Mergers and acquisitions – Russia – Taxation of cross-border M&A
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Introduction
Mergers and acquisitions (M&A) have become increasingly global and competitive. In every jurisdiction, there are different tax specifics and some regimes are more burdensome than others. Furthermore, taxes become even more critical in large deals, as many issues can impact deal-related risks and valuation. This report highlights specifics of Russian tax regulations which are worthwhile considering while planning an M&A involving a Russian angle.
Recent developments
Russian tax legislation is subject to regular changes and 2020 was not an exception. Several significant amendments have been introduced to the Russian Tax Code, most important of which relate to the taxation of holding structures and IT companies. Moreover, in 2020 the government attempted to amend certain Russian Double Tax Treaties, the details of which are discussed below.
In certain cases, Russian beneficial owners of dividends payable by the Russian payers even if such beneficial owners do not hold the interest directly may apply the 0 percent income tax withholding (WHT) rate by invoking the look-through approach. The 0 percent rate will be abolished starting from 1 January 2024. Thereafter a standard 13 percent income tax rate would apply.
· The sale of shares/participation interest in a subsidiary by its Russian shareholder is subject to the 0 percent profits tax rate if the shareholder owns shares for more than 5 years. The 0 percent rate did not apply to the sale of shares/participation interest in a foreign subsidiary. Starting from 1 January 2021, the 0 percent would apply to the disposal of interest in non-Russian companies provided that the disposed of subsidiaries are not located in the countries which are named on the Finance Ministry’s blacklist of states and territories providing favorable tax regimes and/or non-providing information on financial transactions.
· One of the ways to fund a company’s activities is a contribution to its assets. In Russian GAAP accounts, such a contribution is recorded as additional paid-in capital. The contribution to a company’s assets has not increased the cost of investments in a contributor’s tax accounts. In other words, when a subsidiary is disposed the seller could not reduce its sale proceeds by funds previously contributed to the disposed company’s assets. Starting from 1 January 2021, cash contributions to a company’s assets increase the historical tax value of the investment and can be deducted against sale proceeds when the subsidiary is divested.
· From 1 January 2021, the recipient of property rights without consideration is exempt from profits tax due by the recipient. The exemption applies if the contributor is:
o a parent company that owns at least 50 percent of the recipient’s equity
o a subsidiary that is owned at least 50 percent by the recipient.
Furthermore, the contribution of assets and property rights does not trigger profits tax for the recipient if the contributed assets and property rights are not disposed of by the recipient within a year.
Previously, this exemption has applied only to assets transferred without consideration.
Shelf companies in Russia can be bought by local and foreign entrepreneurs looking for a fast start on the market, without having to wait for all the incorporation procedures. The ownership transfer needs to be evaluated at the time a shelf company is bought in Russia.
This is often the option of foreign investors who would rather skip any courtesies linked to company registration in Russia and instead purchase a ready-made company in Russia.
On 11 October 2020, an order of the Russian Ministry of Finance came into effect which approved the procedures and the deadlines for submitting and considering an application for MAPs. Such an application may be submitted in a free form to the Russian Ministry of Finance if the taxation is or would be inconsistent with the treaty’s provisions. The deadline for submission is 3 years from the date of delivery of the tax audit Summary of Findings which led to double taxation.
Within 90 days from the date of receipt of the application, the Finance Ministry reviews the application and supporting documents and decides on the performance of the MAPs or its refusal. A refusal is possible in the case of:
· failure to meet the deadline for applying
· incomplete and/or inaccurate information provided
· availability of the court ruling on the issue described in the application entered into force.
Notification of the commencement of the MAPs should be sent to both the taxpayer and the competent authority of a foreign country. The decision on the results of the MAPs is taken by the Ministry of Finance based on the results of MAPs reached with the competent authority of the foreign state.
Multilateral convention to implement tax treaty-related measures to prevent BEPS (MLI) About MLI developments, on 26 November 2020 Russia notified the OECD of the completion of internal procedures required for the entry into effect of the MLI concerning 34 treaties, including Austria, Belgium, Cyprus, Finland, Luxemburg, the Netherlands, Singapore, the UK, and others. The MLI provisions would apply to start from 1 January 2021 for both income tax withholding and other taxes. Concerning other countries, Russia would provide regular notices as the MLI enters into force in those countries
Starting 1 January 2021, companies which are:
· accredited with the Ministry of Communications,
· generate more than 90 percent of their total revenue from qualified IT activities, and
· have at least seven employees
are entitled to the 3 percent income tax (the standard rate is 20 percent) and 7.6 percent social insurance contributions (the maximum standard rate is 30 percent).
Starting from 1 January 2021, the sale of rights on software is exempted from VAT (the standard rate is 20 percent) only if the software is included in the Unified Register of Russian Software. Previously, there were no requirements that software should be listed in a specific register to seek a VAT exemption.
Asset purchase or share purchase
An acquisition in Russia can be structured as an asset or share deal. The main difference is that, in a share deal, all rights and obligations of the target company (including all historical tax liabilities) remain in the company acquired by the buyer, whereas in an asset deal, historical liabilities remain in the selling entity, with certain exceptions.
A share deal could be performed by acquiring shares in a Russian joint stock company (JSC) or by acquiring participation interest in a limited liability company (LLC). Share deals can also be affected by acquiring shares in the foreign holding companies of Russian targets.
An asset deal is usually a purchase of certain assets of the target company. In certain cases, especially if the target and the new company to which the target’s assets and business were transferred are related, the new company may be liable for the target’s historic tax liabilities which it could not settle.
An asset deal is usually subject to Value Added Tax (VAT), which generally can be claimed for offset (or refund) by the purchaser, whereas a share deal does not trigger VAT.
Alternatively, the deal could be structured as the purchase of an enterprise as a ‘property complex’, where all the assets and liabilities are assumed as well. This procedure is more complicated and without clear regulations, which explains why it is rare in practice (in many cases, the purchase of an enterprise as a ‘property complex’ occurs when a bankrupt company sells its business).
The implications of both types of purchases are summarized at the end of this report.
Generally, the purchase price is determined by the mutual consent of the parties. The authorities are entitled to audit the purchase price if they suspect that it is not in line with arm’s length principles resulting in underpayment of Russian taxes.
Goodwill could arise in a purchase of an enterprise as a property complex. ‘Goodwill’ is defined as the difference between the purchase price of an enterprise as a property complex and the net book value of its assets. Where the purchase price is higher, the positive difference (positive goodwill) could be deducted for profits tax purposes over 5 years from the month following the month of the state registration of the property complex transfer.
For statutory accounting purposes, goodwill is subject to impairment over 20 years or until the company’s dissolution, whichever is sooner.
Where the purchase price is lower than the value of assets, the negative difference (negative goodwill) is subject to profits tax in the month of the state registration of the property complex transfer.
The seller can deduct a loss on the sale of an enterprise as a property complex for profit tax purposes.
Goodwill could arise in a purchase of an enterprise as a property complex. ‘Goodwill’ is defined as the difference between the purchase price of an enterprise as a property complex and the net book value of its assets. Where the purchase price is higher, the positive
Depreciation charges are generally deductible. Depreciation charges depend on the asset’s useful life.
The useful life of an asset is determined at the date when the fixed asset is put into operation, based on the classification of fixed assets included in prescribed depreciation groups.
Where a particular fixed asset is not included in the classification, the taxpayer should determine the fixed asset’s useful life, taking into account the technical characteristics of the asset and recommendations of the manufacturer.
A taxpayer is entitled to apply either a straight-line or a reducing-balance method of depreciation.
A depreciation premium of 10 percent to 30 percent of the acquisition cost of fixed assets is available as an immediate deduction when the fixed assets are commissioned.
Tax losses of the target company are not transferred to the buyer under an asset deal.
The sale of most assets is subject to 20 percent VAT which usually can be claimed for offset/refund by the Russian buyer. If a foreign company acquired an asset, it would not be able to claim the related input VAT for offset or refund. Such a VAT becomes the buyer’s cost.
The contribution of an asset to the charter capital of a Russian company is not subject to Russian VAT. The Russian subsidiary contributing the asset to the charter capital should reinstate previously offset VAT (for fixed assets, at their net book value). Reinstated VAT should be shown separately in the transfer documents and can be claimed to offset against the output VAT of the company that received the contribution in kind.
The sale of an enterprise as a property complex is subject to specific VAT rules. For example, the tax basis should be defined as the net book value of assets per statutory accounting multiplied by a special ratio (where the purchase price differs from the net book value of the assets sold).
Where the purchase price is lower than the net book value of assets, the correcting ratio is determined by the proportion of the purchase price to the net book value. Where the purchase price exceeds the net book value, the correcting ratio is calculated in the same way but the numerator and denominator of the proportion are reduced by the value of accounts receivables and the value of securities (if no decision about their revaluation has been made).
The seller should provide the buyer with an inventory report and a consolidated invoice grouped by type of asset.
The sale of assets and property rights of a bankrupt company is not subject to VAT. Therefore, the buyers of such property or property rights have no obligation to act as a tax agents.
Goodwill could arise in a purchase of an enterprise as a property complex. ‘Goodwill’ is defined as the difference between the purchase price of an enterprise as a property complex and the net book value of its assets. Where the purchase price is higher, the positive
Starting from 1 January 2019, movable property is not subject to property tax. The tax applies to the immovable property only.
Tax is paid either at the rate of 2.2 percent on the asset’s net book value provided in Russian generally accepted accounting principles (GAAP) accounts or its cadastral value.
The asset’s cadastral value is used for:
· administrative, business, and shopping centers and premises situated in them
· non-residential premises to be used or intended to be used for offices, commercial facilities, catering, and domestic services
· any immovable property owned by foreign companies that do not carry out business activity through a permanent establishment (PE) in Russia
· immovable property owned by foreign companies that do not relate to the business activity carried out through the PE by the foreign company.
The statutory tax rate applicable to the asset’s cadastral value is 2 percent. The rate can be reduced by the regional authorities.
Starting from 1 January 2021, a property tax return should include information on the average annual value of movable property items recorded on the taxpayer’s Financial Statements as fixed assets per Russian GAAP. The rule is applied to start with the tax return for 2020.
Generally, a share deal may be preferable for the seller where the seller is a foreign legal entity because capital gains derived (if any) are not taxed in Russia unless the target company is deemed to be property-rich. A company is viewed as property-rich if more than 50 percent of its assets directly or indirectly consist of immovable property located in Russia.
In a share acquisition, the buyer takes over the target company together with all its assets and liabilities, including contingent liabilities. Therefore, the buyer normally requires more extensive indemnities and warranties than in the case of an asset acquisition. To protect itself from potential tax risks, the buyer may wish to initiate a due diligence procedure and include some indemnities in the sale-purchase agreement.
Net operating losses (NOLs) which arose on 1 January 2007 can be carried forward indefinitely (it used to be that an NOL could be carried forward for 10 years as a maximum). For the period starting from 1 January 2017 through 31 December 2020, a taxpayer is entitled to reduce its taxable profit for the current tax period by up to 50 percent of NOLs generated in earlier years.
In a reorganization, a company that takes over all the rights and obligations of the reorganized company is entitled to reduce its taxable profit by NOLs incurred by the reorganized company before its reorganization.
As the buyer of shares takes over the target company together with all its liabilities, the buyer inherits all the target’s historical tax risks. Therefore, the buyer usually obtains an appropriate indemnity from the seller regarding outstanding historical tax liabilities. The buyer may ask the target company to obtain a reconciliation statement and a statement of personal account from the tax authorities at the latest possible date preceding the date of a share deal. Nevertheless, where the target company has no outstanding tax obligations according to these documents, the possibility remains that the tax authorities may challenge the accuracy and timeliness of the tax calculations and payments and claim additional taxes and late-payment interest.
Generally, 3 calendar years preceding the current year are subject to field audit by the tax authorities. However, in certain cases, the closed tax periods may be subject to repeat tax audits. Among other things, such a repeat audit could be performed where:
· the taxpayer is regarded as inhibiting the exercise of tax control by the tax authorities
· the higher tax authorities are reviewing work done by the lower tax office
· a criminal case is brought against the officers of the company on the grounds of tax evasion.
The DEMPE concept was introduced into the tax law in 2019 and came into effect starting on 1 January 2020. DEMPE stands for Development, Enhancement, Maintenance, Protection, and Exploitation of intangible assets. The DEMPE concept has resulted from the evolution of relatively new transfer pricing (TP) models to remunerate DEMPE activities and the related risks that are not performed and borne by the intellectual property (IP) owner.
The major TP methods applied to transactions with intangible assets are as follows: comparative uncontrolled price (being a priority for applying), comparable profitability, profits allocation, and value chain analysis (VCA).
Application of the VCA method is driven by different changes in the law in line with the base erosion and profit shifting (BEPS) Plan, as well as changes in the tax authorities’ approach to scrutiny methods applied for assessment of the market level of prices under transactions with intangible assets.
When analyzing the comparability of the commercial and financial terms of transactions with intangible assets with the terms of uncontrolled transactions, several indicators should be taken into account, including the type of the intangible asset, its exclusiveness, the terms of its legal protection, the territory where the rights for the asset are enforced, stage of its life cycle, rights and functions of the parties under the transaction, and ability to receive income from usage of the asset.
Concept of ‘unjustified tax benefit’
In July 2017, the Russian Tax Code was amended to include the concept of ‘unjustified tax benefit’ (introduced in 2006 by the Supreme Arbitration Court). Following these amendments, expenses can be deducted, and taxes can be refunded where:
· the company has recorded the transaction for accounting and tax accounting purposes by its substance
· the main purpose of the transaction is not the underpayment or recovery of taxes
· the contractual obligation was performed by the party to the contract concluded with the taxpayer and (or) a person to whom the obligation to perform the transaction was assigned by another contract or by the law.
There is no per se tax ruling institute in Russia. Nevertheless, taxpayers can obtain tax clarifications from the tax authorities on unclear or questionable provisions in Russian tax legislation. If a taxpayer follows such clarifications and the tax authorities then challenge the case, the taxpayer can be exempt from a tax fine.
There is a special type of tax control executed by the tax authorities — a tax monitoring regime. Companies that apply this regime grant the tax authorities access to their financial systems. The tax authorities’ comments received by companies within their tax monitoring supervision are obligatory for the execution by companies.
Choice of acquisition vehicle
Several possible acquisition vehicles are available to a foreign investor, and tax consequences often influence the choice.
International holding companies
The procedures and terms for taxation of income of international holding companies (IHC), entered into force on 3 August 2018. IHC is recognized as an international company that simultaneously meets the following conditions:
· The company is registered in the course of re-domiciliation (change of jurisdiction) of a foreign organization, which was established by its law before 1 January 2018.
· Not later than 15 days from the date of its registration, the company submitted to the tax authorities its Financial Statements for the last financial year before the date of registration along with the positive audit opinion and information on the controlling persons of the company.
· As of the date of its registration, the controlling persons of such a foreign organization became its controlling persons before 1 January 2017.
IHC is subject to registration in the unified state register for legal entities in connection with a change in the procedure of re-domiciliation. In addition, to obtain IHC status, such a company should:
· apply the conclusion of a contract on the performance of activity as a participant in a special administrative region (SAR) Russian Island (Primorsky Krai) and Oktyabrsky Island (Kaliningrad Oblast)
· be located within the territory of SAR
· assume obligations on the performance of investments in Russia in the amount of at least RUB50 million (approximately EUR542,000) within at least 6 months from the date of registration of the international company
· be registered (created) in a state that is a member or observer of the Financial Action Task Force (FATF) and/or a member of the Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism (MONEYVAL)
· carry on business activity in the territory of several countries, including Russia.
The controlling person of IHC is a Russian individual or a Russian legal entity whose interest in this international company is more than 15 percent.
Dividend income received by IHC is subject to income tax withholding at the rate of 0 percent, provided that:
· as of the date of the decision on the dividend payment, the IHC owns at least 15 percent in a foreign payer of dividends for at least 365 calendar days
· the tax residency jurisdiction of a foreign organization paying dividends is not included in the list of offshore zones
· the tax agent paying dividends has been provided with confirmation that as of the date of dividend payment the conditions for recognizing an international company as the IHC are met.
Dividend income received by foreign persons from IHC is subject to the 5 percent income tax withholding, provided that:
· IHC has a status of a public company as at the date of dividend payment
· the foreign person receiving dividend income shall provide IHC with the confirmation that as at the date of payment this foreign person has the actual right to receive such income.
Where the buyer uses debt financing to acquire a Russian target, it may be reasonable to set up a Russian holding company as an intermediary. Interest expenses are deductible irrespective of whether a loan was taken out for investment or current business needs. There are still certain limitations on interest deductibility (see ‘Deductibility of interest’ section).
A post-acquisition merger of the intermediate holding company and the target company could be considered.
This would make it possible to offset the holding company’s interest expenses against the target company’s income (the holding company would not have such income). Maintaining one company instead of two also would reduce administrative costs. However, such a cascading structure is inefficient for dividend payments. Dividends are subject to tax at a rate of 0 percent where certain conditions are met or at 13 percent when distributed to the Russian holding company. This tax may not be creditable against further taxation of dividends paid to the foreign shareholder.
Where the merger is mainly motivated by tax considerations, the tax authorities could invoke the concept of ‘unjustified tax benefit’ and assess additional taxes as if no merger had occurred. Currently, the court practice is developing in this respect and Russian tax authorities pay close attention to the matters of economic justification and business purpose of financial transactions, their context, and all the attendant circumstances.
Under the ‘beneficial ownership’ concept, the Russian tax authorities may challenge the application of the rates for Russian tax residents and apply the rate of 15 percent on dividends unless the reduced WHT rates apply.
A foreign buyer may wish to acquire the shares of a Russian company without an intermediary, which should be considered where the foreign parent plans to resell the target. Russia does not tax capital gains on shares sold by a foreign legal entity unless more than 50 percent of the assets of the Russian target directly or indirectly consist of immovable property located in Russia.
Although Russia levies WHT on dividends, interest, and royalties paid to a foreign entity, WHT can be reduced or eliminated by an applicable tax treaty provided that certain criteria are met.
A foreign investor may acquire shares in a Russian company for cash or in exchange for contributions in kind of property (assets or shares). In this case, the tax basis of the acquired shares in the Russian company is equal to the tax basis of property (shares) given in exchange for the shares and costs related to the contribution.
The tax basis of property (assets or shares) received by the Russian company is also equal to the tax basis of the contributed property stated in the records of the investor on the date of transfer (but not higher than the market value of the transferred property, as confirmed by an independent appraiser for transfers made by a foreign investor). Where the Russian company lacks supporting documents for the cost of property received, the tax basis of property is zero for Russian profits tax purposes.
PE issues should also be taken into account. The activities of a foreign legal entity may create a PE in Russia where the foreign entity has a place of business in Russia (i.e. branch, office, bureau, or other separate division) and regularly engages in business activities through this place (unless the activities are preparatory or auxiliary). Most Russian tax treaties provide similar criteria for determining whether a PE of a foreign legal entity (FLE) exists in Russia.
The non-resident intermediate holding company
A non-resident intermediate holding company can be used to reduce WHT on dividends, interest, and royalties by applying a favorable tax treaty with Russia. However, the Russian tax authorities may challenge the application of a tax treaty if they consider that the holding company is a conduit company established to obtain a tax benefit (the so-called ‘unjustified tax benefit’ concept). PE issues should also be taken into account.
Instead of directly acquiring the target company, a foreign buyer may structure the acquisition through its Russian branch. The taxation of a branch depends on whether it constitutes a PE in Russia.
Where the branch does not constitute a PE, the tax consequences on the subsequent sale of the target are the same as where a foreign parent company is used as an acquisition vehicle: there is no capital gains tax on shares sold by a foreign company unless the Russian company sold is deemed to be property-rich.
Where the branch constitutes a PE, capital gains are taxed in the same way as capital gains of the Russian company (i.e. at the 20 percent profits tax rate).
A JSC is a legal entity that can be either public or non-public. The shares of public JSCs are traded on a stock exchange.
· The minimum share capital for a public JSC is RUB100,000 (approximately EUR1,100); for a non-public JSC, it is RUB10,000 (approximately EUR110).
· The minimum number of shareholders (public and non-public) is one (unless the only shareholder is a legal entity owned by one person).
Limited liability company (LLC)
· The minimum charter capital for an LLC is RUB10,000 (approximately EUR110).
· The minimum number of participants is one (unless the only participant is a legal entity owned by one person).
· The maximum number of participants is 50.
· Participants are not liable for the company’s debts.
· Shareholders are not liable for the company’s debts.
· The taxation regime does not depend on the legal form of the company.
Generally, the anti-monopoly law sets certain restrictions on transactions and contractors. Several transactions require preliminary consent from the responsible authorities or a simple notification after the event.
For example, prior consent is required for:
· a reorganization in the form of a merger of commercial organizations where:
· the aggregated net book value of their assets at the last reporting date preceding the request to the anti-monopoly authorities exceeds RUB7 billion (approximately EUR76 million)
· the aggregated sales turnover for the year preceding the merger exceeds RUB10 billion (approximately EUR110 million)
· certain sales of shares (participation units), rights, and/or property where:
· the aggregated net book value of the target and buyer’s assets exceeds RUB7 billion (approximately EUR76 million)
· the aggregated sales turnover for the year preceding the deal exceeds RUB10 billion (approximately EUR110 million) and the net book value of the target’s assets exceeds RUB400 million (approximately EUR4.3 million).
The conditions that need to be met to obtain group relief effectively mean that there are few consolidated taxpayers in Russia.
For other Russian legal entities that do not form consolidated tax groups but have branches or representative offices, the profits tax is calculated on a consolidated basis by the head office. Profit is attributed to each branch based on a proportion of the average number of employees of the branch and the residual value of the depreciated fixed assets of the branch.
As of 1 January 2012, tax grouping was introduced in Russia. This regime applies to a group of companies where one company has direct or indirect participation of not less than 90 percent in the charter capital of each group company. Tax-grouping is only available where, for the preceding year, the total amount of taxes paid by the applying companies is not less than RUB10 billion (approximately EUR110 million), total sales are not less than RUB100 billion (approximately EUR1.1 billion) and total assets as at 31 December of the preceding year are not less than RUB300 billion (approximately EUR3.3 billion). Tax-grouping is available for profits tax only and should be formalized by an agreement signed by the participating companies. The tax group is formed for a period of not less than 5 profits tax periods (calendar years).
The accumulated tax losses incurred by the taxpayer before the tax-grouping agreement is concluded are not deductible against the consolidated profits of the tax group.
Where the taxpayer chooses to exit the tax group, these losses become available for deduction.
Similarly, individual taxpayers cannot utilize part of tax losses incurred by the tax group if they choose to exit the tax group or are no longer eligible for the tax consolidation.
Considering the turnover and asset requirements and the limitations on the utilization of accumulated tax losses, KPMG in Russia expects that tax grouping will remain rare in Russia.
Currently, the creation of new consolidated tax groups has been suspended.
Russian TP rules generally correspond to OECD principles. Under TP rules, the tax authorities should calculate price adjustments:
· based on prices available on comparable transactions having the same or similar financial or commercial conditions, including functions performed, assets employed, and risk undertaken by the parties of a transaction
· by applying the most suitable pricing method that, in the facts and circumstances, enables a justified conclusion regarding the level of prices
· based on market price intervals or profitability intervals estimated based on available information regarding transactions between unrelated parties
· as corresponding adjustments for both parties of the transaction (e.g. if sales revenue of one party of the transaction is increased, the cost of sales of the other party should be increased accordingly).
Amendments introduced into Russian TP regulation and valid from 1 January 2019 reduced the number of transactions subject to TP regulation (so-called ‘controlled transactions). Currently, the following transactions are treated as controlled transactions if turnover on all transactions between the parties exceeds RUB60 million (approximately EUR650,000) in a calendar year:
· cross-border transactions between related parties
· transactions with related parties via an independent intermediate company (SPV) with no (or) limited functions, risks, and assets
· cross-border trading of commodities
· transactions with an unrelated party that is a tax resident in a country included in the Russian Ministry of Finance’s blacklist.
Transactions between Russian-related parties are controlled if turnover on all transactions exceeds RUB1 billion (approximately EUR11 million) in a calendar year and:
· the parties apply different profits tax rates
· one party is subject to the mineral extraction tax
· one of the parties is subject to the mineral extraction tax (under certain conditions)
· one party applies a special tax regime
· one of the parties is exempted from profits tax
· one of the parties is involved in the production of hydrocarbon raw materials in a new maritime offshore hydrocarbon field (under certain conditions), or
· etc.
The following transactions are not considered controlled transactions:
· transactions among the members of a consolidated group of taxpayers
· provision of interest-free loans between Russian-related parties
· provision of warranties (guarantees) between Russian-related parties
· transactions among companies that simultaneously meet the following criteria:
o are registered in the same Russian region
o do not have separate subdivisions
o do not have tax losses to be carried forward, and
o Etc.
Controlled transactions involve goods, works, and/or services. When analyzing the comparability of the commercial and financial terms of these transactions with the terms of uncontrolled transactions, several indicators should be taken into account, including:
· characteristics of the goods, services, or works
· functions of the parties to the transaction
· terms and conditions of the contracts
· economic environment
· market (commercial) strategies of the parties to the transaction.
Fines are being introduced for violating the transfer pricing law. Thus, if taxes are underpaid because of non-arm’s length prices, a tax fine of 40 percent of the unpaid taxes should apply.
The following methods can be used to determine the range of arm’s length prices: comparative uncontrolled price
(CUP), resale price, cost plus, comparable profitability, and profits allocation.
The CUP method usually is the preferred method. However, for transactions in which goods are purchased and resold without any modification, the resale price method is the preferred method. Where the preferred method cannot be applied, the method that is most appropriate for the transaction should be applied.
Taxpayers should keep transfer pricing documentation as evidence that the prices used are within the range of arm’s length prices and submit information to the tax authorities for all controlled transactions.
For taxpayers who qualify as ‘major taxpayers’ (as defined in the Russian Tax Code), there is a possibility of concluding advance pricing agreements (APA) with the tax authorities (i.e. where the taxpayer and the tax authorities agree in advance to apply a specific methodology to calculate the range of arm’s length prices). A duty of RUB2 million (approximately EUR21,700) is payable for the signing of an APA.
With these recent changes, Russian transfer pricing legislation has become more detailed and well developed, which could enable the tax authorities to more successfully defend their positions in court.
Generally, dual residency conflicts are resolved by the relevant tax treaty using tax credit or exemption. Since obtaining these usually involves certain bureaucratic and time-consuming procedures, intentional dual residency is usually not used by Russian companies (the Russian residency which is defined by registration).
Foreign investments of a local target company
There are certain limits on the activities of non-Russian investors participating in companies that are of strategic value to Russia (so-called ‘strategic companies’). These activities include:
· exploration of subsoil and extraction of mineral resources on land plots of national significance
· aerospace activities
· certain services provided by a natural monopoly or a company with a dominant position on the Russian market
· harvesting of live aquatic resources
· activities controlling hydrometeorological and geothermal processes and events
· certain activities related to the use of nuclear and radiation-emitting materials
· certain activities related to the use of encrypting facilities and bugging equipment
· military-technical activities.
Non-Russian investors (i.e. non-Russian private companies, non-Russian individuals, and Russian companies controlled by non-Russian companies or individual(s)) are permitted to carry out transactions that would result in their obtaining control over a strategic company. However, such transactions, among others, must be approved by state authorities.
Comparison of asset and share purchases
· The possibility to acquire only those assets that the buyer needs (which could be useful, among other things, where the buyer wants to acquire only part of a business).
· The assets’ fair market acquisition price is deductible.
· Tax liabilities and tax exposures of the target company (if any) should remain with the target company, etc.
Disadvantages of asset purchases
· Goodwill cannot be depreciated for profit tax purposes.
· The sale of assets is subject to VAT, except for assets and property rights of a bankrupt company, which affects cash.
· Accumulated tax losses remain with the seller of the assets.
· Customs risks for the buyer cannot be eliminated.
· It may not be possible to transfer all assets to another company where, for example, some assets are used as collateral securing loans and borrowings.
· Transfer of licenses may be impossible, etc.
· Capital gains from the sale of shares in certain cases can be tax-exempt.
· Value of shares may account for goodwill.
· Sale of shares is not subject to VAT.
· Tax losses accumulated by the target before the acquisition may be used after the changes in control.
· The share acquisition procedure is technically less complicated than an asset deal; however, it may be necessary to perform anti-monopoly procedures, etc.
Disadvantages of share purchases
· All tax liabilities and tax risks of the target are inherited.
· Capital gains received by the seller could be subject to taxation in Russia: 20 percent profits tax is payable by a corporate seller or 13 percent personal income tax payable by an individual seller who is a Russian tax resident.
· Consolidation of profits and losses of the buyer with the profits and losses of the target company is not allowed (except in the case of a post-acquisition merger).
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