Although
Russia has (or had) its own domestic 'offshore' in the
form of tax-haven territories which were much used by
manufacturing and extractive businesses in the early
1990s to shelter income from taxation, legislation has
now largely removed such possibilities, and in any case
the horrible fate of Yukos acts as a major disincentive
to any Russian company thinking of using home-grown
tax shelters.
That
is not to say however that 'offshore' is out of bounds
for Russian companies, or for foreign companies investing
in Russia. Far from it - almost any major exporter or
importer, whether of capital, goods or services, can
hardly do without the use of offshore international
financial centres (OIFCs) if they are not to commit
fiscal suicide. In this feature we will first examine
the characteristics of the Russian corporate taxation
system which govern the use of OIFCs, we will describe
the types of structure that can be used by Russian and
foreign investors, and finally we will survey key features
of some of the OIFCs which have been particularly used
for Russian business purposes.
The Russian Corporate Taxation System
A
fuller description of Russian corporate taxation will
be found in our Knowledge Base;
here we will just summarize those features of the system
that are most relevant to the use of OIFCs. In most
'high-tax' OECD countries, fiscal consolidation practices,
'Controlled Foreign Corporation' (CFC) rules and transfer
pricing legislation operate to constrain the use of
OIFCs. This situation is the result of 50 years of tangoing
between multinational businesses and national tax authorities.
As tax rates have risen and the multinationals have
become more adept at minimizing tax, so have the rules
gradually tightened. A typical Western multinational
will be unable to retain untaxed profits in its foreign
subsidiaries, will be unable to price international
sales so as to maximize profits in low-tax countries,
and will be unable to mix foreign profits and losses
at will in its home jurisdiction in order to reduce
its tax bill. This is not - yet - the situation in Russia.
Tax consolidation is available in very limited circumstances,
and there are limitations on loss carrybacks - there
are no CFC rules at all, and the transfer
pricing legislation is virtually toothless (although
new rules are set for introduction in 2011). A Russian-owned
business is taxable on its world-wide income, so that
the income of a foreign subsidiary would not as such
be taxable in Russia - of course, income received into
the foreign bank account of a Russian company is taxable,
as are dividends received from a foreign subsidiary.
Foreign taxes paid on such income is creditable against
Russian tax only to the extent that this is provided
for in a tax treaty. For a foreign company operating
as a taxable permanent establishment in Russia through
a Representative Office - the usual scheme for all but
the most substantial businesses - only income received
by the Representative Office, whether from Russia or
abroad, is taxable. Its remittances abroad will usually
be subject to withholding tax, and will fall under a
tax treaty if appropriate. In fact, Russia over 70 tax
treaties, many of which have highly favourable withholding
tax rate provisions, and these are a key part of tax-planning
both for Russian international businesses and for foreign
investors.
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Russians Investing Overseas
We
are not concerned here with the complications of moving
money out of Russia. This is not easy to achieve legally
without incurring costs, sometimes substantial ones.
However, in one way or another many Russian individuals
and businesses have accumulated overseas assets, and
have the problem of how best to utilize them in a tax-efficient
way, whether that be by re-investing them in Russia,
or by investing them internationally. OIFCs play a key
role in intermediating both types of investment. Typically,
a Russian investor will use an OIFC company to hold
business operations or assets whether in Russia or abroad.
If the income-earning asset is abroad, there will of
course be the problem of local taxation, but gains or
profits once safely harvested by the offshore holding
company may remain untaxed perpetually due to the absence
of CFC rules, as long as they are not repatriated to
Russia. In the situation that a Russian investor has
an importing business, the lax transfer pricing rules
allow much of the profit inherent in the importation
of, say, an electronic device from Taiwan to Russia
to be harvested in an intermediate OIFC. Hong Kong springs
to mind. In the case of a Russian investor re-investing
overseas assets into Russia - much more frequent nowadays
than previously - the use of a holding company or financial
intermediary in one of the IOFCs with a good Russian
tax treaty - for instance Cyprus or Luxembourg - will
allow the remittance of Russian profits, royalties or
interest with minimal tax cost, and once again the money
is safely offshore. It is no coincidence that the early-1990s
saw a rush of Russian banks to Cyprus, in support of
schemes to expatriate Russian capital and profits, whether
legal or otherwise; later, Malta and Gibraltar became
popular for the same reasons. Now, Russian holding companies
or IBCs (International Business Companies) are to be
found in a wide variety of OIFCs.
N.B.
At the behest of President Medvedev, in 2009 the Russian
Ministry of Finance prepared an amendment to Article
7 of the Tax Code to crack down on tax avoidance by
means of offshore companies set up to benefit from lower
tax rates granted under double taxation treaties.
The primary objective of the
legislation would be to deny Russian residents who set
up offshore companies for the purposes of tax avoidance
the benefit of lower treaty withholding tax rates.
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Foreign Investors In Russia
As
can be seen from the table of Russian
tax treaties, most OECD countries have such treaties,
and there is nothing to prevent an investor based in
any of those countries from investing directly into
Russia, and relying on the tax treaty to minimize Russian
withholding taxes on repatriated profits (dividends),
interest or royalties. Usually this will result in a
withholding tax rate of between 5% and 15% on dividends,
and between nil and 10% on interest or royalties. That
doesn't sound too bad, but then the income is in the
investor's high-taxing home jurisdiction. For this reason,
most foreign investors choose to use a holding company
in a low-tax OIFC through which to finance a Russian
involvement. Providing that capital injections to the
Russian operation have been correctly recorded by the
Russian authorities, repatriation of the capital will
be untaxed; in the absence of a tax treaty, the normal
rate of Russian withholding tax on a dividend paid by
a Russian company or Representative Office to its foreign
parent (if that parent is a company) is 15% (exempt
if for companies with a participation of at least RR500m
in the paying company, provided they do not appear on
the 24-nation 'blacklist'). Interest payments would
be taxed at 20%. However, Cyprus and Luxembourg both
have tax treaties with Russia, making them the favourite
OIFCs for foreign investment into Russia. In the case
of Cyprus, the treaty rate of withholding tax on dividends
is 5% if the original investment was greater than USD100,000,
and 10% otherwise, while the treaty rates for interest
and royalty payments are nil. With Luxembourg, the treaty
rate of withholding tax on dividends is 10% for a participation
which is greater than 30%, and 15% otherwise. The treaty
rates for interest and royalty payments are nil. Both
Cyprus and Luxembourg have local taxation regimes and
corporate structures that allow foreign income to be
very lightly taxed or untaxed if the beneficial owners
of the holding company are non-resident. Cyprus is therefore
apparently the best place in which to locate a holding
company for a Russian investment, and indeed very many
such holding companies exist. The best structure for
any particular foreign investment will however depend
on complex factors such as the tax domicile of the individual
investor, the nature of the business to be carried on,
etc, and other OIFCs or even OECD countries may have
their place in the structure. A number of European Union
high-tax countries nonetheless have very attractive
holding company regimes (see other countries in the
offshore-onshore section
of lowtax.net) which taken together with their Russian
tax treaties may qualify them to be used in a Russian
investment structure. Denmark is the most obvious example,
but there are others.
N.B.
In April 2009, Russia and Cyprus signed a new double
taxation avoidance agreement which, once ratified, will
secure Cyprus's removal from a new Russian 'blacklist'
of jurisdictions which have not demonstrated a sufficient
level of cooperation with the Russian tax authorities.
Cypriot Finance Minister Charilaos
Stavrakis said that the new agreement maintains "the
very low and competitive factors Russians are enjoying
today concerning investments through Cyprus" although
he conceded that Russia succeeded in winning "a
significant number of concessions" that they had
been asking for.
A major concession won by Russia
will see capital gains made by Russian subsidiaries
of Cypriot holding companies with more than 50% of their
assets in Russian property taxed at the prevailing rates
in Russia.
Ilya Trunin, a senior tax official in the Russian Finance
Ministry remarked that the amendments ensure that the
double tax agreement will not be used "in an inappropriate
way" by residents and investors in Cyprus and Russia,
but would nevertheless result in Cyprus's removal from
Russia's "list of offshore jurisdictions"
which he stopped short of calling a "blacklist."
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OIFCs Used In Russian Investment Structures
Cyprus:
Cyprus
is an independent democratic republic, and a member
of the Commonwealth. It is prosperous: GDP USD27,000
per head. The economy is dominated by services, with
tourism particularly important. Unemployment is low.
The Cyprus Government has worked hard to create a favourable
offshore tax regime while at the same time maintaining
a normal-looking domestic economy, albeit with rates
of taxation that are low by international standards.
The success of this programme is attested by the nearly
50,000 offshore companies registered in Cyprus since
1975. However, the island's entry to the EU in 2004
meant a restructuring of the tax regime, which took
place on January 1, 2003. Domestic and offshore companies
alike now pay 10% tax, although income from foreign
sources is exempt for non-residents. Cyprus has double-tax
treaties withmore thna 40 other countries, including
most major Western 'high-tax' countries, and most Central
and Eastern European states. This is unusual for an
international offshore financial centre and the effect
is that Cyprus is a very effective location for holding
and investment companies aimed at emerging markets.
Cyprus has a good, European-standard business infrastructure,
and English is widely spoken. However, it is a relatively
expensive jurisdiction for offshore operations, and
many documents need to be filed in Greek. The legal
system is predominantly based on English law, and provides
for various types of trust. The division of the island
into Greek Cypriot and Turkish Cypriot zones separated
by a UN buffer zone following the Turkish invasion of
1974 does not seem to impede normal commercial or offshore
operations, which take place in the Greek zone. In November,
2002, the United Nations presented a plan for a 2-state
federation under a common government intended to resolve
the problem before Cyprus's admission to the EU. Even
after the Copenhagen summit in December which confirmed
the island's admission to the EU in 2004, negotiations
between north and south continued; but they broke down
in early 2003 and the island signed its EU accession
treaty in April. The European Commission and the US
strenuously supported the United Nations' Annan Plan
for reunification, but it was rejected by a Greek Cypriot
referendum in April, 2004. Reunification, it if takes
place, may form part of Turkey's negotiation to join
the EU. The island's listing by the FATF in June, 2000,
as one of 15 offshore jurisdictions said to have inadequate
defences against money-laundering hastened a process
of adjustment to international standards of banking
supervision and information exchange. After
the EU finally agreed its Tax Directive in June, 2003,
Cyprus announced that it would implement the 'information
sharing' provision of the Directive on entry to the
Union in 2004. This means that information about savings
returns received in Cyprus by nationals of other EU
countries is now passed to the tax authorities in the
individuals' home countries. In late 2003 the government
also announced plans to weaken previously tight banking
confidentiality, although these were strongly attacked
by the banks. See the Cyprus
section of lowtax.net for a full description of
Cyprus's tax regime.
Luxembourg:
Luxembourg
is a constitutional monarchy, has a land area of about
1,000 sq miles, a population of 486,000, and is sandwiched
between Belgium, France and Germany. With Belgium and
the Netherlands, it forms part of Benelux, which was
a precursor of the EU. Luxembourg was a founder-member
of the EU and hosts many of the EU's financial institutions.
Languages spoken are French, German and English, with
Luxemburgish the everyday language of Luxembourgers.
Luxembourg's economy was dominated by steel production,
but since the Second World War the Government has successfully
encouraged development of a diversified financial sector.
Tourism is also important. In Europe, Luxembourg has
the second most extensive banking industry after London.
The Luxembourg private banking industry is possibly
Europe's biggest. The Stock Exchange specialises in
collective investment funds and many of the 7,000 Luxembourg-registered
funds are also listed there. According
to figures released by the World Bank in May, 2001,
Luxembourg was the richest country in the world in 1999
when it came to purchasing power per capita with an
average wage of USD41,230. Luxembourg was also listed
as the wealthiest country in terms of gross national
income (GNI) in 1999 at USD42,930 per head. With GDP
per capita now approaching USD85,000 it remains a wealthy
enclave. Unemployment is rising slightly but is less
than 4.5%, and inflation is on the European average
at 2%. Luxembourg
is a high-tax country, but has specialised types of
'holding' company which are tax-exempt (although these
are being phased out at the behest of the European Union).
There are 18,000 of these - they are suited to holding
international investments, but are not allowed to trade
themselves. UCIs (collective investment funds) are also
tax-exempt. As a member of the EU, Luxembourg finds
itself in an uncomfortable situation squeezed between
the EU/OECD attack on harmful tax competition and its
dependence on its successful 'offshore' sector. The
EU's Savings Tax Directive also threatens problems for
Luxembourg banks and UCIs, although after threatening
to veto the EU's plans at the end of 2002 because competitor
Switzerland had not offered 'equivalent' measures, the
country fell into line in January, 2003, and has applied
a withholding tax to non-residents' investment returns
since the Directive came into force in 2005.
After the OECD issued its final list of offshore jurisdictions
in April 2002, it made threatening noises towards Luxembourg,
and considered what sanctions could be imposed on the
country after its 2003 deadline for the removal of 'harmful'
tax practices. Income
Tax, Municipal Business Tax on Profits and a corporate
surtax give a combined corporation tax rate of about
30%; the rates for individuals are higher, and they
pay a wealth tax in addition. The tax system is mostly
based on German originals, apart from VAT which is of
course an EU-inspired tax. EU citizens have freedom
of movement in Luxembourg of course, but other nationals
need residence and work permits. See the Luxembourg
section of lowtax.net for a full description of
Luxembourg's tax regime.
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