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Capital Amnesty: The Third Stage of Declaration

Forecast for the transfer of foreign companies to special administrative regions – the territory of Russky Island (Primorye Territory) or Oktyabrsky Island (Kaliningrad Region).

At the time of this writing, the draft law has not yet been published. However, public statements by officials already make it possible to predict the use of capital amnesty in terms of foreign company redomiciliation (Federal Law N 290-FZ dated August 3, 2018 (as amended on December 25, 2018) "On International Companies"). In fact, the tricky word “redomiciliation” is understood as the relocation of a company to the Russian Federation, or, in simpler terms, a change of legal address together with deregistration (or liquidation) at the place of the company's previous registration.

Foreign company redomiciliation is not something new. As part of the second stage of declaring (to comply with the tax-free liquidation procedure), options were used to transfer companies from one jurisdiction to another if, for one reason or another, the company could not be liquidated within the required time frame in its original jurisdiction.
Redomiciliation is also applied (and will be applied) in connection with toughening requirements for the BVI.

Main conditions for registering a foreign company in these special administrative regions are as follows:

(It should be noted that Clause 3, Article 2 of Federal Law N 290-FZ dated August 3, 2018 "On International Companies" does not indicate whether it is necessary to meet all these conditions simultaneously or at least one of them. However, within the meaning of these conditions, we can conclude that they shall be met simultaneously.)

  • Condition 1. A foreign company conducts its economic activities in the territory of several states including in the territory of the Russian Federation at the time of the decision to change its personal law, but in any case no later than January 1, 2018, independently, or through its directly or indirectly controlled persons, or through branches or representative offices (other separate divisions).
    • It can be assumed that this condition means exactly the companies registered before January 1, 2018.
    • It is not clear how the condition of conducting activities in the territory of several states can be interpreted, e.g. in relation to a company registered in the territory of the Republic of Cyprus having an account with a Cypriot bank and having no subsidiaries, branches or representative offices in other countries. Given that Article 2 contains a reference to a group of persons defined in accordance with competition law, it can be assumed that if the founder/beneficiary of this Cypriot company is a Russian individual with a company and/or close relatives in the Russian Federation having their business here, then such a Cypriot company meets this criterion. It is also not clear how the condition on activities in the territory of several states will need to be confirmed upon registration. Apparently, documents about registered branches/representative offices in the Russian Federation, the presence of other legal entities in the Russian Federation controlled by the founders/beneficiaries of a foreign company and/or their relatives will be needed.
    • There is an additional (more stringent) condition for international holding company registration with the tax authority of the Russian Federation: persons controlling an international company on the date of this international company registration for the purpose of redomiciliation became controlling persons of such a foreign organization in the period before January 1, 2017 (Subclause 3, Clause 1, Article 24.2 of the Tax Code of the Russian Federation).
  • Condition 2. The company has applied to conclude an agreement on operation as a participant in a special administrative region.
    • This means that the company shall be entered in the register of participants in a special administrative region (in accordance with Federal Law N 291-FZ dated August 3, 2018 "On Special Administrative Regions in the Kaliningrad Region and Primorye Territory").
    • The application procedure for entry into such a register is not defined in detail at the time of this writing. The law contains a list of information for the application. However, a number of features can be distinguished that can affect this process:
      • The application shall be signed by a person(s) entitled to act on behalf of the applicant without POA (Clause 2, Article 5 of Federal Law N 291-FZ dated August 3, 2018).
        • In most cases, the director in controlled foreign companies is a nominee. However, it can be expected that the nominee director with a high probability will refuse to sign this application due to a lack of understanding of its essence. This, in turn, will necessitate the appointment of another director.
        • When a tax resident who is a citizen of the Russian Federation is appointed as a director formally (or in fact), a place of foreign company management will be created in the territory of the Russian Federation. At the time of this writing, Article 246.2 of the Tax Code of the Russian Federation does not provide for exemption from recognizing a foreign company as a tax resident of the Russian Federation upon registration of this company in special administrative regions. Thus, this is an standalone serious risk that needs to be assessed: is a foreign company ready to fully calculate the tax base for taxes in accordance with the Tax Code of the Russian Federation (not only for income tax, but also for other taxes) or not.
    • In addition to the application, the company must conclude an agreement on operation in the territory of a special administrative region. The agreement is concluded with the management company and may be terminated by the management company unilaterally if the company fails to comply with its obligations.
      • It is not clear whether the termination of the agreement will affect amnesty guarantees (e.g. if the company was entered in the register, but it was excluded from the register on formal grounds by the time of filing a special declaration on amnesty).
    • The standard form of the agreement was approved by Order of the Ministry of Economic Development of Russia N 510 dated September 20, 2018 "On Approval of a Standard Agreement on Operation in the Territory of a Special Administrative Region".
      • It is important that Clause 3.3.1 of the specified model agreement provides for the obligation of the company to provide an annual report on its activities. It can be assumed that the report will be drawn up in free form and depending on the specifics of the activity. Since the management company has the right to terminate the agreement unilaterally if the company fails to comply with its obligations, it can be predicted that this report will be considered by the management company rather carefully.
      • A similar obligation to report is provided for in Subclause 1, Clause 2, Article 11 of Federal Law N 291-FZ dated August 3, 2018. The report should also contain information on investment made in the territory of the Russian Federation if this information was not reflected in previously sent reports.
    • The state registration of an international company for the purpose of redomiciliation is the basis for its entry into the register of participants in a special administrative region. The management company shall enter it into the register no later than one day from the date of state registration of the international company. (Clauses 1 and 2, Article 7 of Federal Law N 291-FZ dated August 3, 2018)
      • Most likely, all the necessary documents (including an agreement with the management company) shall be submitted for state registration for the purpose of redomiciliation, since it is unlikely that these documents will be considered in one day.
      • The management company considers the documents within a period of no more than two working days and makes a decision (Clause 6, Article 5 of Federal Law N 290-FZ dated August 3, 2018):
        • On sending documents to the registration authority (tax office) or to the Central Bank of the Russian Federation (in case of public joint-stock companies);
        • On refusing to send the documents. In addition to the management company, the registration authority also has the right to refuse registration with a corresponding notice sent to the management company. However, the grounds for refusal in this case are not clearly spelled out in the law (Clause 13, Article 5 of Federal Law N 290-FZ dated August 3, 2018).
      • The documents for state registration include, in particular: a copy of the annual financial statements and/or the annual consolidated financial statements of a foreign legal entity for the last completed reporting year, the date of formation of which has come in accordance with the personal law of the foreign legal entity, with an attached copy of the auditor's report drawn up in relation to such statements (if any) (Subclause 6, Clause 3, Article 5 of Federal Law N 290-FZ dated August 3, 2018).
        • It should be borne in mind that in relation to e.g. companies in Cyprus, in the UK (LLP or LTD), Hong Kong and Singapore, there is often a delay in the preparation of financial statements for various reasons (both on the part of the client and due to the slow work of local accountants/auditors).
        • There is an additional requirement specified in Subclause 2, Clause 1, Article 24.2 of the Tax Code of the Russian Federation to provide financial statements and an auditor's report, which does not contain a negative opinion or refusal to express an opinion, to the tax authority no later than 15 days from the date of international holding company registration. In this case, the clarification "if any" is absent, which means that there are different requirements in relation to this document imposed by the management company and the tax authority. Accordingly, the audit report must still be available for successful registration if the company intends to be registered as an international holding company.
    • Currently it is not clear what will happen to a foreign company if the management company terminates the agreement. In practice, foreign company redomiciliation is connected in one way or another with the exclusion of this company from the register of legal entities at the place of its previous registration. Accordingly, if the agreement is terminated, the foreign company will have to return to its former jurisdiction. The procedure for this return will probably not be clearly defined in the original jurisdiction that may create a problem: the foreign company will be completely outside any jurisdiction for a certain time. It will not be possible to remain in two jurisdictions at the same time, since Clause 14, Article 5 of Federal Law N 290-FZ dated August 3, 2018 provides for the obligation: a foreign company is subject to exclusion from the register of legal entities in the state of its original personal law within six months from the date when information on international company registration for the purpose of redomiciliation is entered in the Unified State Register of Legal Entities, unless a longer period is established by legislation of the state of the initial personal law of the foreign company.
      • Probably, exclusion from the original register of legal entities means liquidation (without the possibility of restoring the company in its previous jurisdiction). Many jurisdictions have a strike off procedure, which makes it possible to restore a company within a certain period. On the one hand, the strike off procedure could solve the problem of restoring a company when losing the status of an international company. For example, in Cyprus there is a special company redomiciliation procedure, which does not imply the liquidation of a Cypriot company. But in this case, when applying the strike off procedure, or if the redomiciliation procedure is carried out without liquidation (e.g. in Cyprus), in our opinion, there is a risk of terminating the agreement with the management company. Although to date, formally, this is not a condition for terminating the agreement and is not included in the list of conditions for international company registration (this is logical, since at the time of filing documents for international company registration it is still impossible to start the procedure for excluding a company from the previous register).
    • In accordance with Clause 3, Article 13 of Federal Law N 291-FZ dated August 3, 2018, the financial support of management company activities is carried out at the expense of the management company's own funds, as well as from other sources in accordance with the legislation of the Russian Federation.
      • It is not clear whether this means that the agreement with the management company will provide for financing management company activities at the expense of the foreign companies.
      • A section on funding sources is not currently outlined in the structure of the report on management company activities (Order of the Ministry of Economic Development of Russia N 590 dated October 29, 2018 "On Approval of the Requirements for the Structure of the Management Company Report and the Period of its Posting on the Internet").
      • Clause 3, Article 18 of Federal Law N 291-FZ dated August 3, 2018 mentions legal and accounting services. It is possible that the management company will provide these services. However, in this case, a conflict of interest may arise, since the management company will simultaneously be interested in payments from the foreign company and at the same time it shall monitor the fulfillment of the terms of the agreement with the participant of the special administrative region. It is also not clear to what extent the qualifications of management company employees will be sufficient. For example, a foreign company may open an account in a foreign bank, which implies an accountant's understanding of the practice of reflecting information in bank statements of an account in a foreign bank (the issue is not only the knowledge of English).
  • Condition 3.  A foreign company has undertaken obligations to make investment in the Russian Federation including on the basis of a statement of intention to invest in the Russian Federation, a special investment agreement, a concession agreement, a public-private (municipal-private) partnership agreement or another agreement.
    • Probably the simplest document in this case will be a statement of intent, since it will be unilateral on behalf of the foreign company. A statement of intent to invest in the territory of the Russian Federation is a unilateral transaction made in a simple written form (Clause 8, Article 2 of Federal Law N 290-FZ dated August 3, 2018).
    • The minimum investment is RUB 50 mln. Investment means:
      • Capital investment
        • The cost of capital investment is determined based on accounting data, regardless of payment.
          • An international company has the right to choose IFRS or another internationally recognized accounting standard. However, for submission to the authorized government bodies in cases stipulated by the legislation of the Russian Federation, the international company prepares accounting (financial) statements in accordance with the legislation of the Russian Federation. These cases are not given in Federal Law N 290-FZ dated August 3, 2018.
      • Investment in the capital of Russian companies (authorized capital, contributions to property)
        • The cost of investment is determined based on the amounts actually paid.
    • In accordance with Clause 6, Article 2 of Federal Law N 290-FZ dated August 3, 2018, the period for making investment is 6 months from the date of the international company state registration. Clause 8.1, Article 2 of Federal Law N 290-FZ dated August 3, 2018 supplements this as follows: "The commencement date of obligations under a statement of intent to invest in the territory of the Russian Federation is the date of international company state registration for the purpose of redomiciliation."
      The relevant supporting documents on investment made must be submitted to the management company within ten working days from the date of the end of this period.
      • Thus, in our opinion, a foreign company is not entitled to submit supporting documents on investment made before the redomiciliation (registration of an international company). This will seriously limit the redomiciliation process since many taxpayers who would be interested in redomiciliation as a capital amnesty condition have already made investment indirectly through controlled foreign companies. 
    • The relevant supporting documents on investment made shall be submitted to the management company within ten working days after six months from the date of the international company state registration in special administrative regions.
  • Condition 4. A foreign company is registered in a state that is a member or observer of the FATF and/or a member of MONEYVAL.
    • Thus, traditional offshore companies, by definition, cannot be registered as international companies. It means they cannot be amnestied on this basis. Or, the offshore company shall first be redomiciled to a country included in the list (e.g. Cyprus is on the MONEYVAL list), and then redomiciled in special administrative regions of the Russian Federation.

Certain Important Features in the Regulation of International Companies

1. Indirect Disclosure of Information on the Internet

It should be borne in mind that the management company shall publish a report on its activities on the Internet by May 1 of the year following the reporting year (Order of the Ministry of Economic Development of Russia N 590 dated October 29, 2018 "On Approval of the Requirements for the Structure of the Management Company Report and the Period of its Posting on the Internet"). This report assumes the disclosure of information about foreign companies that could potentially be confidential, namely:

  • Full name of the SAR participant in Russian, abbreviated name of the SAR participant in Russian (if any), address within the SAR participant location, telephone number, fax number, email address of the SAR participant, date of the SAR participant entry into the register.
  • Information on the checks carried out by the management company for the compliance of international companies with international company requirements indicating the full name of the SAR participant in Russian, abbreviated name of the SAR participant in Russian (if any) subjected to check and the results of these checks.
    • Information on assets and/or investment of a foreign company may be disclosed indirectly or directly from the results of inspections.

2. Checks by the Management Company

The management company carries out annual scheduled and unscheduled audits of an international company that has received the status of a special administrative region participant for compliance with investment requirements. The first audit is carried out no earlier than one year from the date of the international company state registration.

3. Annual Registration Fee

An international company pays an annual registration fee. The size is determined by the Tax Code of the Russian Federation. At the time of this writing, it is undefined.

4. Notice of Participation in Foreign Companies

Within one month from the date of its registration, an international company submits a notice of participation in foreign organizations in relation to shares of participation in foreign organizations (foreign structures without forming a legal entity) as of the date of state registration of such an international company (Clause 3, Article 25.14 of the Tax Code of the Russian Federation ).

  • It can be assumed that the tax authorities will establish control over the payment of income tax on CFC profits in the future. Unless the company becomes an international holding company that is exempted from CFC profit taxation (Subclause 9, Clause 1, Article 25.13-1 of the Tax Code of the Russian Federation).

Main Tax Consequences of Redomiciliation

(excluding the impact of the third stage of the capital amnesty since the draft law has not yet been published at the time of this writing)

  1. The risk of recognizing a foreign company as a tax resident of the Russian Federation at the place of its effective management remains (Article 246.2 of the Tax Code of the Russian Federation).
    • Clause 3, Article 285 of the Tax Code of the Russian Federation separately specifies that the first tax (reporting) period for international companies and foreign organizations recognized as tax residents of the Russian Federation is the period beginning, respectively, from the date of registering a foreign organization as an international company or from the date of recognizing a foreign organization as a tax resident of the Russian Federation in the manner established by Article 246.2 of the Tax Code of the Russian Federation.
    • This means that the legislator unambiguously provides for a situation when an international holding company is simultaneously a tax resident of the Russian Federation.
  2. A reduced limit has been introduced for recognition as a controlling person of an international company registered for the purpose of redomiciliation: the share of participation for individuals (together with spouses and minor children) is more than 15 percent (Clause 3.1, Article 25.13 of the Tax Code of the Russian Federation).
    • Thus, it should be kept in mind that the controlling person undertakes future obligations to submit notifications about CFCs, prepare financial statements, pay personal income tax if applicable, etc.
  3. CFC profits are exempted from taxation (personal income tax for an individual who is a controlling person) if the company is registered as an international holding company for the purpose of redomiciliation as of December 31 of the year following the reporting year (Subclause 9, Clause 1, Article 25.13-1 of the Tax Code of the Russian Federation). A similar exemption is provided for income tax on the profits of the international holding company itself on the profits of CFCs controlled by this international holding company (Subclause 58, Clause 1, Article 251 of the Tax Code of the Russian Federation).

  4. Tax authorities may conduct onsite tax audits of international companies. There are the following features (Clause 5.2, Article 89 of the Tax Code of the Russian Federation):
    • Periods before redomiciliation (before registration as an international company) cannot be checked.
    • However, if the company had separate subdivisions (branches, representative offices) in the Russian Federation before redomiciliation, then such subdivisions can be checked before the date of redomiciliation.
      • This clarification is highly relevant. Many Russian entrepreneurs have registered real estate assets for branches or representative offices of foreign companies. This was seen as additional property protection.
  5. An important clarification is provided for the value of shares of an international company for the purpose of tax deduction for personal income tax (a similar rule is also provided for in terms of income tax expenses):
    • Shares of an international company upon redomiciliation instead of previously issued shares of a foreign company (before redomiciliation) owned by an individual who is a tax resident of the Russian Federation are not recognized as disposal or sale of securities, which does not lead to tax consequences on formal grounds (as if it were exchange of shares).
    • The value of these shares recognized upon redomiciliation will be determined based on the value of the primary shares before the redomiciliation:
      • For example, if a taxpayer previously acquired shares of a Cypriot company for a certain amount and has confirmation of the acquisition costs paid, then when selling shares of an international company after the redomiciliation of the same Cypriot company, the taxpayer will be able to take into account the costs of acquiring the original shares.
  6. A preferential rate of personal income tax introduced on dividends (5%) received from an international holding company, under the following conditions (Clause 6, Article 214.6 of the Tax Code of the Russian Federation, Paragraph 8, Clause 3, Article 224 of the Tax Code of the Russian Federation):
    • On the day of the decision to pay dividends, the international company is simultaneously an international holding company and a public company, and
    • The international company was a public company as of January 1, 2018, and
    • Dividends were received before January 01, 2029.

The conditions are such that they are unlikely to be met by a large number of taxpayers. Similar conditions are provided for receiving a preferential rate on dividends by foreign persons (since there is no clear indication of individuals or legal entities, we consider this to be relevant for all persons), if these persons really have a de facto right to income (Clause 1.2, Article 284 of the Tax Code of the Russian Federation).

  1. A preferential rate of income tax (0%) introduced on dividends received by an international holding company, under the following conditions (Clause 1.1, Article 284 of the Tax Code of the Russian Federation):
    • On the day of the decision to pay dividends, the international holding company continuously owns at least 15 percent contribution (shares) in the authorized capital of the organization paying dividends for at least 365 calendar days.
    • On the date of income payment, the company that receives dividends is recognized as an international holding company.
    • Prior to the dividend payment date, an international company shall provide the tax authority with an assurance that the conditions for recognition as an international holding company are met as of the date of income payment.
      • The specified wording is contradictory: it is not clear how the company will provide assurance about fulfilling the conditions in the future.
      • Moreover, the tax authority, which registered the international holding company upon redomiciliation, already has information on the fulfillment of these conditions (otherwise the registration simply would not have passed).
      • Perhaps the legislator had in mind a confirmation that no events would occur as of the date of dividend payment, as a result of which the international holding company would lose its holding status. These are the following events (Clause 2, Article 24.2 of the Tax Code of the Russian Federation):
        • If an international holding company decides to reorganize in the form of a takeover or merger, except for the case of a takeover or merger with another international company that meets the conditions for its recognition as an international holding company on the date of the decision on reorganization.
        • If, within 365 calendar days after the registration of an international company, a new controlling person appears among other controlling persons of such an international company, which is not recognized as the controlling person of the international company at the date of its registration.
        • In case of termination of the international company status in accordance with the Federal Law "On International Companies".
  2. Taxation at the rate of 0% of income from the disposal (redemption) of shares (stakes in the authorized capital) of Russian or foreign organizations received by an international holding company, while complying with all the following conditions (Clause 1, Article 284.7 of the Tax Code of the Russian Federation):
    • Shares of a Russian or foreign organization are continuously owned by an international holding company on the basis of ownership or other property rights for at least 365 calendar days and constitute at least 15 percent contribution (share) in the authorized capital of such an organization.
    • Shares constitute the authorized capital of organizations with maximum 50% of assets directly or indirectly formed by real estate located in the territory of the Russian Federation as of the last reporting date preceding the date of disposal.
      • This condition is actually aimed at preventing hidden sale of real estate.
    • Shares of a Russian or foreign organization were not:
      • Contributed to the charter capital of an international holding company within 365 calendar days before or after the date of registration of such a company as an international company.
      • Acquired by such a company as a result of reorganization within 365 calendar days before or after the date of registration of such a company as an international company.
    • An additional condition in relation to shares of foreign companies: such foreign companies shall not be registered in countries included in the list of offshore countries and territories (Order of the Ministry of Finance of Russia N 108n dated November 13, 2007 “On Approval of the List of States and Territories Providing Preferential Tax Treatment and/or not Providing for the Disclosure and Provision of Information during Financial Transactions (Offshore Zones)").
  3. There is a separate article in the Tax Code of the Russian Federation – Article 275.3 – on the procedure for determining the value of assets of an international company at the time of redomiciliation (by the way, a similar procedure is provided for foreign companies recognized as tax residents of the Russian Federation in accordance with Article 246.2 of the Tax Code of the Russian Federation). Basic principles of value formation are:
    • According to the accounting data of a foreign company
      • That is, it is necessary to have financial statements not only for the past period, but also on the date of international company registration (on the date preceding the date of registration).
    • Value shall be documented
      • It is likely that the tax authorities can request the specified documentary evidence of the value during an onsite tax audit, although these documents will be dated before the date of redomiciliation, and the tax authority is not entitled to carry out the audit before this date (see above).
    • But not higher than market value
      • Thus, for significant assets (e.g. real estate) it is recommended that an independent appraiser is hired to carry out an appraisal
    • In rubles at the exchange rate on the date of redomiciliation (on the date of registration of an international company)
    • Securities and shares in the authorized capital are valued at the cost of documented costs of their acquisition at the ruble exchange rate at the date of their acquisition
      • This may cause a problem because securities may already contain a revaluation in the financial statements. Accordingly, it will be necessary not only to find out the cost of acquiring securities, but also to prepare supporting documents, which again contradicts the prohibition of the tax authority to check the periods preceding the date of redomiciliation.
      • For shares in organizations with more than 50% of assets in the form of real estate in the territory of the Russian Federation, there is one more restriction: not higher than the market value of such shares
        • In this case, it is not disclosed on what date the market assessment is required: on the date of acquisition of such shares or on the date of redomiciliation.
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