Russian CFC regulation
In order to fight the use of the offshore jurisdictions to hold Russian assets (the process known as deoffshorisation) with the main aim to increase tax collection, the Russian Parliament passed a new Federal Law On amendments to parts one and two of the Russian Tax Code which introduced a new term and legal entity: controlled foreign corporation or simply CFC. The new law was passed by the end of 2014 and it came into effect on January 1, 2015. The proposed regulation has had a significant impact on Russian business owners who are operating through offshore holding structures.
Companies that are categorised as CFC
CFC regulation applies to non-Russian entities that are controlled by at least one Russian tax resident (private person or legal entity) and are not Russian tax residents. According to the CFC regulation, a Russian tax resident is considered to control a legal entity, if he or she (together with affiliates and certain family members) is entitled to:
- January 1 – December 31, 2015: over 50% of the interest in that company; or
- starting from January 1, 2016: either:
- over 25% of the interest in that company, or
- over 10% of the interest in that company in case more than 50% of the total interest in that company is distributed to Russian tax residents.
This definition of the controlled foreign corporation covers also pass-through entities, such as trusts, funds as well as collective investment vehicles. There is also a rather long list of exemptions set by the CFC regulation:
- foreign non-commercial entities whose shareholders do not receive any profit;
- companies registered in the member states of the Eurasian Economic Union;
- companies registered in countries that have a double tax treaty as well as a tax information exchange agreement signed with Russia (only if this country’s effective annual income tax rate is 75% or more of the Russian corporate profits tax rate);
- companies registered in countries that have a double tax treaty as well as a tax information exchange agreement signed with Russia (only if dividends, interest, royalties and other passive income constitute for less than 20% of the company’s total income);
- pass-through entities whose:
- participants are not entitled to receive assets;
- participant rights cannot be transferred to third parties;
- participants are not entitled to receive income;
- policy does not allow distributing profits to its participants.
- banks and insurance companies registered in countries that have a tax information exchange agreement with Russia;
- Eurobond issuers (if the interest from its parent is 90% or more of its annual income);
- companies that are participating in agreements of production sharing or other agreements with a similar aim with the foreign government;
- companies that operate with offshore deposits of hydrocarbons in Russia.
Legal impact of CFC regulation
The main idea of the CFC regulation is to deny all benefits provided by double tax treaties to companies registered as controlled foreign corporation. Instead, the CFC income is taxed as if it was received by the Russian shareholder (regardless of whether or not the actual distribution took place). The law also foresees a new requirement for Russian tax residents to report their holdings in foreign companies.
In addition, the CFC regulation introduced a place of effective management test, which is used to determine whether or not a foreign company is a Russian tax resident. This test is carried out in addition to the already existing tests meant to establish tax residency through double tax treaty provisions.
According to the CFC regulation, the income of the CFC is:
- treated like the income of the Russian controlling taxpayer (in proportion to its interest share in the company);
- deemed to be received by the Russian controlling taxpayer when distributed by the CFC (also if no distribution has taken place in the financial period);
- calculated based on the financial year of the CFC in compliance with the laws applicable to the CFC.
In order to be applicable to the tax set by the CFC regulation, the income of the entity has to exceed 10 million RUB (starting from January 1, 2017). The applicable tax rate for corporations is 20% and for individual controlling taxpayers – 13%.
Possible solutions to CFC regulation
Surely, numerous companies with Russian resident shareholders became controlling foreign corporations with additional reporting and taxing liabilities. Additionally, changes in the tax residency regulation led to a significant number of foreign holding companies (non-residents of Russia) being liable for income according to Russian tax law.
In case a company is willing to remove its CFC status, it would be useful to consider potential ways to reorganize the holding structure and compare the current tax expenses with expenses deriving from the transitioning to the new structure and other new ongoing costs.
Another option is to move the holding company to a jurisdiction that has an effective corporate tax rate at least 75% of the Russian weighted average corporate profits tax rate and has a tax information exchange agreement signed with Russia.