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Experts comments on specific issues related to the implementation of CFC

Subject/Question: At the moment, taxpayers don’t fully understand what evil our CFC law fights against.

Artem Paleev:
The CFC law is not our invention. It’s a trend. And we now move with the time. However, when reading the law one thing is clear: in a first approximation our bill is a usual CFC law. If you look under a magnifying glass, the question: what were the goals of the legislator while adopting the law arises. Classic CFC rules aim at fighting against tax “deferral”, which the taxpayer benefits from, accumulating funds due to foreign companies. Russia, as seems, aims to make a crusade against offshore zones, not so much as against tax havens, but as against opaque jurisdictions that don’t disclose information. This means that the goal of our CFC law is to gather information, primarily for the sake of information, and then later to decide what to do with it. Therefore, it is quite obvious that the main concerns of our taxpayers are not associated with the obligation to pay the tax. The 13% rate is still one of the lowest in the world. Most of the taxpayers are concerned because of the need to disclose information, as well as the consequences of such disclosure. All of us are sane people and all ask ourselves questions. Therefore, as for the CFC law, all of us ask: what will follow after disclosure of information? Will compliance with the tax laws spill over into violation of the law on money laundering?

Subject/Question: Division of the CFC income into passive and active one is likely to become a stumbling block in disputes with tax authorities, rather than a benefit for taxpayers

Irina Kocherginskaya:
One of the exemptions of the CFC law had to become the condition that only the profit of active CFCs is not imputed to the income of controlling persons and does not increase their tax base. Now the Tax Code defines this condition as follows: the CFC profit is exempt from taxation if the passive income makes up at most 20% in the total income of such company. Furthermore, the law reveals the very concept of passive income. In such income, as many experienced taxpayers could assume, the law included dividends, interests, royalties and income received in the event of liquidation, income from transactions with securities, financial instruments, shares in funds, income from sale of real estate, rental and leasing income, income from provision of consulting services and staffing services. As you can see, the exemption is very doubtful. Firstly, the legislator had a careful approach to the preparation of the list and included in the list of passive income all instruments that are usually used by taxpayers in tax planning. Secondly, the law declared the operating companies, whose main business is renting, granting rights to software or trading, passive without the right to rehabilitation. And thirdly, the legislator insured itself and left the list of passive income twice open. According to the law the list may be completed with similar (sub-point 12) and other income (sub-point 13). We’ll see in the near future how widely the tax authorities will interpret these terms.

Subject/Question: Does the introduction of the new norm on possible confiscation of corporate property (used in the case of tax evasion by means of a controlled foreign company) mean perception by the Russian criminal law of the idea of possibility to bring legal entities to criminal liability?

Alex Oskin:
Indeed, some professionals call the confiscation of corporate property “quasi-criminal” liability of legal entities. However, it should be noted that similar rules providing for the possibility to confiscate corporate property existed before the adoption of the CIC bill (see, for ex., p. 3 art. 104.1 CC RF, effective since 2006). At the same time, the new norms still don’t describe and don’t answer the question about the possibility to bring legal entities to criminal liability, but only expand the list of grounds on which such measures of criminal law influence as confiscation can be applied.

Therefore, in my opinion it is wrong to say that the adoption of this bill will anticipate a new era associated with change in the Russian criminal law approach to the issue of corporate criminal liability. However, the mere possibility of application to the organization of criminal law measures may be regarded as the first herald of future change of the Russian legislator approach to this issue.

Subject/Question: From 22 October 2014 investigators are granted the right to initiate criminal proceedings on tax evasion and failure of a tax agent to perform the obligations prior to receipt of the corresponding opinion of the tax authority

Olga Kuramshina:
The norm in force since 2012, which limited the investigator in making decisions on initiation of criminal proceedings, was then a novelty for the Russian law and by itself was weakly consistent with the general spirit of the criminal procedure legislation. It was rather an ace in the sleeve of entrepreneurs gifted them by the President Dmitry Medvedev, who limited the possibility of law enforcement authorities to initiate criminal proceedings for three types of crimes: evasion from taxes levied on individuals and legal entities, failure to perform the obligations of tax agent and concealment of funds or property due to which taxes and (or) duties should be collected under the Articles 198, 199, 199.1 and 199.2 of the Criminal Code of the Russian Federation. Initiation of criminal proceedings on the basis of elements of these offences was possible only and exclusively if the of offence was previously found by tax authority under point 1.1 of art. 140 of the Criminal Procedure Code of the Russian Federation, as amended by the Federal law No. 407-FZ of 06 December 2011.

Now this benefit is cancelled, and the composition of the reasons for initiation of criminal proceedings returned to its former state. What does this mean? I dare to assume that this change firstly is another and obvious example of “crackdown” and return to law enforcement bodies of almost comprehensive rights at the pre-trial stage, and secondly, as strange as it may sound, - an indicator of observance of the principle of separation of powers. The first circumstance needs no comment: an additional barrier to making by the investigator of the decision on initiation of criminal proceedings is removed again, the excess element of control is eliminated, and the investigator in the evaluation of elements of an offence is not bound by the opinion of the tax authority any more. As for the second one, (this position is close firstly to theorists of law) involvement of the executive authority - tax inspectorate - in administration of justice, even at the stage of initiation of criminal proceedings, means mixing of these two branches, which led to another strengthening of positions of the executive power in Russia.

In spite of everything, the fact remains and the investigator may initiate criminal proceedings related to tax offences. The position of the tax authority on the issue of availability of grounds for opening of a criminal case will be considered as evidence on a par with the opinions of other professionals and the results of the examinations.

Subject/Question: Contrary to the expectations of taxpayers, the legislator gave up the black and white lists, as well as the development of other elements by which jurisdictions could be sorted. The legislator spread the net wider and everything turned out to be simpler: the law covered all jurisdictions.

Irina Otrokhova:
With the November amendments to the Tax Code of the RF the legislator introduced the concept of controlled foreign company and controlled entities, the procedure for taxation of controlled foreign companies. In the event where a foreign company is recognized controlled company, the retained profit of such company will be taxed in accordance with the Russian legislation (20 % or 13%).

Of course, such changes cannot not to affect the residents who prefer to do business abroad. All will be interested in changing the structure of foreign business. But thinking about changes the taxpayer shall be aware that it should not think of replacing a jurisdiction with another one. Replacing Cyprus with Switzerland or Holland does not itself solve the problem. In the current situation, the taxpayer should focus on the profit of foreign company, even if it is recognized controlled one, to be exempt from taxation. In addition, it is worth considering other activities that can help the taxpayer, for example:

  • distribution of dividends (at the rate of 13% from 1 January 2015);
  • liquidation of company until 1 January 2017;
  • controlling persons can become residents of another country;
  • recognition of company a tax resident of the Russian Federation;
  • change in the share of participation.

In any case, one thing is clear: measures for reorganization of foreign entities are required and the action plan shall be individual for each particular company.

Subject/Question: The problem of relations between concepts of “actual recipient of income”, “economic substance” and “real substance” will have its effect. In the light of introduction of these concepts in the Russian legislation, economic entities should be established more carefully and responsibilities should be allocated within the holding.

Yana Karausheva:
Under the Russian legislation the actual recipient of income is a person that actually benefits from income paid and determines its further economic destiny. This can be both individual and legal entity. In the OECD documents, this term is used with a similar meaning. The term “economic substance” is used by the OECD to designate the set of facts and circumstances that shall to be analyzed in order to identify the real meaning of a business transaction. In the Russian legislation this concept is not used yet. The concept of “real substance” in the world practice means a complex of different factors that together prove the genuineness of company’s transactions that have real economic value, as well as the fact that the activity of the company does not have the main purpose of obtaining tax benefits. The change of the concept of tax residency introduces some elements of “real substance” in the Russian legislation. Due to amendment of the Tax Code each entity of the holding will have to prove its economic viability and the actual right to receive income, as otherwise it will not be able to take advantage of international double taxation agreements. To prove the actual right to receive income each company of holding should be empowered to dispose of the assets and make other business decisions. The risks associated with making such decisions, also distinguish the actual recipient from the nominal recipient of income. In other words, the company have to prove its real economic activity.

Subject/Question: There is an opinion that the law provided for only exemption from tax liability (fine) in the transition period and nobody is going to provide exemption from criminal liability.

Leonid Kunin:
Why not? The acts related to default or partial payment of the tax due to failure to include in the tax base in the years 2015 - 2017 the profit of controlled foreign companies, are not reason for making the taxpayer criminally liable if the damage caused to the budget system of the Russian Federation as a result of the offence is compensated in full (p. 4. art. 3 of the Federal Law of 24.11.2014 N 376 -FZ. In addition, a person who committed a crime for the first time in the form of tax evasion, including by failure to include in the tax base the profit of controlled foreign company is exempt from criminal liable if that person or organization paid in full the arrears and related penalties, as well as the fine in the amount determined in accordance with the Tax Code of the Russian Federation (p. 2. Notes to art. 199 CC RF). This exemption applies in any case, rather then during the transition period only.

Subject/Question: Does it make sense to make a controlled foreign company tax resident of the Russian Federation under the new rules for determination of residency of legal entities?

Tanya Frolova:
This solution may be attractive to controlling persons that don’t want to file a notice of their participation in a foreign company, as well as provide additional statements. The benefits of residency of a foreign company is that the activity of the company is governed by foreign law, the possibility to consider disputes in international arbitration is maintained, in making M&A transactions flexible institutions of the English law can be used, while from a taxation perspective these are investments in a company that is a tax resident of the Russian Federation, which makes it possible to apply a 0% rate of taxation of dividends payable by the Russian company. It should be remembered that the 0% rate may be applied upon distribution of dividends, if the foreign organization that pays dividends has a permanent location in the country, which is not included in the list of countries and territories as approved by the Ministry of Finance of the Russian Federation that provide preferential tax treatment and (or) don’t provide for the disclosure and provision of information in making financial transactions (offshore zones).

Subject/Question: Prospects in the international exchange of information - real prospects or exchange of promises

Anna Senchenko:
In early 2014, the OECD published the Single Global Standard for the automatic exchange of information on taxpayers' income, which consists of the Model Agreement and the Common Reporting Standard. The Single Global Standard was developed for the Big Twenty and is based on the agreement with the USA (FATCA). In this connection, the countries will annually and automatically receive information about foreign income of their residents (legal entities and individuals). In this case, sanctions will not impede automatic exchange under existing bilateral agreements. The Russian Federation also plans to join the Model Convention and become a member of the OECD, as well as to approve the Single Global Standard for the exchange of tax information. However, given the current political situation related to Ukraine and imposed sanctions the negotiations on this matter are somewhat delayed. Nevertheless, despite the fact that Russia does not yet have any available bilateral agreements on the exchange of tax information with some jurisdictions, their conclusion is planned in the future. In this case, the automatic procedure of exchange is possible both on the basis of the already existing double tax agreements, as well as future bilateral agreements.