Is a Good Plan Today Better than a Perfect One Tomorrow?
In November 2014, the law on controlled foreign companies, which was the target for criticism, discussions, comments and etc., was adopted. The Ministry of Finance tried as much as possible to clarify certain urgent matters arising among taxpayers.
In particular, there were two controversial explanations given on the matter of procedures for recognizing an individual a tax resident of the Russian Federation for the purposes of filing notification on the participation in companies and structures. In accordance with explanations of the Russian Federal Tax Service, individual may be recognized a tax resident of the Russian Federation in three cases:
- If individual stayed in the Russian Federation for less than 183 days during the period from January 1 until December 31 of the calendar year.
- If individual has permanent home in the Russian Federation.
- If individual’s center of vital interests is in the Russian Federation1.
In its turn, the Russian Ministry of Finance gave the following explanation: for the purposes of filing notification on participation in companies and structures, tax residency is defined in accordance with the number of days spent by individual in the Russian Federation as of the date obligation to file notification arises2.
Also, there were three controversial letters issued regarding the possibility for calculating profit of CFC on the basis of financial statement subject to voluntary (proactive) instead of mandatory audit (provided other requirements are followed):
- On April 30, 2015, the Ministry of Finance issued a letter, which said that provisions of the Tax Code of the Russian Federation did not stipulate possibility for calculating profit of CFC on the basis of financial statement provided the statement is confirmed by voluntary (proactive) instead of mandatory audit3;
- On June 17, 2015, the Ministry of Finance issued a letter, which said that par. 1 Article 309.1 of the Tax Code of the Russian Federation may apply if the CFC performs audit voluntary4;
- On July 27, 2015, the Ministry of Finance issued a letter, which said that profit of the CFC cannot be calculated on the basis of financial statement only because provision on mandatory audit is stipulated in the constituent documents of the CFC.
In respect of special aspects of taxation of controlling parties, in particular, whether income of controlling party, which is an organization, in form of monetary funds obtained at liquidation of the CFC is released of taxation, the Ministry of Finance issued the following explanation.
Monetary funds are deemed property. Full tax exemption is applied to monetary funds, including in any of the following cases:
- If monetary funds are expressed in foreign currency;
- If the amount of monetary funds exceeds the cost of shares of the CFC subject to liquidation de facto paid-up and documented by the applicable shareholder5.
Taking into the account the abovementioned, legislators resolved that there was an objective need to make alterations in the law.
In the middle of December of 2015 deputies of the State Duma S.E. Naryshkin, V. A. Vasiliev, I.I. Melnikov, V.V. Zhyrinovsky, M. V. Emelianov and A. M. Makarov introduced in the State Duma amendments to the Law On Controlled Foreign Companies (CFC) (Draft Law No. 953192-6).
The said Draft Law was published on the Federal Portal of Draft Laws and offered highly anticipated amendments to the current rules for taxation of controlled foreign companies and their tax-exempt liquidation.
At this point, the State Duma passed the Draft Law in the first reading.
The main amendments can be provisionally divided in 4 blocks.
Procedures and deadlines for submission of notifications on participation in foreign organizations (bodies of foreign structures without formation of a legal entity) (hereinafter, the “Notification on Participation”)
- Parties, which control the foreign structure without formation of a legal entity or are de facto entitled to income gained by such structure, are released of obligation to submit notification on participation in foreign organizations. It means that only incorporators of foreign structures will be obliged to submit notifications on participation. Beneficiaries or other parties should not have such obligation.
- It is specified that, if a party participates in a foreign organization using the structure without formation of legal entity (or other legal entity, which does not have capital or fund), in respect of which such party is deemed a controlling party, such participation is also taken into the account at determination of equity in the said foreign organization.
- The current revised Tax Code of the Russian Federation did not govern procedures for the submission of notification on participation, when as of the date of occurrence (amendment of equity) of participation individual was not a tax resident of the Russian Federation, but following the results of the calendar year acquired the status of the Russian tax resident. The Draft Law specifies that in such case notification on participation should be submitted until February 1 of the year following the said calendar year. However, for the purposes of submitting notification, equity and the fact of existence of such foreign structure incorporated by such party is determined as of December 31 of the said calendar year.
Thus, gaps in current requirements to procedures and deadlines for submitting notifications on participation are eliminated.
Grounds for Acknowledgement of Parties Controlling a Foreign Company
In particular, they will not include those participating in the CFC through Russian public companies. “Due to the transparency of statements and activity” of public companies, acknowledgement of “high-ranking” parties as controlling foreign subsidiaries after full disclosure of information is unreasonable, reads the explanation note.
Acknowledgement of the managing party of the foreign investment fund (unit fund or other form of collective investments) a tax resident of the Russian Federation, as well as the fact of performance by such managing party of activity related to management of assets of such fund (company) in the territory of the Russian Federation per se do not constitute grounds for recognizing such fund (company) as controlled foreign company, for which the said managing party is the controlling party.
Procedures for the Calculation of taxable profit of the CFC
Profit of the CFC may be calculated on the basis of its financial statement provided one of the following terms is observed:
- Permanent location of the CFC is a foreign state, which has an international treaty on taxation executed with the Russian Federation, except states (territories), which do not exchange information with the Russian Federation for taxation purposes.
- Auditor’s report for the report financial period does not contain negative opinion or rejection of opinion expression. However, it is allowed to use results of both mandatory and voluntary audit of the said statement. Thus, procedure for calculation of retained profit of the CFC is significantly simplified in most cases.
Income of a taxpayer being a controlling party in form of dividends received following the allocation of profit of the CFC is exempted of taxes provided such profit was specified by the taxpayer in tax returns in form 3-NDFL subject to supporting documents. Please, be aware that previously the Ministry of Finance issued explanation stating the following: the Tax Code of the Russian Federation does not have provisions on tax exemption for dividends paid from the profit of the CFC subject to taxation on behalf of the controlling party. This issue will be analyzed in course of improvement of the tax law of the Russian Federation6. Thus, the existing problem of double taxation of income of a taxpayer being a controlling party is eliminated.
Tax-exempt Liquidation of a Foreign Organization (Termination of Foreign Structure)
It is proposed to extend discount on tax-exempt liquidation of a foreign organization (termination of a structure without formation of a legal entity) until January 1, 2018. However, if decision on liquidation of the CFC is made prior January 1, 2017, but liquidation procedure cannot be completed until January 1, 2018 due to limitations set forth in the personal law of the CFC or due to CFC participation in court proceedings, provisions on tax-exempt liquidation will apply until termination of such limitations or court proceedings.
Individual being a controlling party does not have income in form of material benefit, in case of acquisition from the CFC of securities at their documented cost registered by the CFC, if in respect of such CFC decision on liquidation is made and liquidation procedure is completed until January 1, 2018 (in some cases this period may be extended). In case of further sale of such securities, the received income may be decreased by the amount of de facto made expenses defined as the cost of such securities as of the date of transfer of title to the said securities, but not exceeding their market value as of such date.
Thus, additional opportunities for business restructuring are granted.
Also, the said draft law introduces separate amendments, which eliminate inaccuracies revealed during the first months of validity of new taxation rules for the profit of the controlled foreign company, and are intended to neutralize some existing opportunities for the avoidance of Russian taxation rules. In particular:
- Elaboration of procedure for independent acknowledgement of residency and regulations related to such acknowledgement;
- Elaboration of technical controversies between Article 232 of the Code in part of elimination of double taxation and provisions of Article 309 1 of the Code;
- Elaboration of separate provisions related to application of provisions of international treaties for the avoidance of double taxation in respect of parties de facto entitled to income received in form of dividends from the Russian organization (Article 312 of the Code);
- Elaboration of provisions of Articles 23 and 386 of the Code stating that obligation on the submission by the foreign organization of information on its members arises, if it beneficially owns precisely real estate;
- Elaboration of transitional provisions in part of threshold values of profit of the controlled foreign company: profit of the controlled foreign company should be above stated threshold. In the current version the word “above” is absent, which may be understood as the amount of profit of the controlled foreign company should be equal to threshold value.
Please, be aware that by the beginning of introduction of the Draft Law for consideration in the State Duma of the Russian Federation or during readings the text of the draft law may undergo significant changes.
- Letter of the Federal Tax Service No. OA-3-17/87@ dd. January 16, 2015; Letter of the Federal Tax Service No. 3H-3-17/2536@ dd. June 30, 2015.
- Letter of the Ministry of Finance No. 03-01-11/25295 dd. April 30, 2015.
- Letter of the Ministry of Finance No. 03-03-06/25341 dd. April 30, 2015.
- Letter of the Ministry of Finance No. 03-01-10/35077 dd. June 17, 2015.
- Letter of the Ministry of Finance No. 03-03-06/20280 dd. April 9, 2015.
- Letter of the Ministry of Finance No. 03-08-05/22683 dd. April 21, 2015.
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