What is a CFC under the new law?
A controlled foreign corporation (or CFC) is a non-Russian entity which:
- is not tax resident in Russia; and
- is controlled by legal entities and/or individuals that are treated as Russian tax residents.
The definition of a CFC covers pass-through entities (such as funds, trusts, partnerships and collective investment vehicles) which generate income for the benefit of their participants / settlors or beneficiaries, as well as corporate entities. There are however exemptions in relation to:
- foreign non-commercial companies which do not distribute income to their participants / shareholders;
- foreign companies where their place of registration is in one of the member-countries of the Eurasian Economic Union;
- companies with their place of registration in a country which has a double tax treaty with Russia and a tax information exchange agreement with Russia and which has an effective annual income tax rate of not less than 75% from the weighted average corporate profits tax rate in Russia;
- companies where their place of registration is in a country which has a double tax treaty and a tax information exchange agreement with Russia and not more than 20% of the company’s income consists of passive types of income (dividends, royalties, interest, etc.);
- pass-through entities:
- the participants / settlors of which are not entitled to receive assets of the entity;
- the rights of participants / settlors cannot be assigned to third parties;
- the participants / settlors are not entitled to any income from the entity;
- the entity has no right to distribute profits to its participants / settlors (or their related parties);
- banks or insurance companies resident in a jurisdiction which has a tax information exchange agreement with Russia;
- Eurobond issuers (or SPVs involved in Eurobond structures), if the interest receivables from its parent comprise at least 90% of its annual income);
- companies participating in production sharing agreements, concession agreements or other agreements of a similar nature with foreign governments; and
- companies/operators of new offshore deposits of hydrocarbons (special newly introduced regime for the exploitation of offshore licence areas) in Russia (or a shareholder of such operator).
The law defines “control” over a corporate entity as exercising influence (or having the ability to exercise influence) over the distribution of profits of that entity through:
- direct or indirect participation in the capital of that entity (e.g. as a shareholder); and
- having rights under a shareholders’ agreement regulating the management of that entity, or
there is a similar definition in relation to pass-through structures.
Establishing whether “control” (as defined above) exists will require proof of factual circumstances which demonstrate influence over decision making in relation to distributions of income in an entity, which is likely to be difficult in practice for the Russian tax authorities. However, the CFC rules in the law also contain objective “control” tests.
A Russian taxpayer will be deemed to “control” a corporate entity if that person, together with his/her/its affiliates (including certain family members), is beneficially entitled to:
- from 1 January 2015 until 31 December 2015 - more than 50% of the interest in that entity; or
- from 1 January 2016 onwards - either:
- more than 25% of the interest in that entity, or
- more than 10 % of the interest in that entity and Russian tax residents (together with their respective affiliates including certain family members) are in aggregate beneficially entitled to more than 50% of the interest in that entity.
A “beneficial ownership of income” test may apply to foreign company (including a CFC) to determine whether the company serves merely as a conduit function.
A person will be treated as “beneficially entitled” to the income from the entity if he/she/it has the right to use or dispose of that income through, among other things:
- direct or indirect participation in the capital of the income distributing entity (e.g. as a shareholder); or
- being able to decide whether to consume or direct the transfer of such income to any third person.
Where a person (e.g. an offshore holding company) has a right to use or dispose of income which it receives, the functions performed and risks assumed by that person will be taken into account in order to determine whether that person is “beneficially entitled” to that income. The person will not be treated as beneficially entitled to that income if it:
- has limited rights to dispose of that income;
- performs purely intermediary functions in respect of that income and does not enter into any commercial activities nor does it perform any other functions; and
- transfers that income, all or part, to another person who (or which), if they had received that income directly from the original source of such income, would not have been able to claim double tax treaty benefits.
What reporting obligations will apply?
A Russian tax resident must file a report with his/her/its local tax inspectorate to notify the Russian tax authorities of:
- any CFC which the taxpayer together with its affiliates controls, by not later than 20 March in the year following the tax year in which his/her control of the CFC began;
- any direct or indirect shareholding or other relevant interest of more than 10% in any foreign company within 1 month after that interest is obtained (for interest held before 1 January 2015 the reporting deadline is 1 April 2015); and
- any direct or indirect foreign pass-through structures (e.g. funds, partnerships, trusts and other forms of collective investments) due to participation in which the Russian tax resident would have the right to the income.
Reports must also be filed by the taxpayer upon the cessation of holding any of the abovementioned interests.
How will the taxable income of a Russian controlling party be calculated?
The income of a CFC:
- will be treated as the income of the relevant Russian controlling party (whether corporate or individual) of the CFC in proportion to the interest of that controlling party in the capital of the CFC;
- will be deemed to be received by the relevant Russian controlling party when it is distributed by the CFC or, if there is no such distribution in the relevant tax year, on 31 December in that tax year (with proportionate reductions made where the relevant controlling party held its interest for less than the full tax year); and
- will be calculated based on the financial reporting period of the CFC under the laws applicable to the CFC.
The income of a CFC will not need to be accounted for by a Russian controlling party if the income of the CFC does not exceed:
- 50 million Rubles in the year ending 31 December 2015;
- 30 million Rubles in the year ending 31 December 2016; or
- 10 million Rubles thereafter.
The taxable income of CFC is calculated according to its annual financial statement, if such statement is subject to mandatory audit and the CFC is located in a treaty jurisdiction. Otherwise the taxable income is calculated in accordance with rules of Russian Tax Code. The following are main issues relevant for determining the amount of taxable income of CFC:
- the applicable tax rates will be 20% for corporate and 13% for individual controlling parties;
- the taxable income of the CFC will be reduced by the amount of any dividends distributed by it;
- the income of the CFC will need to be supported by appropriate financial reporting documentation for the relevant tax period(s) of the CFC;
- the income of the CFC which is denominated in foreign currency will need to be converted into Russian Rubles at the average exchange rate of the Central Bank of Russia for the relevant tax period(s) of the CFC; and
- tax credits will be available to a Russian controlling party - Russian tax payable on the income of the CFC will be reduced by: (i) any tax paid by the CFC (or withheld on behalf of the CFC) on that income in the country of its incorporation or in Russia; and (ii) any tax paid by a Russian branch of the CFC.
- If the CFC is indirectly controlled through other entities which also qualify as “controlling” with respect to the CFC, the income of the “top” controlling entity is reduced by income reported by the other controlling entities through which the indirect control is exercised; and
- the losses of the CFC are indefinitely carried forward.
What penalties will apply for non-compliance?
The law contains the following main penalties for non-compliance:
- failure to report and pay tax on a CFC’s income - 20% of the underpaid tax (does not apply until 1 January 2017);
- failure to report participation in a CFC and a foreign company on time – 100,000 Rubles; and
- failure to report participation in a foreign company on time - 50 000 Rubles.