Changes in Russian tax legislation affecting foreign companies in 2017
In the near future, perhaps the most significant new development for “multinational” businesses operating in multiple countries including Russia is the introduction of several legal norms intended to combat illegal trans-border tax optimisation schemes.
International data exchange: possible consequences in terms of statutory responsibility for tax offences
In October 2015, the joint project of ОECD member states and the G20 aiming to counter base erosion (i.e. the reduction of taxable income) and profit shifting to low-tax countries, also known as the BEPS plan, issued concrete recommendations in the struggle against international tax optimisation. Among other things, these measures will seek to enhance taxation transparency in multinational corporations and cut tax authorities’ information deficit in the various countries where these companies operate.
The introduction, in the State Duma, of a bill entitled “On amendments to the first section of the Russian Federation’s Tax Code in light of the introduction of international automatic financial data and document exchange for international groups of companies” means that Russia has, on the state level, embarked upon the practical implementation of the aforementioned recommendations.
In addition to well-known new developments on transfer pricing rules (reports by country, disclosure of local and global data etc.) the legislative changes also contain other, less widely reported innovations which will, however, have equally far-reaching ramifications for businesses in Russia.
Firstly, they create a legal framework enabling the tax authorities of various countries to automatically exchange data on taxpayers without the need for individual requests in every particular case. The taxman gains the right to collaborate with foreign colleagues on tax control measures (for instance, tax audits) on its sovereign territory.
Further, Russian legal entities classed as operating on the “financial market” such as banks, insurance companies and equity brokers will soon be required to collect data on their foreign clients and their financial transactions and automatically inform the Russian tax authorities. An analogous duty to inform their national tax authorities on the accounts and assets of Russian tax residents (including individuals, i.e. natural persons) will likely be imposed on foreign financial institutions in partner countries. These data will then be automatically submitted to the authorities of the сountry where the account holders/asset owners are resident for tax purposes. Thus, 2017 is expected to bring the creation of a national legal framework facilitating the implementation of automatic tax and financial information exchange under internationally developed CRS standards.
Technical guidelines for tax authorities worldwide
Other than the creation of the aforementioned legal framework, the Russian Federation has already taken steps to undertake the actual implementation of relevant measures. Last September, the parties signed an international agreement on tax information exchange (Multilateral Competent Authority Agreement – MCAA), which is to serve as a “technical” guideline for trans-border information exchange between fiscal authorities. Russia will join the data exchange mechanism in 2018. Please note that the first tax year on which data will be available automatically is 2017.
What could this actually mean for foreign companies operating in Russia?
It means that several business models currently employed by foreign companies in Russia could lose their attractiveness entirely.
For instance, let us consider two strategies intended to avoid the registration of foreign entities operating in Russia with the local tax authorities.
One such strategy provides that within a group of related companies, all the group’s operations in Russia are officially carried out through a single legal entity which is registered in Russia and reports to its tax authorities. The business activity of all other group entities is “camouflaged” as the operations of a single legal person which within the group is considered as “a special vehicle for executing projects in Russia”. For example, its staff includes specialists (including foreign employees) who do not in fact engage in its core business, but only work for their “true” employers that have successfully avoided registration with the Russian tax authorities.
Of course, such a model does not in itself break the law. But for it to function flawlessly one must develop and accurately execute certain internal rules in accounting for all expenses separately, breaking out each project and task carried out for the various corporate beneficiaries “at home”. Also, the beneficiaries must reimburse these expenses, which makes the model unattractive for those short-sighted managers who seek to avoid the application of “complicated and obscure” Russian accounting rules to each and every business activity of the company.
The new methods of tax management based on global tax data exchange will enable the Russian taxman to identify Russian taxpayers’ operations on behalf of each individual related foreign company which is not itself registered in Russia.
The second set of risks affects foreign companies that permanently employ Russian citizens (residents) to represent their interests in Russia without officially registering subsidiaries or affiliates as required by law. Typically, the emoluments of such employees are paid out through foreign accounts. However, once the Russian fiscal authorities can more easily access information on Russian citizens’ foreign accounts it is not hard to prove the unregistered activity of such foreign companies in Russia, especially when the employer-employee relationship between the company and its Russian representative is confirmed.
Since the mechanism of global data exchange is now fully equipped to reveal the use of such business models in Russia, there is now a very high probability that companies will be held accountable for infringing fiscal law in this manner.
Statutory responsibility for tax offences
The requirement that foreign organisations register their operations in Russia with the local tax authorities arises from Article 83, Section 1 of the Russian Tax Code and the Ministry of Finance’s executive order № 117n (30th September 2010), with due regard to the details given in the Russian Ministry of Finance’s letter N PA-4-6/2688@ dated 18th February 2011.
Under ministerial order № 117n, foreign companies must register with the Russian tax authorities if they operate through a “permanently establishment” in Russia. According to the Russian tax authorities, a “permanent” place of business is established through the presence of employees over a (cumulative!) period exceeding 30 days per calendar year or through operational plans that require such a presence. Specifically, the criteria of a “permanent establishment” are defined in Article 306 of the Russian Tax Code.
The company must register no later than 30 days after commencing operations through a permanent establishment in Russia. Later registration is punishable by a fine of 10,000 roubles.
It is considered a significant tax offence to simply ignore this requirement. Under Article 116 of the Russian Tax Code, the applicable fine is up to 10% of revenues generated in Russia (in any case, not less than 40,000 roubles).
The fine is calculated from the foreign company’s revenue over the period beginning from the date when it was required to register (i.e., as mentioned earlier, 30 days after regular operations start).
Russian legal persons are subject to automatic registration with the tax authorities at the time of incorporation. Additionally, and independently of the penalty already mentioned, the lack of a Russian tax registration gives rise to additional tax charges. In this case, the competent authority can adopt the following measures:
Through a comprehensive tax audit of the offending enterprise (technically speaking, they may receive information from cross-checks with suppliers, contractors or clients), the authorities assess the total charges payable on operations undertaken without a tax registration, often using market prices for analogous goods or services. This method is applied where it is impossible to calculate the tax base from the taxpayer’s own records.Other than back taxes, other measures may be taken against reluctant taxpayers. Under Article 122 of the Tax Code, penalties amount to 20% of the unpaid sum where the non-payment was made in error and 40% if it was intentional.
Moreover, Article 119 of the Tax Code stipulates additional punitive measures for the failure to submit tax declarations if the company’s type of economic activity required it to do so. For example, if the enterprise cannot benefit from favourable tax regimes (simplified taxation, unified tax on imputed income) and sells goods and services subject to VAT in Russia, it must submit quarterly VAT returns to its local tax office. If staff are hired or contracts of civil law are сoncluded (e.g. subcontracting), the company must declare the income paid out to them, the personal income tax and the compulsory social security contributions (pensions, medical and social insurance).
The total pecuniary sanctions for late submissions amount to 5% of tax therein declared for each month they are overdue. Still, there is an upper limit: not more than 30% of relevant taxes payable.
When employing Russian citizens in Russia, both Russian and foreign companies withhold income tax and social security contributions on their behalf. Under Article 123 of the Tax Code, the withholding agent is liable for non-payment of such taxes, with fines building up at 20% of total unpaid taxes. Needless to say, this penalty is applied over and above the relevant tax payment itself and includes late charges.
Further, it is worth noting that Article 120 of the Russian Tax Code also establishes the taxpayer’s liability for blatant violations of accounting rules when recording revenue and expenditure. The first infringement is punishable by a 10,000 rouble fine, with repeated infractions over the year running at 30,000 roubles each. If the error has led to a reduced tax base, the liability can increase to as much as 20% of unpaid taxes (not less than 40,000 roubles).
Another flagrant violation can result from a failure to abide by Article 9 of the Russian Accountancy Law, including records on business operations without a genuine economic objective or operations based on inauthentic documentation (first and foremost, documents reflecting so-called sham transactions). Supervisory bodies can arrive at such conclusions when they discover attempts to pass off sales of certain goods or services by the foreign company as sales of its Russian subsidiary by means of formally producing the relevant paperwork.
The aforementioned serious violation as defined by the Russian Accountancy Law also gives rise to personal consequences for the relevant company executives in the form of an administrative fine under Article 15.11 of the Administrative Violations Code. The first offence is punishable by a fine ranging from 5,000 to 10,000 roubles while repeated infringements carry a fine between 10,000 and 20,000 roubles. Relief from liability is only possible in cases where the company corrects the error of its own volition, on the condition that the concomitant charges are settled.
This “personal” liability concerns “the officials responsible” under Russian law. It is worth noting that this definition is rather flexible; depending on the circumstances it may designate the employees who put together the transaction paperwork or implicate management right up to the chief accountant or CEO of the company.
The measures of administrative pressure against offending companies described above can also be applied in cases where the company is shown to have operated without due registration with the tax authorities. In all cases mentioned, the executive responsible (CEO or COO) may be prosecuted under criminal law, and so may other employees when intentional actions designed to illegally reduce the tax burden are discovered.
Under Article 199 of the Russian Criminal Code, the failure to submit tax declarations and other mandatory documents to the tax office constitutes a criminal offence in cases where such failure is motivated by tax evasion.
In cases where the Russian tax authorities suspect tax evasion they have the right to pass the case to the police (specifically, the Economic Crime Department) for further investigation. The criminal responsibility of company executives (and in some cases, of other involved persons such as the chief accountant or company representatives authorised to enter into transactions and acting without due registration with the tax authorities) arises under the rules provided by Article 199 of the Russian Criminal Code if the sum intentionally left unpaid exceeds 15 million roubles over a three-year period (i.e. three consecutive financial years).
This threshold decreases to 5 million roubles when the concealed tax liability accounts for 25% of total taxes and other levies that should have been paid for the period under review.
If wrongdoing can be proven, the transgressor is fined 100,000 to 300,000 roubles, compelled to disgorge all salaries and other income to the state over a period of 1 to 2 years, sentenced to 1-2 years of correctional labour or jailed for up to 2 years (in the last two cases the perpetrator is barred from assuming certain posts in Russian organisations or practising certain professions for up to 3 years).
If the same crime is committed in collusion with other participants or on a large scale, it is punished much more severely under Article 199, Section 2 of the Criminal Code.
Large-scale tax evasion occurs if unpaid taxes over three financial years exceed 15 million roubles as well as 50% of the total sum that should have been paid, or if they exceed 45 million roubles.
In the above circumstances the offender is fined 200,000 to 500,000 roubles, has his/her salary confiscated over a 1-3 year period, is sentenced to up to 5 years of correctional labour or jailed for up to 6 years. Again, the offender can be barred from assuming certain posts in Russian organisations or practising certain professions for up to 3 years.
Relief from liability for tax crimes in possible only for first-time offenders; at the same time, taxes are due in full, plus late payment interest and a fine as defined by the Russian Tax Code.
Other risks of operating in the Russian Federation without due registration
Due to the obvious constraints of the article format, of the consequences arising from a lack of due registration with the Russian tax authorities, we could only discuss those related to tax law. Our brief overview did not consider other risks that may apply (civil law risks as counterparties may contest transactions, reputational risks etc.) Especially worth noting are risks for companies operating in certain countries that require corporations to adhere to applicable law throughout the world. This compliance requirement is very important for companies present in the US market, for example.
However, in our view, even the negative consequences listed in this article are more than sufficient for a rational executive in a global corporation to do the right thing and not tempt fate in pursuit of questionable savings (meaning, first and foremost, not even the desire to save money on the registration itself but an unwillingness to expend funds on accounting and reporting in Russia). Those savings are illusive: those several thousand Euros a month spent on quality accountancy in Russia cannot be compared to the drastic consequences to offenders when off-the-books transactions are exposed. Ignorance is not a defence, and neither is a voluntary acknowledgement of past sins ahead of a tax audit. You must still pay fines.
The probability that dishonest taxpayers who arbitrarily reassign income and expenses between related companies registered in multiple countries to reduce the tax base are found out is becoming much higher as new measures based on international administrative collaboration (the BEPS plan) are being put into practice. This is the key difference between yesterday and today in terms of tax compliance.