee
Foreign countries
Loan
Shareholder (Russia)
Russia
Unsecured loan
Russian borrower
19
Repatriation of profits
  • No withholding tax on repatriation of profits
    from the branch
  • Dividend distributions from Russian subsidiary
    generally subject to 15 domestic withholding tax
  • Domestic withholding tax may be reduced to 5
    under the Russia Cyprus treaty, if
  • - beneficial owner of dividends is a tax
    resident in Cyprus
  • - cumulative direct investment of at least USD
    100 000 (EUR 100 000 under the Protocol)
  • Non-qualifying participations may still reduce
    withholding tax to 10
  • Direct participations
  • - contributions to the charter capital of
    Russian subsidiary in exchange for shares/
    interest
  • - Sale and purchase of shares/ interest in the
    Russian subsidiary from a third party
  • NB! Receiving stake in a Russian company as
    capital contribution will not qualify as direct
    investment

20
Beneficial ownership
  • Cyprus Russia DTT dividend income, may also
    apply to interest and royalties in the future
  • RF President and RF Ministry of Finance seek to
    use this concept to combat treaty shopping
  • This concept targets multilayer structures
  • How does it work? No treaty benefits (0 or
    reduced withholding tax rates) apply to income
    received by person not qualifying as beneficial
    owner
  • Who is beneficial owner of income (Russian
    approach)?
  • - person having formal title on income AND
  • - person detemining economic destiny of income
  • Beneficial ownership concept does not apply to
    repatriation of profits from branches/ rep.
    offices

21
  • Beneficial Ownership Impact on Treaty Application

RusHoldCo
IsrHold Co
  • If CypCo not considered beneficial owner of
    dividend income, benefits under Cyprus Russia
    DTT will be denied
  • If treaty benefits denied then Russian
    domestic tax rules should apply
  • May Israel Russia DTT apply?

CypCo
100 EUR 107 000
5 WHT
RusCo
15/ 10 WHT
9 WHT
22
  • Beneficial Ownership Impact of Treaty
    Application
  • What factors may indicate person is not
    beneficial owner of income?
  • - person has no presence in the residence state
    (no office, no personnel, no bank accounts, no
    financial reporting obligations etc)
  • - person has no activities other than those
    which treaty benefits are claimed for
  • - person does not bear normal commercial risks
    (subsidies from parent company no adequate
    margin)
  • - person assumes legal obligations to distribute
    income it receives
  • - the terms of back - to - back operations are
    same or similar (e.g. for debt financing
    principal amount, currency, interest rate,
    payment terms etc)

23
  • Beneficial Owner Impact of Treaty Application
  • How could we mitigate the risks? Case by case
    approach
  • General recommendations
  • - simplify structures do not use multilevel
    structures until necessary
  • - substance and presence in residence state
    office space, personnel, bank accounts, board
    and shareholders meetings, bookkeeping and
    accounting,general overhead expenses etc
  • - consolidation of business functions (group
    financing company group IP holding company)
  • - multiple project vehicles
  • - arms length remuneration (margin)
  • - sound economic reasons behind use of offshore
    companies (foreign markets, foreign investors
    and flexibility of foreign law, statutory
    requirements under foreign law when making
    outbound investments)

24
  • Basic Exit Structure Onshore Sale
  • No VAT on share deals
  • Capital gains generally subject to 20 Profit
    tax
  • 0 Profit tax introduced on capital gains from
    alienation of stakes in the capital of Russian
    companies, provided
  • - applies to both corporate and individual
    shareholders
  • - uninterrupted more than 5 year holding period
    by the date of alienation of stake in the capital
  • - if shares of joint stock companies
    (additionally)
  • should be non-tradeable securities within the
    term of holding or
  • if tradeable should qualify as the high tech
    shares within the term of holdig or
  • should be non-tradeable securities when acquired
    and tradeable high tech shares when disposed of

CypCo 1
RusCo1
SPA
RusCo
25
  • Basic Exit Structure Offshore Sale
  • No Russian wihtholding tax on capital gains
    unless RusCo is a qualifying real estate company
    (more than 50 of assets immovable property in
    Russia)
  • Currently the Cyprus Russia DTT protects sale
    of shares/ interest in qualifying real estate
    companies
  • The Protocol to the treaty allows taxation of
    capital gains prom alienation of qualifying real
    estate companies
  • No withholding mechanism when seller and
    purchaser foreign companies, but could become
    an issue if purchaser is a Russian company or a
    foreign company with Russian PE

CypCo 1
CypCo
SPA
RusCo
26
  • Advanced Exit Structure
  • Russian domestic tax law currently does not
    target sale of shares/ interest in foreign
    companies
  • Although the Protocol to the Cyprus Russia DTT
    does not limit the scope of taxation to Russian
    real estate companies only, it is believed that
    Russia may not expand its taxing jurisdiction
    unless domestic law is changed
  • No withholding mechanism if sale preformed
    between two foreign companies
  • Still may become an issue if purchaser is a
    Russian company or a foreign company with Russian
    PE

CypCo
CypCo1
SPA
Cyp HoldCo
RusCo
27
  • Alternative Exit Structure EU Cross Border Merger

EU Co
  • CypCo owns Russian real estate company
  • The Protocol to the Cyprus Russia DTT
    exemption of capital gains from sale of
    qualifying real estate companies is no longer
    available
  • Purchaser is hesitant to acquire shares of CypCo
  • Alternative solution upstream merger of CypCo
    into LuxCo and sale of shares in Russian real
    estate company (still exempt from Russian
    withholding tax under many DTTs of Russia with EU
    states)
  • Transfer of shares by CypCo to LuxCo as part of
    merger should not be subject to tax in Russia
    (Art.251-3 of the RF Tax Code no tax agent)

CypCo
sale
RusCo
28
Contact
Boris Bruk, Of Counsel
Tax Practice, Salans Moscow bbruk_at_salans.com Sala
ns Balchug Plaza, Ul. Balchug, 7 115035 Moscow,
Russia Tel. 7 (495) 644 0500 (ext.4534) Fax
7 (495) 644 0599
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