Russia: Taxation of Foreign legal entities that carry out their business in Russia

In spite of the fact that the tax system of the Russian Federation, as well as the tax systems of other countries, has a number of shortcomings and it should be improved, the Russian tax system continues to be one of the most liberal systems that allows foreign investors to choose the most favorable taxation system for a certain type of their business. 

Foreign legal entities that carry out their business in the Russian Federation through representative offices and branches, as well as establishing subsidiaries with or without Russian equity, as a general rule, shall pay to the Russian budget the following taxes: value added tax, income tax, personal income tax (for employee benefits) and property tax. 

Value added tax 

There are three VAT rates effective in the Russian Federation (RF): 18%, 10% and 0%. The RF Tax Code also stipulates a number of operations that are not subject to value added tax. 

Thus, foreign investors can independently choose the types of activities and / or sales of those goods and services in Russia that will be subject to VAT at the reduced tax rate or will not be taxed at all.

Meanwhile, even if a company makes VAT payments at the general tax rate (18%), the Tax Code of the Russian Federation stipulates VAT deductions that enable at a reasonable course of business to reduce the tax burden concerning the VAT payments. 

Income Tax 

The general rate for income tax is 20%, and the general rate for income received by a foreign organization in the form of dividends on shares of Russian companies, as well as dividends from equity interest is 15%. 

However, in this case it is important to know the provisions of agreements on avoidance of double taxation that envisage reduced tax rates payable under the said income. 

Pursuant to the general rule set out in cl. 1 art. 1 of the RF Tax Code, the Russian Federation laws on taxes and levies consist of the RF Tax Code and federal laws on taxes and levies adopted thereunder.

In compliance with article 7 of the RF Tax Code, if an international treaty of the Russian Federation, containing provisions relating to taxes and levies, stipulates the rules and regulations other than those set forth in the Russian Tax Code and legal enactments on taxes and (or) levies adopted thereunder, then the rules and regulations of international treaties of the Russian Federation shall be applied. 

This adds further credence that before starting a business in Russia, one should be familiar with the text of the international agreement on the avoidance of double taxation. 

International agreements on avoidance of double taxation are the way to solve the problem of double taxation at the international level. The purpose of their conclusion is, first of all, the elimination of double taxation, since it has a negative effect on the possibility to expand sales of goods and services and on the movement of capital and persons, i.e. it seriously hampers the development of economic liaisons. Secondly, it is desirable the taxpayers doing their business in several countries could have some accurate information on the tax system in these countries and have been assured that the states apply general methods for tax payments. 

Currently, the Russian Federation has concluded and applies the international agreements on the avoidance of double taxation with 79 countries, including but not limited to China, Vietnam, Mongolia, the Philippines, India, Sri Lanka, Singapore, etc., as well as it continues to apply the agreements signed between the USSR and Japan, and the USSR and Malaysia. 

For example, pursuant to the Agreement dated 27 May 1994 between the Government of the Russian Federation and the Government of the People’s Republic of China concerning the avoidance of double taxation and prevention of fiscal evasion with respect to income taxes, the tax so charged shall not exceed 10% of the gross amount of dividends. 

A lower tax burden for entities will be applied if the individuals - residents of foreign countries participate directly in the formation of the authorized capital for a newly established or existing entity in the Russian Federation.

In this case, the Russian company is enable to use one of the special tax regimes, for example, a simplified tax system - the entity will pay only a single tax rate at 6% of income. 

Personal Income Tax 

In Russia, personal income tax is one of the lowest taxes in the world. Moreover, this is not a progressive tax where the tax rate would not be increased as the taxable income increases. 

In compliance with cl. 3 of article 224 of the RF Tax Code, 30% personal income tax rate applies to the incomes of individuals who are not tax residents of the Russian Federation but perform their work in Russia. However, upon expiration of 183 days, the foreign employee who entitles for the Russian tax resident status, will pay income tax rate at the 13%, and the overpaid taxes will be refunded.

Highly skilled professionals have a special treatment where they are entitled to pay income tax rate at 13% from the first day of their employment in Russia (Federal Law N 115-FZ “On the Legal Status of Foreign Citizens in the Russian Federation” dated 25.07.2002). 

Transfer pricing 

Since 2012 new rules for transfer pricing have come into effect pursuant to Section V of the Tax Code of the Russian Federation. The Article 105.14 of this Section discloses the concept “controlled transaction”. Such transactions mean the business operations subject to submission to the tax authorities in due approved form. 

These transactions, in particular, include such deals, one of the parties of which is a person whose place of registration, place of living or place of tax residence is a state or a territory included in the list of countries and territories approved by the Russian Ministry of Finance. Currently, this list is supplemented with Macau and Hong Kong. 

Therefore, in the case that during a financial year the amount of transactions concluded with an entity registered for example, in Macau or Hong Kong, is exceeding 60 million rubles, the Russian company should submit a relevant notice to the tax office next year. 

If a Russian entity and a foreign entity are related persons for purposes of the Tax Code of the Russian Federation, namely, for example, they have the same shareholder and the same head, the notification of controlled transactions must be submitted to the tax authority, regardless of the transaction amount. 

Agreements on avoidance of double taxation it is necessary to note that such agreements are used as a means of combating tax evasion and unwanted slip away of national capital abroad. 

In this case, the important concept is the “beneficial receiver (beneficial owner) of income” that means the immediate recipient of the income shall not be treated on default as a beneficial owner of the income received in the state of residence only for the reason that it may be qualified as a resident. 

For the recognition of a person as the actual recipient of income (beneficial owner) it is not enough only to have a legal basis for direct income receipts. That person must also be a direct beneficiary, i.e. such a person who actually receives benefits from the received income and defines its further economic destiny. In the course of determining the actual recipient (beneficial owner) income one should also consider the functions performed and the risks taken by a foreign company which claims to receive benefits in accordance with international tax treaties. 

In order to prevent the use of provisions of agreements on avoidance of double taxation with the aim of tax evasion, a draft law aimed to fight against the tax evasion by using low-tax jurisdictions was introduced for consideration in the State Duma of the Russian Federation in the late October 2014

The main purpose of the draft law is the creation of an effective mechanism to restrain the use of low-tax jurisdictions aimed at the creation of unreasonable preferences and receipts of unjustified tax benefit. 

The draft law on the taxation of income of controlled foreign companies and incomes of foreign entities was supported as well by the Government of Russia. 

This draft proposes to add a new chapter into the Tax Code of Russia which stipulates the establishment of the mechanism of taxation for controlled foreign companies. Also, according to the document, the profit of controlled foreign entities is taken into account in the calculation of the tax base for the income tax or for the personal income tax if its value is exceeding 10 million rubles. (With effect from 2015 the value is exceeding 50 million rubles, and 2016 is 30 million rubles). 

The controlled foreign company means a foreign entity which is not a tax resident of Russia but the individuals or legal entities that control this company are the RF tax residents. In addition, the concept “controlling person” is introduced, of which the amount of the equity interest of an individual or a legal entity is over 25% (up to 2017 – over 50%). By the way, if the total share of the RF tax residents is over 50%, the equity share of the controlling person means an individual or a legal entity is over 10%. It is expected as well to consider not only actual equity shares but also abilities to have an impact on the decisions taken by entities with respect to the allocation of profits received.

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