The representative office conducts business: is it possible and safe enough?
It is believed that the representative office of the foreign company can only have a ‘representative’ function but it can not do business on behalf of the parent organization. Meanwhile the foreign company can establish a separate business unit for either commercial or supporting/preparatory activities. Tax consequences depend on the conducting business method.
The Federal Law dated 09.07.1999 № 160-FZ ‘On foreign investments in the Russian Federation’ provides that the foreign legal entity that has a commercial purpose of creation or activity can function in Russia via its representative/branch office as from their accreditation date.
In other words, to conduct business in Russia a foreign company can open a separate business unit in the form of a representative/branch office. At the stage of accreditation foreign companies often have to choose the form of such separate business unit.
Neither representative nor branch office is a legal entity. The scope of authority determines the difference between them. The representative office represents the interests of the legal entity and the branch office exercises functions of the legal entity (Article 55 of the Civil Code of the Russian Federation).
Choosing the representative office foreign companies wonder how to settle a business transaction via the separate business unit in the future. May it become a problem? What sanctions may the representative office face in case of receiving profit?
The main activity of the representative office is to represent and protect interests of the foreign legal entity (item 1, Article 55 of the Civil Code of the Russian Federation). There is no clear definition of ‘representation of interests’ in the legislation. Within the meaning of the civil legislation it is the empowerment given by one person to another for the representation in front of the third party (Article 185 of the Civil Code of the Russian Federation).
The ‘representative office’ term in the civil law is the transaction settled by one person (a representative) on behalf of another (a representee) by the authority based on the power of attorney (Article 182 of the Civil Code of the Russian Federation). Therefore, the representation of interests also includes making transactions. In other words, the representative office can make any transactions in the interests of the foreign company.
Thus, the legislation has no prohibiting from doing business by the foreign representative office on behalf of the parent organization. The representation of interests may include various actions and, in our opinion, the representative office may be vested different authorities which can be limited by virtue of the direct reference of the law only.
The representative office may lose its accreditation only on the grounds stated in the law (item 7, Article 21 of the Federal Law dated 09.07.1999 № 160-FZ). For instance, if the representative office does not submit the tax reporting or carries out no operations on at least one bank account; also if the activity of the representative/branch office of the foreign company is contrary to the Constitution of the Russian Federation, international agreements of the Russian Federation, the legislation of the Russian Federation, creates a threat to the sovereignty, political independence, territorial integrity and national interests of the Russian Federation.
Thus, the Russian legislation does not allow sanctions for doing business by the representative office in favour of the representee.
In terms of currency legislation, the procedure of currency control and transaction certificate filing during the execution of the contracts with counterparties will be the same for representative and branch offices.
In case the representative office received profit from its business in the territory of the Russian Federation, it is important to know what taxes have to be paid.
The term of ‘representative office of foreign organization’ in civil and tax law should be differentiated. For tax law purposes conducting business involves receiving profit in the territory of the Russian Federation and it does not matter what form a separate business unit has (either a branch or representative office).
In case the representative office of the foreign company receives profit from business activities in the territory of the Russian Federation, it is considered to be a full-value taxpayer which means it has to calculate and pay the following taxes:
Corporate profit tax (20%)
Value added tax (10% or 18%)
The value added tax will appear in case the representative office is going to realize goods, work, services in the territory of the Russian Federation or move the goods to the customs territory of the Russian Federation.
The profit tax burden will appear in case the foreign company is going to do business which leads to the ‘permanent establishment’ in the territory of the Russian Federation.
According to Article 306 of the Tax Code of the Russian Federation the foreign company business in the territory of the Russian Federation leads to the permanent establishment in case it simultaneously meets the following criteria:
- The presence of any foreign company establishment (separate business unit, representative/branch office, bureau, agency, worksite);
- Doing business by such foreign company in this establishment;
- Doing such business by the foreign company regularly.
Thus, the representative office of the foreign company may conduct transactions in the territory of the Russian Federation without any sanctions. However, it is important to remember that if such business leads to the permanent establishment, it has to calculate and pay all necessary taxes in Russia as well as submit the corresponding tax reporting.
In our opinion, in case the foreign company initially plans to do business regularly and receive profit in Russia, we advise to organize it via a branch office as it best meets the purpose of foreign company administration in the territory of the Russian Federation.