Taxation of Profit of Controlled Foreign Companies in Russia
17 September 2015
On 1 January 2015, the Federal Law of 24.11.2014 No 376-FZ (hereinafter Law No 376-FZ) enacted the Tax Code amendments that provided for creation of the mechanism for taxation of profit earned by controlled foreign companies (CFCs). This document contains the brief summary of the main changes.
The taxation of CFCs corresponds to the world experience. The rules for CFC taxation are provided by laws of many developed countries such as USA, UK, Germany, Sweden, Japan, Australia.
The objectives of the above mentioned Law:
- creation of the prevention mechanism against the use of low-tax jurisdictions for the purpose of creating unreasonable preferences and obtaining unjustified tax benefit;
- improvement of laws on taxes and duties in terms of taxation and control of foreign organizations.
The law applies to both organizations and individuals participating in foreign companies or controlling them in any other way.
The new provisions are applied by controlling entities of CFC in determining the tax base on foreign company's profits to be determined from the periods starting in 2015.
The Law introduces a number of new concepts such as a controlled foreign company and a controlling entity.
Controlled foreign company (CFC) is a foreign organization that satisfies all the conditions below:
- organization is not recognized as a tax resident of the Russian Federation;
- controlling entities of this organization are organizations and (or) individuals recognized as tax residents of the Russian Federation.
At the same time the law determines the range of organizations recognized as tax residents of the Russian Federation. They include:
- Russian organizations;
- foreign organizations recognized as tax residents of the Russian Federation in accordance with the international treaty on tax matters for the purpose of this international treaty;
- foreign organizations if the place on which they are actually managed is the Russian Federation, unless otherwise stipulated by the international treaty on taxation. This law defines the criteria to identify the place of actual management (the place where the board of directors holds most meetings, the executive body regularly carries out its activities, or the chief executives primarily carry out their activities).
As for individuals, they are recognized as tax residents of the Russian Federation in the same way as before on the basis of their actual stay in Russia for at least 183 calendar days within 12 consecutive months.
Controlling entity of a foreign organization is an individual or a legal entity:
- whose participation interest in an organization is more than 25% (before 1 January 2016 – more than 50%), or
- whose participation interest in an organization (for individuals along with their spouses and minor children) is more than 10%, if a direct and (or) indirect participation interest of all entities recognized as tax residents of Russia in this organization (for individuals along with their spouses and minor children) is more than 50%, or
- exercising control over such an organization in their own interests or the interests of their spouse and minor children.
An entity's participation interest in CFC is determined under the transfer pricing rules of the RF Tax Code. Thus, one takes account of both the direct and indirect (through a chain of entities) participation.
CFC's profit reduced by an amount of paid dividends is included as a portion corresponding to participation interest in CFC into the tax base of a controlling entity - resident of the Russian Federation:
- for controlling entity as an individual – on personal income tax;
- for controlling entity as a legal entity – on corporate income tax.
This aforementioned procedure is valid only if CFC's profit is more than 10 million rubles (for 2015 – more than 50 million rubles, for 2016 – more than 30 million rubles).
Income in the form of sums of CFC's profit is recorded in income of a controlling entity as of 31 December of the year following the tax period that includes the end date of the period for which financial statements for the fiscal year are prepared in accordance with the personal law of such a company.
The Law defines the fine of 20% of the relevant unpaid tax amount but not more than 100, 000 rubles (applies to tax periods from 2018) for failure to pay (incomplete payment of) tax amounts as a result of failure to include CFC's profit share in the tax base.
The law provides for a number of cases in which CFC's profit is free of tax in the Russian Federation, in particular, if CFC's permanent location is a state (territory) with which there is an international treaty on taxation, except for states (territories) that do not provide the exchange of information with Russia for the tax purpose, while:
- The effective rate on income (profit) tax for this foreign organization is at least 75% of the weighted average rate of corporate income tax, or
- The proportion of passive income in the total amount of income of this organization is not more than 20%.
The list of states (territories) that do not provide the exchange of information for the tax purpose is subject to approval by Russian Federal Tax Service.
The law establishes the obligation of residents - individuals and legal entities to submit the following statements to tax authorities.
Notification of participating in foreign organizations (if the participation interest exceeds 10%) and of establishment of foreign institutions without status of a legal entity
To be submitted not later than one month after the date of occurrence (change of an interest) of participation in such a foreign orhanization, which is the ground for the submission of such notification. If the participation interest remains unchanged onwards, repeated notifications are not submitted.
In 2015, notification of participation in international organizations is submitted, taking into account the following aspects:
- notification of a participation interest in international organizations as of 15.05.2015 is submitted not later than 15.06.2015;
- notification is not submitted if participation in an international organization ceases in the period from 01.01.2015 through 14.06.2015.
For failure to submit or for submission of inaccurate notification, the law defines the fine of 50, 000 rubles (on each foreign organization whose information was inaccurate or not submitted).
Notification of controlled foreign companies
Notification of CFC is submitted not later than 20 March of the year following the tax period in which the share of controlled foreign organization's profit must be recognized by a controlling entity in its accounting.
For failure to submit or for submission of inaccurate notification, the law defines the fine of 100, 000 rubles (for each CFC whose information was inaccurate or not submitted).
The forms and formats of notification were approved by the Order of Russian Federal Tax Service on 24.04.2015 No MMV-7-14/177@.
FinExpertiza provides a full range of services related to the Law No 376-FZ according to conditions of a certain business. In particular, FinExpertiza's advisers:
- explore existing structure of a group of companies and identify entities that are subject to the rules on CFC;
- assess financial implications of applying the rules on CFC and associated risks;
- analyze the possibility of applying statutory grounds for exemption from taxation of CFC's profit in Russia;
- offer a clear plan of actions for modernization of existing corporate structure in order to eliminate or substantially mitigate effects of the application of the Law No 376-FZ,
- calculate CFC's profit to be included in income of controlling entities;
- prepare and submit necessary notifications and supporting documentation to tax authorities;
- in the case of disputes with tax authorities on issues of CIC's profit taxation, our advisers provide for a reasoned position for your protection and will represent interests of your company against tax authorities and in all court instances.