Russia - Taxation of cross-border M&A | KPMG | GLOBAL

Russia - Taxation of cross-border mergers and acquisitions

Russia - Taxation of cross-border M&A

Mergers and acquisitions (M&A) have become increasingly common in Russia in recent years.

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Russia, St Petersburg, Dvortsovaya Place, Alexander Column and General Staff Building

Introduction

Mergers and acquisitions (M&A) have become increasingly common in Russia in recent years. A number of legal and tax issues should be considered when such transactions are planned. This report summarizes the applicable provisions in Russian legislation. M&A issues are complex, so every transaction should be planned taking into consideration all the facts and circumstances.

Recent developments

The following summary of Russian tax considerations is based on current tax legislation as of 1 January 2018.

Anti-offshore tax policy

As of 1 January 2015, the following amendments to the Russian tax legislation came into effect as part of the Russian De-offshorization Law:

  • controlled foreign company (CFC) rules
  • definition of ‘tax residency’ based on place of effective management
  • definition of a ‘beneficial owner for tax treaty purposes
  • disclosure of information about beneficiaries of companies.

Where a Russian group has companies registered in foreign jurisdictions with favorable tax regimes that are directly or indirectly controlled by a Russian tax resident (company or individual), any accumulated retained profits of these companies could be subject to profits tax in Russia at a rate of 20 percent or personal income tax at 13 percent.

As of 1 January 2018, a ‘controlling person’ for Russian tax purposes is a Russian tax resident (company or individual) that owns directly or indirectly more than 25 percent of the CFC’s capital (or more than 10 percent if the equity interests of all persons who are Russian tax residents exceed 50 percent).

The profits of a legal entity or structure that would otherwise be treated as a CFC are exempt where:

  • the CFC is a non-profit organization that does not distribute profits in accordance with the local legislation under which the organization was founded
  • the CFC is a tax resident of a country that has concluded a tax treaty with Russia and that exchanges tax information, provided that:
    • the effective tax rate (taking into account withholding tax — WHT) is not less than 75 percent of the weighted average Russian profits tax rate, or
    • the portion of the CFC’s passive income is not more than 20 percent of all income.
  • the foreign organization is a member state of the Eurasian Economic Union, an operator of a coastal shelf project or a participant in PSA projects, or in certain other cases.

On 12 May 2016, at the Organisation for Economic Cooperation and Development’s (OECD) Forum on Tax Administration, Russia signed the Multilateral Competent Authority Agreement on the Automatic Exchange of Financial Account Information, thereby joining the OECD’s Standard for Automatic Exchange of Financial Account Information (Common Reporting Standard — CRS).

Joining the CRS will enable the Russian tax authorities to obtain information on financial accounts held by Russian tax-resident individuals and legal entities abroad from the tax authorities of other participating countries. The Russian tax authorities also will be obliged to provide similar information to the tax authorities of partner jurisdictions regarding financial accounts held by tax residents of those jurisdictions with Russian financial institutions. The first exchange of information with partner jurisdictions will occur in 2018.
In June 2017, Russia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS). Russia chose to supplement the principle purpose test with a simplified limitation on benefits test.

Concept of ‘unjustified tax benefit’

In July 2017, the Russian tax code was amended to include the concept of ‘unjustified tax benefit’ (introduced in 2006 by the Supreme Arbitration Court). Under these amendments, expenses can be deducted and taxes can be refunded where:

  • the company has recorded the transaction for accounting and tax accounting purposes in accordance with its substance
  • the main purpose of the transaction is not the underpayment or recovery of taxes
  • the contractual obligation was actually performed by the party to the contract concluded with the taxpayer and (or) a person to whom the obligation to perform the transaction (operation) was transferred by another contract or bylaw.

Jurisprudence on deductibility of exchange losses and interest

The tax authorities began treating loans from related parties as capital investments where:

  • interest on the loans was accrued but not actually paid
  • the debt was not even partially settled by the debtor during the period of the loan maturity
  • the loan maturity period was unreasonably extended.

As a result, the tax authorities tend to disallow the deduction of interest expenses and currency exchange losses on such loans. In 2016 and 2017, the Russian courts supported the tax authorities’ approach.

Thin capitalization rules

As of 2017, Russia’s thin capitalization rules were significantly changed — see ‘Deductibility of interest’ later in this report.

Tax attributes

In another major change, as of 2017, tax losses accumulated since 2007 can be carried forward indefinitely. However, from 1 January 2017 to 31 December 2020, a taxpayer is entitled to reduce its taxable income for the current tax period by up to 50 percent of tax losses incurred in earlier years.

Asset purchase or share purchase

An acquisition in Russia can be structured as an asset or share deal. The main difference is that, in a share deal, all rights and obligations of the target company (including all historical tax liabilities) remain in the company acquired by the buyer, whereas in an asset deal, historical liabilities remain in the selling entity, with certain exceptions.

A share deal could be performed by acquiring shares in Russian joint stock company (AO) or by acquiring the so-called ‘participations’ in Russian limited liability companies (OOO). Share deals can also be affected by acquiring shares in the foreign holding companies of Russian targets.

An asset deal is usually a purchase of certain assets of the target company. Tax risks of the target company could transfer to the buyer of assets. Alternatively, the deal could involve the purchase of an enterprise as a property complex, where all the assets and liabilities are assumed as well. This procedure is more complicated and rare in practice (in many cases, the purchase of an enterprise as a property complex occurs when a bankrupt company sells its business).

Note that where parties sign a sale and purchase contract of all the target’s assets, there is a risk that the deal could be re-classified as a purchase of an enterprise as a property complex (as has happened). This would cause the liabilities as well as assets to be transferred. In this case, the Russian tax authorities could claim that the buyer has inherited the historical tax liabilities.

KPMG in Russia notes that Russian court practice on asset deals is evolving. Historically, assets deals were generally used to mitigate historic tax risks of the acquired targets. Developing court practice indicates that where the target and the new company to which the target’s business was transferred are related, the new company should be liable for the historic tax liabilities of the target.

An asset deal is generally subject to valued added tax (VAT), which could be recoverable for the buyer and profits tax, whereas a share deal, if performed in Russia, is only subject to profits tax. The implications of both types of purchase are summarized at the end of this report.

Purchase of assets

Assets of a Russian business may be acquired by a foreign legal entity directly or through a Russian branch. The acquired assets may also be contributed to the charter capital of a Russian subsidiary of the buyer. Contributions in kind to the charter capital of joint stock companies must be valued by independent appraisers, unless otherwise stipulated by law. Contributions in kind to the charter capital of limited liability companies must also be valued by independent appraisers. Alternatively, a special-purpose vehicle may be set up in Russia to acquire the assets of the target company.

Purchase price

Generally, the purchase price is determined by the mutual consent of the parties (under the so-called ‘freedom of contract’ concept). However, the tax authorities could challenge the applied prices using the transfer pricing rules applicable to an asset deal.

Goodwill

Goodwill could arise in a purchase of an enterprise as a property complex. ‘Goodwill’ is defined as the difference between the purchase price of an enterprise as a property complex and the net book value of its assets. Where the purchase price is higher, the positive difference (positive goodwill) could be deducted for profits tax purposes over 5 years from the month following the month of the state registration of the property complex transfer.

For statutory accounting purposes, goodwill is subject to impairment over 20 years or until the company’s dissolution, whichever is sooner.

Where the purchase price is lower than the value of assets, the negative difference (negative goodwill) is subject to profits tax in the month of the state registration of the property complex transfer.
The seller can deduct a loss on the sale of an enterprise as a property complex for profits tax purposes.

Depreciation

Depreciation of assets is generally deductible for profits tax purposes in Russia. Depreciation rates depend on the assets’ useful life.

The useful life of an asset is determined at the date when the fixed asset is put into operation, based on the classification of fixed assets included in prescribed depreciation groups.

Where a particular fixed asset is not included in the classification, the taxpayer should determine the fixed asset’s useful life, taking into account the technical characteristics of the asset and recommendations of the manufacturer.

According to Russian tax legislation, a taxpayer is entitled to apply either a straight-line or a reducing-balance method of depreciation.

A depreciation premium of 10 to 30 percent of the acquisition cost of fixed assets is available as an immediate deduction when the fixed assets are commissioned.

Tax attributes

Tax losses of the target company are not transferred to the buyer under an asset deal. The buyer inherits customs risks of the assets of the target company in an asset deal. Tax liabilities of the target company could transfer to the buyer of assets in an asset deal, where the deal had no business rationale and was aimed at tax avoidance.

Value added tax

The sale of most assets is subject to 18 percent VAT. Where a foreign legal entity acquires an asset directly and wishes to transfer the acquired asset to its business in Russia (e.g. contribute the asset to the charter capital of its subsidiary in Russia) and where the foreign legal entity is not tax-registered in Russia, the amount of the input VAT paid on the acquisition is a cost to the investor. Where the asset is acquired by an investor’s Russian subsidiary, the input VAT on the acquired asset may be offset against the subsidiary’s output VAT.

The contribution of an asset to the charter capital of a Russian company is not subject to Russian VAT. However, the Russian subsidiary contributing the asset to the charter capital should reinstate previously offset VAT (for fixed assets, at their net book value). Reinstated VAT should be shown separately in the transfer documents and can be offset against output VAT of the company that received the contribution in kind.
The sale of an enterprise as a property complex is subject to specific VAT rules. For example, the tax basis should be defined as the net book value of assets per statutory accounting multiplied by a special ratio (where the purchase price differs from the net book value of the assets sold).

Where the purchase price is lower than the net book value of assets, the correcting ratio is determined by the proportion the purchase price is of the net book value. Where the purchase price exceeds the net book value, the correcting ratio is calculated in the same way but the numerator and denominator of the proportion are reduced by the value of accounts receivables and the value of securities (if no decision about their revaluation has been made).

The seller must provide the buyer with an inventory report and a consolidated invoice grouped by type of asset.

The sale of assets and property rights of a bankrupt company is not subject to VAT. Therefore, the buyers of such property or property rights have no obligation to act as a tax agent.

Property tax

Generally, property tax is levied at a maximum rate of 2.2 percent (set by the regional authorities) of the average net book value of the taxpayer’s fixed assets.The net book value of fixed assets is determined based on statutory financial statements.

Starting from 2018 regional authorities can provide the property tax exemption for movable property recorded in the taxpayer’s financial accounting on or after 1 January 2013 except for:

  • property received in the process of reorganization or liquidation of a legal entity
  • property received from the related parties and classified in a depreciation group other than the first and second depreciation groups.

If regional authorities did not determine property tax exemptions for movable property by 1 January 2018, the exemption would not apply from that date. However, for 2018, the maximum rate is 1.1 percent rate.

The property tax base for the following immovable properties is determined based on their cadastral value:

  • administrative, business and shopping centers and premises situated in them
  • non-residential premises to be used or intended to be used for offices, commercial facilities, catering and domestic services
  • any immovable property owned by foreign companies that do not carry out business activity through a permanent establishment (PE) in Russia
  • immovable property owned by foreign companies that does not relate to business activity carried out through the PE by the foreign company.

The tax rate for these items is 2 percent.

Purchase of shares

Generally, a share deal may be preferable for the seller where the seller is a foreign legal entity since, according to Russian tax legislation, capital gains from the sale of shares are tax- exempt unless more than 50 percent of the assets of a target company directly or indirectly consist of immovable property located in Russia.

Tax indemnities and warranties

In a share acquisition, the buyer takes over the target company together with all its assets and liabilities, including contingent liabilities. Therefore, the buyer normally requires more extensive indemnities and warranties than in the case of an asset acquisition. In order to protect itself from potential tax risks, the buyer may wish to initiate a due diligence procedure and include some indemnities in the sale-purchase agreement.

Tax losses

Tax losses accumulated since 2007 can be carried forward indefinitely. The taxpayer is entitled to reduce its taxable profits by the previously incurred losses, provided that during the whole period of their use, the taxpayer retains the supporting documents that prove the losses were incurred.

From 1 January 2017 to 31 December 2020, a taxpayer is entitled to reduce its taxable profit for the current tax (reporting) period by tax losses incurred in prior years by not more than 50 percent of the taxable profit of the current period.

In a reorganization, a company that takes over all the rights and obligations of the reorganized company is entitled to reduce its taxable profit by the amount of losses incurred by the reorganized company before its reorganization.

Crystallization of tax charges

As the buyer of shares takes over the target company together with all its liabilities, the buyer inherits all the target’s historical tax risks. Therefore, the buyer usually obtains an appropriate indemnity from the seller regarding outstanding historical tax liabilities. The buyer may ask the target company to obtain a reconciliation statement and a statement of personal account from the tax authorities at the latest possible date preceding the date of a share deal. However, where the target company has no outstanding tax obligations according to these documents, the possibility remains that the tax authorities may challenge the accuracy and timeliness of the tax calculations and payments and accrue additional taxes and penalties in the future.

It is also advisable to consider carefully the results of the field tax audits of the target company. Generally, 3 calendar years preceding the current year are subject to field audit by the tax authorities. However, in certain cases, the closed tax periods) may be subject to repeat tax audits. Among other things, such a repeat audit could be performed where:

  • the taxpayer is regarded as inhibiting the exercise of the tax control by the tax authorities
  • the higher tax authorities are checking work done by the lower tax authorities
  • a criminal case is brought against the officers of the company on the grounds of tax evasion.

Transfer taxes

Stamp duty is not applied in Russia, but similar duties are charged at nominal amounts.

Tax clearances

Taxpayers can obtain tax clarifications from the tax authorities on unclear or questionable provisions in Russian tax legislation. If the taxpayer follows such clarifications and the tax authorities then challenge the case, the taxpayer is exempt from penalties (fine and late payment interest) but not the tax itself. However, the authorities may claim that their clarifications were based on insufficient or uncertain information provided by the taxpayer. In this case, the taxpayer is not exempt from paying penalties.

As of 2016, taxpayers have the option of obtaining tax rulings on their planned transactions. The tax ruling tool is available only to major corporate taxpayers that apply the tax monitoring regime, which provides access to the tax authorities to accounting and tax accounting, as well as to source documents of organizations. Taxpayers subject to tax monitoring can apply for a tax ruling from the tax authorities on the tax treatment of certain transactions not explicitly addressed in the current legislation. Such rulings are binding, and taxpayers are required to follow the treatment recommended by the tax authorities.

Choice of acquisition vehicle

Several possible acquisition vehicles are available to a foreign investor, and tax consequences often influence the choice.

Local holding company

Where the buyer uses debt financing to acquire a Russian target, it may be reasonable to set up a Russian holding company as an intermediary. Under Russian tax legislation, interest expenses are deductible for profits tax purposes irrespective of whether a loan was taken out for investment or current business needs. There are certain limitations on interest deductibility (see ‘Deductibility of interest’).

A post-acquisition merger of the intermediate holding company and the target company could be considered.
This would make it possible to offset the holding company’s interest expenses against the target company’s income (the holding company would not have such income). Maintaining one company instead of two also would reduce administrative costs. However, such a cascading structure is inefficient for dividend payments. Dividends are subject to tax at a rate of 0 percent where certain conditions are met or at 13 percent when distributed to the holding company. This tax may not be creditable against further taxation of dividends paid to the foreign shareholder.

Where the merger is mainly motivated by tax considerations, the tax authorities could invoke the concept of ‘unjustified tax benefit’ and assess additional taxes as if no merger had occurred. Currently the court practice is developing in this respect and Russian tax authorities pay close attention to the matters of economic justification and business purpose of financial transactions, and their context and all the attendant circumstances.

Under the ‘beneficial ownership’ concept, the Russian tax authorities may challenge the application of the rates for Russian tax residents and apply the rate of 15 percent on dividends unless the reduced WHT rates could be applied.

Foreign parent company

A foreign buyer may wish to acquire the shares of a Russian company without an intermediary, which should be considered where the foreign parent plans to resell the target. Russia does not tax capital gains on shares sold by a foreign legal entity unless more than 50 percent of the assets of the Russian target directly or indirectly consist of immovable property located in Russia.

Although Russia levies WHT on dividends, interest and royalties paid to a foreign entity, the WHT can be reduced or eliminated by an applicable tax treaty subject to ownership test. Russia has an extensive network of such treaties.

A foreign investor may acquire shares in a Russian company for cash or in exchange for contributions in kind of property (assets or shares). In this case, the tax basis of the acquired shares in the Russian company is equal to the tax basis of property (shares) given in exchange for the shares and costs related to the contribution.

The tax basis of property (assets or shares) received by the Russian company also is equal to the tax basis of the contributed property stated in the records of the investor on the date of transfer (but not higher than the market value of the transferred property, as confirmed by an independent appraiser for transfers made by a foreign investor). Where the Russian company lacks supporting documents for the cost of property received, the tax basis of property is zero for Russian profits tax purposes.

PE issues should also be taken into account. According to the Russian Tax Code, the activities of a foreign legal entity may create a PE in Russia where the foreign entity has a placeof business in Russia (i.e. branch, office, bureau or other separate division) and regularly engages in business activities through this place (unless the activities are preparatory or auxiliary in character). Most tax treaties between Russia and other countries set similar criteria for determining whether a PE of a foreign legal entity (FLE) exists in Russia.
In response to growing demand from market players, the M&ATax practice of KPMG in Russia is developing various structures, such as a ‘transparent’ joint venture, which that would not be considered as a beneficial owner of income by the Russian tax authorities within the process of dividend or disposal income distribution. Such arrangements would allow beneficial ownership to shift to the upper level, so that further dividend or share disposal flows between that sub-holding (i.e. tax-transparent joint venture), so that factual recipients of income could be taxed at preferential tax treaty rates.

Non-resident intermediate holding company

A non-resident intermediate holding company could be used to reduce WHT on dividends, interest and royalties by applying a favorable tax treaty with Russia. However, the Russian tax authorities may challenge the application of a tax treaty if they consider that the holding company is a conduit company established to obtain a tax benefit (so-called ‘unjustified tax benefit’ concept).

PE issues should also be taken into account.

Local branch

Instead of directly acquiring the target company, a foreign buyer may structure the acquisition through its Russian branch.The taxation of a branch depends on whether it constitutes a PE in Russia. An FLE’s acquisition of shares or participation units of a Russian legal entity is not deemed to create a PE in Russia unless other characteristics of a PE are present.

Where the branch does not constitute a PE in Russia, the tax consequences on the subsequent sale of the target are the same as where a foreign parent company is used as an acquisition vehicle: there is no capital gains tax on shares sold by an FLE unless more than 50 percent of the assets of the target directly or non-directly consists of immovable property located in Russia.

Where the branch constitutes a PE in Russia, capital gains are taxed in the same way as capital gains of the Russian company (20 percent profits tax).

Joint venture

A joint venture may be corporate (usually in the form of an OOO) or not corporate (joint venture agreement). A corporate joint venture is considered a Russian legal entity and normally is subject to the general tax regime.

Where a joint venture is to be set up as a simple partnership, certain conditions must be met. For example:

  • Participants in a joint venture must carry out separate accounting of joint venture operations and operations not related to the joint venture activities.
  • If one of the participants is a Russian legal entity, it should carry out the tax accounting of a joint venture.
  • Only a Russian participant is entitled to recover input VAT.

Choice of acquisition funding

Typically, acquisitions are financed with debt, contributions to equity or hybrid instruments. The main tax issues arising for these alternatives are summarized below.

Debt

Debt financing may be preferable from the tax viewpoint because the buyer can deduct interest expenses for profits tax purposes (subject to certain limitations). Payment of dividends, by contrast, does not give rise to a tax deduction. However, before using debt financing, the company should thoroughly consider certain financial factors and determine whether it is better to borrow from a bank or from another legal entity, related or unrelated.

Deductibility of interest

Generally, interest on debt instruments is deductible for profits tax purposes regardless of whether the loan is taken out for investment purposes or current business needs.

nterest expenses accrued on loans under controlled transactions for the purposes of Russian transfer pricing rules is fully deductible for profits tax purposes if the interest rate is in the range determined by the RussianTax Code. Otherwise, the limitation under the Russian transfer pricing rules would apply.

Interest rates for loans received under controlled transactions (regardless to the amount and term of loan) should not exceed:

  • for loans denominated in Russian rubles (RUB): 180 percent (for periods starting in 2015) or 125 percent (for periods starting in 2016 or later) of a key rate of the Central Bank of Russia (CBR)
  • for loans nominated in euros (EUR): Euro Interbank Offered Rate (EURIBOR) plus 7 percent
  • for loans nominated in Chinese yuan: Shanghai Interbank Offered Rate (SHIBOR) plus 7 percent
  • for loans issued in British pounds: London Interbank Offered Rate (LIBOR) plus 7 percent
  • for loans issued in Swiss francs or Japanese yen: LIBOR in appropriate currency plus 5 percent
  • for loans issued in other currencies: LIBOR in US dollars (US$) plus 7 percent.

The key interest rates of CBR, LIBOR, EURIBOR and SHIBOR should be determined:

  • as at the date of receipt of the loan principal at the borrower’s bank account if fixed interest rate is provided by the loan agreement, or
  • as at the date of recognition of interest income (i.e. end of each month) for other loan agreements.

The applicable borrowing period of LIBOR, EURIBOR and SHIBOR rates should be determined similar to the term of loan agreement.

Firstly, the thin capitalization rule applies where

  • a Russian borrower receives a loan from a related foreign company or an individual that directly or indirectly owns more than a 25 percent share in the Russian borrower, or
  • indirectly owns the Russian borrower through a chain of shareholdings in which each preceding person directly owns more than 50 percent of the shareholding in each subsequent company.

Secondly, the thin capitalization rule applies here a Russian borrower receives a loan from a Russian or foreign person that is treated as related to a foreign company meeting the above criteria if the Russian borrower is:

  • a company that directly or indirectly owns more than a 25 percent share in the foreign company or vice versa
  • an individual who directly or indirectly owns of more than a 25 percent share in the foreign company
  • a company more than 25 percent of which directly or indirectly belongs to the same person that directly or indirectly owns more than a 25 percent share in the related foreign company
  • a person that indirectly holds the foreign company through a chain of holdings in which each preceding person directly owns more than a 50 percent share in each subsequent company and vice versa.

Thirdly, the thin capitalization rule applies to a Russian borrower that receives a loan from any Russian or foreign third party (e.g. bank) and the loan is guaranteed by a related foreign person and/or by a related Russian person.

Loans in the second and third instance above are not treated as controlled debt if certain criteria are met and the lender provides written confirmation as to its compliance with these criteria to the Russian borrower.
Interest paid on controlled debt that exceeds the 3:1 ratio (12.5:1 for companies that perform only leasing activity) is non-deductible and is treated as a dividend that is subject to Russian profits tax withholding when paid.

Exchange losses on loans are fully deductible, and gains are fully taxable. However, the Russian tax authorities may seek to challenge negative exchange losses on interest on the basis of the limitations in the thin capitalization rules or treat the loan as capital investment rather than debt financing.

Withholding tax on debt and methods to reduce or eliminate it

The statutory WHT rate on interest income is 20 percent, whereas the majority of tax treaties, which override domestic law, provide for 0 or 5 percent rates. To obtain treaty relief, the foreign company receiving the interest income should be a beneficial owner and provide the Russian company and its tax agent with:

  • a tax-residency certificate, and
  • documents confirming the beneficial ownership to the passive income being paid from Russia.

Checklist for debt funding

  • The use of a bank loan could help the buyer eliminate or mitigate thin capitalization and transfer pricing problems.
  • The 20 percent statutory WHT rate on interest income may be reduced by applying the provisions of a tax treaty that provides for a lower rate.

Equity

According to Russian law, the contribution of cash by a shareholder (parent company) to the share capital of a Russian company (target company) is not a taxable event, but dividends paid to a parent company are subject to WHT. Where a parent company is a Russian legal entity, dividends paid are subject to WHT at a general rate of 13 percent (0 percent if certain conditions are met). Dividends paid to a foreign parent company are subject to WHT of 15 percent, unless reduced by treaty (WHT can be reduced to 5 percent under some treaties).

Forms of reorganization

Generally, the reorganization of a legal entity is tax-neutral. Neither the reorganized company nor the new company created by the reorganization should be subject to any additional taxation.

According to Russian civil law, the reorganization of a legal entity can take one of five different forms: merger, takeover, split-off, spin-off and conversion.

The Russian Tax Code stipulates that obligations to pay taxes and fees of a reorganized legal entity should be fulfilled by its legal successor(s):

  • On a merger of several legal entities, the legal entity resulting from the merger should be recognized as the successor regarding the obligation to pay taxes and fees of each of the original legal entities.
  • On a takeover of one legal entity by another legal entity, the accessing legal entity should be recognized as the successor to the obligations to pay taxes and fees of the accessed legal entity.
  • On a split-off of a legal entity into several legal entities, the legal entities resulting from the division should be recognized as successors regarding the obligations to pay taxes and fees of the original organization.
  • On a spin-off from a legal entity, no succession to the reorganized legal entity regarding its obligations to pay taxes should arise. Where the reorganized legal entity cannot fulfill its obligations to pay taxes and fees in full due to the separation from a legal entity by one or more legal entities, then, pursuant to a court decision, the separated legal entities may be obligated jointly and severally to pay the taxes and fees of such legal entity
  • On a conversion of one legal entity into a new one, the legal entity resulting from the conversion should be recognized as the successor to the obligations to pay taxes and fees of the reorganized legal entity.

Hybrids

Hybrid instruments are classified as debt or equity for tax purposes depending on their legal form, rather than on their economic substance. Thus, in principle, hybrid instruments, such as profit-sharing loans and interest-free loans, are classified as debt for tax purposes. In theory, the tax authorities may claim in arbitration court that such instruments are not debt by asserting that they are fictional instruments that actually disguise the distribution of profits. However, the tax authorities’ chances of being successful in court are very low. Note that hybrid instruments are very rare in Russia.

Discounted securities

According to the Russian Tax Code, any previously determined income (including a discount) received from any kind of debenture is interest income and subject to a 20 percent tax WHT.

Deferred settlement

An acquisition often involves an element of deferred consideration, the amount of which can only be determined at a later date on the basis of the business’s post-acquisition performance. The Russian Tax Code has no specific provisions on the taxation of such transactions; the tax consequences depend on the wording of relevant supporting documentation and the relationships between the parties. Generally, deferred settlement could be taxed as follows (depending on whether foreign or Russian legal entities are involved):

  • For a foreign seller with no PE in Russia, the Russian buyer’s obligation to withhold tax arises at the moment of payment. Therefore, deferred settlement payments to foreign companies should be subject to Russian WHT (if any) at the moment of payment.
  • The situation where deferred settlement is due to the Russian legal entity is more complicated and depends on the precise contract terms and the tax policy of this Russian legal entity. A tax liability could arise on the receipt or accrual of deferred settlement amounts.

Other considerations

Some of the many other considerations that should be taken into account when structuring M&A transactions are as follows:

  • The target’s business could be transferred to a new legal entity.
  • A simple partnership with joint activities could be formed.
  • Many other options and combinations are available, depending on the specifics of the target and the transaction. Non-tax factors, such as company law, anti- monopoly provisions and currency controls, should be considered.

Concerns of the seller

The tax consequences for the seller depend on whether it is a Russian legal entity or an FLE.
A seller that is a Russian legal entity is subject to a 20 percent tax on capital gains, provided its expenses are supported by the required documents. Where there is no documentary evidence of expenses, the gross income from the sale is subject to taxation.

A seller that is an FLE is exempt from tax on capital gains unless more than 50 percent of the assets of the target company consist of immovable property located in Russia (otherwise, capital gains are subject to 20 percent profits tax).

Where the seller is an individual, capital gains are subject to 13 percent income tax for Russian residents and 30 percent for non-residents.

Tax-free sale of shares

As of 1 January 2011, a 0 percent profits tax rate applies to income received from the sale of shares in Russian companies that are not publicly traded (and publicly traded shares in high technology companies) if a taxpayer held the shares for more than 5 years. The tax authorities interpret this provision as applying to shares acquired after 1 January 2011.

Tax rules for reduction of charter capital

As of 1 January 2018, income in the form of property and property rights received by a shareholder on the reduction of charter capital of a subsidiary is exempt from profits tax (provided certain conditions are met).
On the sale of shares and participation interests, capital gains realized should be increased by the amount of previously exempt income.

Company law and accounting

Commercial entities in Russian are consist of companies, partnerships, production cooperatives and state and municipal unitary enterprises. The most widespread are AOs and OOOs.

Joint stock company (AO)

  • An AO is a legal entity that can be either public or non- public. The shares of public AO are traded on a stock exchange.
  • The minimum share capital for a public AO is RUB100,000; for a non-public AO, it is RUB10,000.
  • The minimum number of shareholders (public and non- public) is one (unless the only shareholder is a legal entity owned by one person).

Limited liability company (OOO)

  • The minimum charter capital for an OOO is RUB10,000.
  • The minimum number of participants is one (unless the only participant is a legal entity owned by one person).
  • The maximum number of participants is 50.
  • Participants are not liable for the company’s debts.
  • Shareholders are not liable for the company’s debts.

The taxation regime does not depend on the legal form of the company.

Anti-monopoly legislation

Generally, the anti-monopoly law sets certain restrictions on transactions and contractors. A number of transactions require preliminary consent from the responsible authorities or a simple notification after the event.

For example, prior consent is required for:

  • a reorganization in the form of a merger of commercial organizations where:
    • the aggregated net book value of their assets at the last reporting date preceding the request to the anti- monopoly authorities exceeds RUB7 billion
    • the aggregated sales turnover for the year preceding the merger exceeds RUB10 billion.
  • certain sales of shares (participation units), rights and/or property where:
    • the aggregated net book value of the target and buyer’s assets exceeds RUB7 billion
    • the aggregated sales turnover for the year preceding the deal exceeds RUB10 billion and the net book value of the target’s assets exceeds RUB400 million.

Group relief/consolidation

The conditions that need to be met to obtain group relief effectively mean that there are few consolidated taxpayers in Russia.

For other Russian legal entities that do not form consolidated tax groups but have branches or representative offices, the profits tax is calculated on a consolidated basis by the head office. Profit is attributed to each branch based on a proportion of the average number of employees of the branch and the residual value of the depreciated fixed assets of the branch.

Tax-grouping

As of 1 January 2012, tax-grouping was introduced in Russia. This regime applies to a group of companies where one company has a direct or indirect participation of not less than 90 percent in the charter capital of each group company. Tax-grouping is only available where, for the preceding year, the total amount of taxes paid by the applying companies is not less than RUB10 billion, total sales are not less than RUB100 billion, and total assets as at 31 December of the preceding year are not less than RUB300 billion. Tax-grouping is available for profits tax only and should be formalized by an agreement signed by the participating companies. The tax group is formed for a period of not less than 5 profits tax periods (calendar years).

The accumulated tax losses incurred by the taxpayer before the tax grouping agreement is concluded are not deductible against the consolidated profits of the tax group.

Where the taxpayer chooses to exit the tax group, these losses become available for deduction.
Similarly, individual taxpayers cannot utilize part of tax losses incurred by the tax group if they choose to exit the tax group or are no longer eligible for the tax consolidation.

Considering the turnover and assets requirements and the limitations on utilization of accumulated tax losses, KPMG in Russia expects that tax-grouping will remain rare in Russia.

Until 2018, the creation of new consolidated tax groups has been suspended.

Transfer pricing rules

As of 1 January 2012, new transfer pricing rules were introduced in Russia. These rules differ significantly from the previously used formal approach and generally correspond to OECD principles. Under the new rules, the tax authorities should calculate price adjustments:

  • based on prices available on comparable transactions having the same or similar financial or commercial conditions, including functions performed, assets employed and risk undertaken by the parties of a transaction
  • by applying the most suitable pricing method that, in the facts and circumstances, enables a justified conclusion regarding the level of prices
  • based on market price intervals or profitability intervals estimated based on available information regarding transactions between unrelated parties
  • as symmetrical adjustments for both parties of the transaction (e.g. if sales revenue of one party of the transaction is increased, cost of sales of the other party should be increased accordingly).

Under the Russian transfer pricing rules, as 1 January 2012, the following transactions are subject to transfer pricing regulation (so-called ‘controlled transactions’):

  • cross-border transactions between related parties (any materiality)
  • cross-border transactions with oil and oil products, ferrous and non-ferrous metals, precious metals and precious stones (e.g. goods traded on international stock exchanges) where proceeds from transactions with the same counterparty exceed RUB60 million in 1 calendar year
  • transactions where one of the parties is a tax resident in a country included in the Russian Ministry of Finance’s blacklist and where proceeds from transactions with the
  • same counterparty exceed RUB60 million in 1 calendar year
  • transactions between related parties where:
    • the total proceeds from the transactions exceed RUB1 billion
    • one party is subject to the mineral extraction tax and the total proceeds from the transactions exceed RUB60 million
    • one party is subject to the unified tax on imputed income or unified agricultural tax regime while the other party does not apply these tax regimes and the total proceeds from the transactions exceed RUB100 million (as of 2014)
    • one party applies a 0 percent profits tax (e.g. currently is a resident of the innovation center Skolkovo) while the other party does not apply this tax rate and the total proceeds from the transactions exceed RUB60 million
    • one party is a resident of a special economic zone in Russia while the other party is not a resident of a special economic zone and the total proceeds from the transactions exceed RUB60 million (as of 2014).

Transactions between members of a consolidated group of taxpayers are not subject to the transfer pricing regulations. The regulations also do not apply to transactions between companies that simultaneously meet the following criteria:

  • are registered in the same region of the Russian Federation
  • do not have separate divisions in different Russian regions or outside the Russian Federation
  • do not pay profits tax in different regions of the Russian Federation
  • do not have tax losses
  • none of the parties are a payer of the mineral extraction tax and the transactions do not fall under points 4.b–4.e above.

Controlled transactions involve goods, works and/or services. When analyzing the comparability of the commercial and financial terms of these transactions with the terms of uncontrolled transactions, a number of indicators should be taken into account, including:

  • characteristics of the goods, services or works
  • functions of the parties to the transaction
  • terms and conditions of the contracts
  • economic environment
  • market (commercial) strategies of the parties to the transaction.

Fines are being introduced for violating the transfer pricing law. For example, if taxes are underpaid because of non-arm’s length prices, the following fines apply:

  • for 2014–2016 — fine of 20 percent of the unpaid taxes
  • for 2017 and later years — fine of 40 percent of the unpaid taxes but not less than RUB30,000.

The following methods can be used to determine the range of arm’s length prices: comparative uncontrolled price (CUP) method, re-sale price method, cost plus method, comparable profitability method, and profits allocation method.

The CUP method usually is the preferred method. However, for transactions in which goods are purchased and re-sold without any modification, the re-sale price method is the preferred method. Where the preferred method cannot be applied, the method that is most appropriate for the transaction should be applied.

Taxpayers must keep transfer pricing documentation as evidence that the prices used are within the range of arm’s length prices and submit information to the tax authorities for all controlled transactions.

For taxpayers who qualify as ‘major taxpayers’ (as defined in the Russian Tax Code), the new law introduced the possibility of concluding advance pricing agreements (APA) with the tax authorities (i.e. where the taxpayer and the tax authorities agree in advance to apply a specific methodology to calculate the range of arm’s length prices). A duty of RUB2 million is payable for the signing of an APA.

With these recent changes, Russian transfer pricing legislation has become more detailed and well developed, which could enable the tax authorities to more successfully defend their positions in court.

Dual residency

Generally, dual residency conflicts are resolved by the relevant tax treaty by means of tax credit or exemption. Since obtaining these usually involves certain bureaucratic and time- consuming procedures, intentional dual residency is usually not used by Russian companies (the Russian residency of which is defined by registration).

Foreign investments of a local target company

Russian legislation limits the activities of non-Russian investors participating in companies that are of strategic value to Russia (so-called ‘strategic companies’). These activities include:

  • exploration of subsoil and extraction of mineral resources on land plots of national significance
  • aerospace activities
  • certain services provided by a natural monopoly or a company with a dominant position on the Russian market
  • harvesting of live aquatic resources
  • activities controlling hydrometeorological and geothermal processes and events
  • certain activities related to the use of nuclear and radiation-emitting materials
  • certain activities related to the use of encrypting facilities and bugging equipment
  • military-technical activities.

Non-Russian investors (i.e. non-Russian private companies, non-Russian individuals and Russian companies controlled by non-Russian companies or individual(s)) are permitted to carry out transactions that would result in their obtaining control over a strategic company. However, such transactions, among others, must be approved by state authorities.

Comparison of asset and share purchases

Advantages of asset purchases

  • The price of purchased assets can be depreciated for profits tax purposes.
  • If the acquiring company is in a loss position, such losses may be used against profits generated by the acquired business in the case of merger or takeover.
  • Possible to acquire only those assets that the buyer really needs (which could be useful, among other things, where the buyer wants to acquire only part of a business).
  • Tax liabilities and tax exposures of the target company could remain with the target company and not transfer to the buyer.
  • Where the target merges with its shareholder after the sale of its assets, the target’s profits of the target
  • accumulated before the transfer of assets are transferred to the shareholder without additional taxation. Under
  • a share purchase, such profits, when distributed, are subject to WHT at 13 (0) or 15 percent, or less in accordance with a tax treaty.

Disadvantages of asset purchases

  • The sale of assets is subject to VAT, except for assets and property rights of a bankrupt company, which may result in a negative cash flow impact for the buyer. If the buyer’s business is VAT-exempt, the input VAT is capitalized.
  • Profits tax could be due if assets with a high market value and low tax basis are sold.
  • Accumulated tax losses remain with the seller.
  • Losses incurred on the sale of fixed assets are not immediately deductible and are recognized evenly over the period of the remaining useful life of the assets.
  • Customs risks cannot be eliminated.
  • An asset deal could be reclassified as the sale and purchase of an enterprise as property complex, resulting in inheritance of all liabilities thereof.
  • It may not be possible to transfer all assets to another company where, for example, some assets are used as collateral securing loans and borrowings.
  • Transfer of licenses might be impossible.
  • Assets not reflected in the Russian accounting principles (RAP) balance sheet may not be transferred.
  • Difficulties in interrupting a long production cycle or construction in progress for the transfer of assets.
  • Difficulties in obtaining consent from minority shareholders for the sale of assets.
  • Long registration process of some asset deals.
  • Significant VAT and customs duties clawback.

Advantages of share purchases

  • Capital gains from the sale of shares could be tax-exempt in certain cases if the deal is properly structured.
  • Sale of shares is not subject to VAT.
  • Tax losses accumulated by the target prior to acquisition may be used after the changes in shareholding of the target.
  • The share acquisition procedure is technically less complicated than an asset deal; however, it may be necessary to perform anti-monopoly procedures.

Disadvantages of share purchases

  • All tax liabilities and tax risks of the target are inherited.
  • Capital gains received by the seller could be subject to taxation in Russia: 20 percent profits tax payable by a corporate seller or 13 percent personal income tax payable by an individual seller who is a Russian tax- resident.
  • Goodwill cannot be depreciated for profits tax purposes; only the net book value of assets can be depreciated.
  • Consolidation of profits and losses of the buyer with the profits and losses of the target company is not allowed (except in the case of a post-acquisition merger or takeover).

KPMG in Russia

Irina Suvorova
AO KPMG
Naberezhnaya tower Complex Block C
10 Presnenskaya Naberezhnaya
Moscow 123317 Russia

T: +7 495 937 4477
E: isuvorova@kpmg.ru

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