Debt forgiveness, when a lender refuses to repay borrowed funds, is a complex legal and financial issue. If the debt is forgiven by a foreign company, then the taxation of this process may become an object of attention of the tax authorities.
Why write debts to foreign companies at all? The fact is that during the introduction of serious anti-Russian sanctions, some foreign firms are ready to “write off” debts to companies on loans and loans issued.
In this article, will consider the tax aspects of Russian legislation in the case of debt forgiveness by a foreign company. It is important to understand the specifics of using such a mechanism and the tax consequences for a foreign creditor and a Russian debtor.
Innovation of 2022
The total amount of debt forgiven is equal to the non-operating income of the debtor on the date of debt forgiveness. Exceptions are the cases prescribed in Article 251 of the Tax Code of the Russian Federation. It originated in March 2022 and applies to relationships that have arisen since January 1, 2022. However, the Ministry of Finance gave its clarifications and stated that the norm can be applied to debt forgiveness under an agreement signed before January 1, 2022.
The innovations of March 2022 state that when determining the tax base for income tax, income in the form of amounts of obligations terminated in 2022 is not taken into account:
- Under a loan agreement, if the contract is concluded before March 1, 2022 with a foreign organization or a citizen making a decision on debt forgiveness.
- At the request assigned to such a foreign organization or citizen before March 1, 2022.
It turns out that if a non-resident company forgave the loan debt to Russian companies, then taxation will not arise if the contract is signed before March 1, 2022, and the debt is forgiven after that date. In this case, the rights purchased or received by a foreign company before March 1, 2022 are equated to the conclusion of the contract. The tax exemption also applies to the amount of interest forgiven.
It is important to know that the application of this norm to the amount of interest forgiven carries certain risks. The fact is that with the direct implementation of this rule, there is a possibility that the Federal Tax Service of Russia will charge additional income tax to companies that have been forgiven interest on loans issued. The reason for additional accrual can be taken into account by taxpayers in interest expenses on the accrual method, which puts them in an unequal position in relation to entities using the cash method. In this situation, the company will receive an unreasonable tax benefit.
It should be noted that in the same year 2022, legislators made amendments to the article of the Tax Code of the Russian Federation on debt forgiveness. The adjustments affected the expansion of the scope of the benefit. At the same time, the amendments excluded the amounts of forgiven interest recorded in expenses from non-taxable income. The effect of the innovations was extended to legal relations from January 1, 2022. It turns out that when a non-resident forgives a debt to a resident under an agreement concluded before March 1, 2022, a domestic company will not have taxable income from the amount of the loan (loan) forgiven. The interest that has been written off should be included in non-operating income. Exceptions are the amounts of those percentages that were not taken into account by the taxpayer in expenses.
Accounting for loan interest in expenses
The general rules state that the method of accrual of interest on debt obligations should be reflected in the non-operating expenses of the borrower at the end of each month and on the closing date of the loan. It turns out that by the time of the write-off, interest expenses had already reduced the taxable base for income tax. In some cases, the lender’s interest will not be able to reduce the tax base on the borrower’s profit:
- Concerns the interest accrued by the taxpayer-borrower to the lender above the amounts that are considered expenses for tax purposes if the loan is an uncontrolled transaction and interest expenses are limited by limits or if the loan debt is controlled, that is, interest in excess of the limit is reclassified into dividends and is not recognized by the borrower as an expense for income taxation purposes.
- Concerns cases when interest on a loan is not considered expenses that reduce the taxable base on profit. The reason may lie in economic unreasonableness. For example, this applies to interest on a loan, due to which the lender has provided interest-free loans to other persons.
It turns out that taxable income cannot arise if a non-resident has written off a debt to a Russian company under a loan agreement concluded before March 1, 2022. At the same time, it is important that the Russian company does not take into account expenses as a percentage in the above cases.
Is it possible to talk about an increase in cases of debt cancellation?
Here is have already told about the list of situations when debts on a “foreign” loan are not tax revenues. It should be noted that Article 251 of the Tax Code of the Russian Federation also speaks about the exemption from income tax of debts that have been written off. However, a few more conditions must be met for this. For example, if foreign partners acquired the right to claim under a loan agreement after January 1, 2022, and they forgave debts, then the Russian company has no income from which to pay income tax.
It is important to note that another Russian company can forgive a foreign debt to a Russian company. This applies to cases when a new lender appears who receives rights under a loan agreement concluded before March 1, 2022 with foreigners. Thus, a Russian company has the right to claim a debt and forgive it.
If a taxpayer reflects in the accounting statements the income from the forgiveness of a foreign loan by a domestic other lender, then it is necessary to submit updated declarations to the Federal Tax Service with a reduction in their tax obligations.
By the way, the Russian new lender may also reduce the tax base. The amounts of obligations to pay for the acquired right of claim, which the foreign creditor forgave the “new creditor” in the situation under consideration, are not included in the income of the “new creditor” in the current year. Such a norm has appeared in Russian legislation to work in relation to legal relations that have arisen since January 1, 2022. Tax agents who have entered the amounts of forgiven liabilities into income before the entry into force of the innovations can submit updated declarations with a reduction in their tax liabilities.
Again, it is important to take into account that the tax-free regime applies only to contracts concluded before March 1, 2022. If the agreement was signed earlier than this period, then debt forgiveness can occur as part of the write-off of accounts payable as a taxable operation. The norm can be applied if the loan debt is forgiven by a participant of the same company with a share in the authorized capital of at least 50%.
Debt forgiveness as income
In accordance with Russian law, debt forgiveness is considered as income and must be accounted for in tax returns. This means that the recipient of the forgiven debt, whether an individual or a legal entity, must pay tax on this income.
If an individual in Russia receives debt forgiveness from a foreign company, this income may be subject to personal income taxation (personal income tax). The personal income tax rate depends on the amount of debt forgiven and can be 13% or 30%, depending on the circumstances.
Legal entities, including LLC, are also required to take into account debt forgiveness in their tax return. Debt forgiveness can be considered as income and is subject to corporate income tax, which is usually 20%.
In some cases, tax deductions or exemptions may be applicable when taxing debt forgiveness. This may depend on the nature of the debt and the legal aspects of the transaction.
If there is a double taxation avoidance agreement between Russia and the country of a foreign company, this may affect the taxation of debt forgiveness, providing for reduced tax rates or exemptions.
Are there any tax implications?
It is important to note that the legislation does not introduce certain consequences from debt forgiveness to a Russian entity by a foreign creditor. Even if it concerns large amounts. Here it is necessary to take into account that income is recognized as a financial benefit in cash or in kind. A foreign creditor company will not have income in this situation, so debt cancellation will not lead to property benefits.
As for the domestic lender who received the loan rights, he also has no financial benefit. Thus, there will be no income, and there will also be no expenses for the acquisition of debt rights.
The taxpayer may not take into account expenses, which are expressed by the value of the property transferred free of charge, as well as expenses related to the transfer. This applies to works, services, property rights.
It is important to note here that tax regulations periodically undergo changes. In order to avoid mistakes in tax accounting, it is necessary to periodically conduct an audit to identify risks and errors.
Debt forgiveness by a foreign company in Russia is subject to taxation in accordance with Russian law. The process can be considered as income for the recipient of the debt and taxed on the income of individuals or legal entities. However, there are a number of nuances that may affect the final tax obligations, such as the existence of international agreements on the avoidance of double taxation and the specifics of the operation. Before debt forgiveness, it is better to consult with professional tax consultants and lawyers in order to properly assess the tax consequences and fulfill the necessary tax obligations. VALEN specialists are ready to advise Russian and foreign business representatives on all the nuances of debt forgiveness.
Question and answer
The right to apply preferences to reduce the tax base must be confirmed with information from the company’s tax records. First of all, here are talking about primary documents, thanks to which the accountant will form analytical registers of tax accounting. On the basis of the same business papers, the income tax base will be calculated. What documents can be provided:
• Accountant’s certificate and other “primary”. Analytical registers of tax accounting.
• Calculation of the tax base.
• For example, to confirm right not to take into account the forgiven loan in the income tax base, it is possible to apply a copy of a foreign company’s decision on debt forgiveness or an agreement of the parties.