Overview (September 2010) - International Law Office

Introduction
Forms of ownership and privatisation
Choosing a property
Land Register
Valuation and purchase price
Financing
Purchase agreements
Acquisition costs and taxes

Introduction

The Russian real estate market has been booming since the 1990s and remains attractive in spite of the economic crisis. In addition to Moscow and St Petersburg, other regions are steadily becoming more appealing to foreign investors, particularly for industrial and manufacturing purposes. Many major western corporate groups have established production facilities in Russia and purchased land there.

Western investors often find Russian real estate law strange because of its separation of land on the one hand and buildings and installations on the other. Expert local advice is indispensable, but many legal and practical questions can be resolved rapidly and reliably.

In Russian law, the term 'real estate' includes land, natural resources and other objects permanently fixed to the land, including buildings and installations. Developed land does not exist as a single legal unit - such land is held to consist of at least two separate entities: the land and the buildings or other permanent structures on it.

In addition, the term 'structure' is widely interpreted and includes utility connections and other permanent structures above and below ground, such as fences and tarmac and concrete surfaces.

Commercial or residential premises can be legally separate from the rest of the building in which they are located; they can be entered as separate real estate objects in the Land Register and sold independently of the rest of the building. The land and the building standing on it may belong to different owners. However, if the building and the land are owned by the same person, they cannot be sold separately.

Forms of ownership and privatisation

Land and buildings may be owned by the state, a municipality or a private owner. Land belonging to the Russian Federation or its constituent entities is considered to be state owned. Land owned by cities, villages, districts or municipal areas is owned by the community. There continue to be public properties whose owner has not yet been specified in the Land Register. Usually, municipal authorities have rights of disposal over such land.

To a certain extent, private land ownership became legally possible in law in 1990. However, mass privatisation and the general purchase and sale of land began after the new Land Code took effect in 2001. As a result, a vast amount of land is available for lease or purchase from public authorities. Buildings and structures have been authorised for privatisation and actively privatised since the 1990s, so there are now fewer privatisations involving buildings.

A special situation exists in Moscow. Until 2008 the city's government created serious political, legal and bureaucratic impediments to the acquisition of land. As a result, most land in the city is still under public ownership and is leased long-term to private lessees.

Some types of land and building are excluded from privatisation and must remain under public ownership. These include:

• forests;
• waterways;
• specially protected areas;
• areas related to state security; and
• public roads and land required for transport infrastructure, such as public railway stations and airports.

However, such property can mostly be leased long-term from the public authorities. For historical reasons, long-term leases of land and property rental are commonplace, the term of such leases usually being up to 49 years. Long-term leases may be assigned or pledged, sometimes without the consent of the lessor; thus, such leases have a certain marketability.

In deciding whether to lease or rent property, it may be significant that transactions with public authorities must be conducted by tender under the Privatisation Act or the Land Code. However, exemptions apply if, for example, the owner of a building wishes to acquire or lease the land on which it stands.

In theory, foreign investors can acquire any private real estate or real estate that can be privatised, but restrictions apply in practice. Agricultural land may not be sold to foreign legal persons or individuals,(1) but may be leased. Foreign legal persons and individuals may not own land in border areas or other areas specified by statute. Border areas will be specified by the president in accordance with the Law on State Borders; however, a register has not yet been established.

There are no restrictions on foreign persons or companies holding a participation in the acquisition of buildings, installations or buildings under construction.

Choosing a property

Anyone intending to acquire a production facility, a logistics centre or other commercial property should first choose a specific location. The factors to consider are:

• geographical situation;
• transport infrastructure and utility connections;
• benefits for investors; and
• availability of trained staff.

All of these factors should be considered together and all may differ significantly between regions.

Once a decision has been made on one or more potential locations, the search for a suitable property begins. Usually, a real estate agent is engaged. However, it is often useful to enquire directly with the government of the region or municipality about suitable land or buildings. This has the advantage of establishing initial contact with the authorities and limiting the search to properties that are suitable from a planning perspective - often, the relevant plans may be made available for inspection.

Care should be taken with the choice of a real estate agent and the contracts that such agents propose. There is no statutory regulation of real estate agents in Russia. A proportion of the fee - depending on the contractual provisions - may be due irrespective of whether a successful introduction to a property is made.

Land Register

Rights to land and other real estate and transfers must be entered in the Land Register. In addition, leases of over one year, mortgages, servitudes and certain other encumbrances must be shown. All properties, including land and buildings/installations, are entered in the Land Register. Under certain conditions, even rooms can be entered as separate properties.

Only properties entered in the Land Register can be the subject of a purchase agreement. However, not all properties that existed before its introduction have been entered. This often prevents the rapid resale of properties, as the old rights must be entered before the property can be resold. For the registration of a transfer of ownership in the Land Register, a cadastral plan (the so-called 'cadastral passport') is necessary, unless it has previously been filed with the registration authorities. The cadastral plan is obtained from the Real Property Cadastre. The Real Property Cadastre covers land and buildings. It contains important technical information about real property, such as maps; the area, classification and permitted use of the land; and its cadastre value.

Information about buildings or installations located on relevant land plots can also be requested. Although the Land Register is regarded with confidence and is reliable according to the wording of the law, it does not provide absolute protection for a property purchase made in good faith. In exceptional cases, property owners that have lost their property (eg, by having it stolen) can recover it from a good-faith purchaser. In addition, the authority which maintains the Land Register has only limited liability for technical errors in the entries or even for negligence in the examination of documents. As registration errors are relatively frequent, the ownership and encumbrances of the property should be comprehensively verified before an investment project is implemented. This requires an examination not only of register extracts, but also of the documents on which they are based.

Valuation and purchase price

When considering a property, it is vital to obtain information about all of its factual and legal features, which often means conducting comprehensive due diligence. Possible risks can be identified and either minimised in advance or made subject to security from the vendor in the purchase agreement.

A number of criteria and circumstances are significant in ascertaining a realistic valuation and purchase price.

In Russia, all land is classified in one of the following categories: agriculture, settlements, industry, state reserves, forestry and waters, and specially protected land and territories. Land may be used only as its categorisation specifies. It can be reclassified (eg, from agricultural to industrial), but the process of reclassifying land as an industrial area usually takes around one year. Moreover, the possibilities for reclassification are limited in the case of certain categories.

Land within each category falls under main and ancillary uses. For example, within a settlement area, land can be used for residential purposes (ie, its main use) and also some land plots for agriculture or industrial projects or as public parkland (ie, its ancillary use). Only industrial areas and certain types of settlement area are suitable for the construction of industrial buildings or infrastructure.

Changing a property's use is normally simpler than reclassifying land. In the case of buildings, installations and rooms, a distinction is made between residential and commercial properties. Residential space is a self-contained area suitable for long-term residence. Commercial space may be used only for commercial purposes - a further distinction is made according to use as, for example, a warehouse, a workshop or a shopping centre. A change in permitted use usually takes place in the course of renovation or reconstruction, for which a construction permit is usually required.

Local construction restrictions are supposed to be contained in the municipal urban development plan. However, many municipalities have not yet issued such a plan. In such cases, the investor must obtain the municipality's agreement to the proposed construction and secure the necessary assurance that it will be taken into account in future urban development planning.

Connections to public roads and utility networks are often not automatic. If such connections do not already exist, either the owner or lessee of the land or the municipality can negotiate with public utility operators on the conditions for connection, including connection points, capacities and prices. Agreed terms are valid for at least two years.

Financing

The financing of a property can be secured by a mortgage, which is entered in the Land Register. In general, a building can be mortgaged only together with the land on which it stands or with the lease to the land. This applies in any event if the owner of the building is also the owner or lessee of the land.

In the case of a loan specifically for a real estate purchase, a mortgage comes into being by law. Nevertheless, it is advisable to conclude a separate mortgage agreement to state the conditions explicitly and to ensure that the mortgage is registered in the Land Register.

The mortgage must be entered in the Land Register. A mortgage established by law must be entered together with the entry of the change of ownership. In the case of a contractual mortgage, a joint application by the creditor and the debtor is required, with the exception of a notarised mortgage, where only one party need make the application.

At the end of 2008, the Russian mortgage and pledge law was fundamentally reformed, closing certain loopholes and considerably improving the position of creditors, particularly with regard to out-of-court execution under the mortgage deed.

If a mortgagor becomes insolvent, the creditor obtains at least 70% of the proceeds from the sale of the mortgaged property, irrespective of other debts. If the mortgage secures debts under a loan agreement with a bank, this guaranteed minimum amount is increased to 80% of the sale proceeds.

A property can be secured by a pre-contract so that the necessary review can be conducted before purchase. Such a pre-contract may stipulate the purchaser's right of rescission if the result of the due diligence is unsatisfactory. The pre-contract need not be notarised, but it must be in writing. Pre-contracts are not entered in the Land Register.

Russian law does not recognise the principle of abstraction. The validity of the assignment of real property depends directly on the validity of the transaction on which it is based (ie, the purchase agreement). However, ownership passes to the purchaser only when the change of ownership is registered. According to law, registration should take no more than one month; however, in practice, this may vary significantly and delays cannot be ruled out.

Purchase agreements

A purchase agreement for real estate in Russia must be subject to Russian law.

The Russian state courts at the place where the real estate is located have exclusive jurisdiction over disputes relating to rights in real property. However, for other aspects of a real estate agreement (eg, the payment of the purchase price), disputes can be referred to a Russian or foreign arbitration tribunal.

A purchase agreement for land, buildings, non-residential rooms or installations must be concluded in writing; oral agreements are invalid. Purchase agreements for residential properties and apartments are formally valid only after they are entered in the Land Register. A change of ownership is usually recorded simultaneously. In the case of other properties, the contract itself is not entered in the Land Register; only the change of ownership is recorded.

Although not customary, notarisation of the purchase agreement can be undertaken in order to increase the security of the conclusion of the contract.

The contractual parties' official data and papers are necessary only when making an entry in the Land Register. The same conditions apply to foreign and Russian purchasers. For the entry in the Land Register, an individual must present his or her identity documents. A legal person must show proof of a current entry in the Commercial Register, as well as its articles of association.

All documents issued abroad must be legalised or marked with an apostille before filing with the Land Register. Documents in foreign languages must be accompanied by a certified translation.

The purchase agreement must contain a precise description of the property and the purchase price. It must also state the name, registered office and commercial register number of the parties, as well as details of the signatories. The property must be described in the contract. This description must correspond to the data in the purchaser's ownership documents and must be consistent with the data in the Land Register and Real Property Cadastre.

If the description of the property is insufficient or incorrect, or the purchase price is not agreed, the entire contract may be invalid. The agreed purchase price is payable in roubles if the transaction is exclusively between Russian entities or individuals. Foreign parties may pay for property transactions in euros, US dollars or other currencies. If payment is made in roubles, the price can, if desired, be stated in a foreign currency, with payment then being made at the agreed exchange rate (often the official rate set by the Central Bank of Russia).

There is no special procedure for securing performance of real estate transactions. Russian law does not stipulate entry in the Land Register of a priority notice to secure the purchaser's rights. In practice, part of the purchase price is paid in advance, with the remainder being paid after the entry of the change of ownership in the Land Register. Unless otherwise agreed in the contract, the payment of the remainder is secured on entry of the change of ownership automatically by a mortgage on the property; this potentially gives rise to a conflict over the mortgage in favour of the financing bank, which should be avoided by contractual provisions.

When entering a change of ownership in the Land Register, both parties must submit a joint application, their data and official papers and the purchase agreement signed by both of them. Normally, one of the parties - usually the vendor - undertakes the filing of the documents with the Land Register, with the other party providing the necessary authority. For security, mutual power of authority can be granted in the purchase agreement so that the purchaser can, if necessary, undertake the entry itself.

Apart from the property, parties and price, the purchase agreement usually stipulates:

• the method of payment of the purchase price;
• the transfer of possession, use and encumbrances, generally before entry of the change of ownership in the Land Register;
• the vendor's warranties and liabilities of the vendor with regard to significant legal and technical features of the property;
• indemnity against existing encumbrances and third-party rights; and
• responsibility for ensuring entry of the change of ownership in the Land Register and the distribution or allocation of related costs.

Acquisition costs and taxes

The related taxes and the cost of entry of the acquisition of ownership in the Land Register are usually borne by the purchaser in accordance with the contractual provisions. There is no land acquisition tax in Russia. Apart from legal fees, real estate agent fees and other service providers' fees, the following costs and taxes arise with the acquisition of real estate.

Registration fees
If the purchaser is an individual, the fee for the entry of the change of ownership in the Land Register is approximately €25; if the purchaser is a legal person, the fee is approximately €400. Each party is legally required to pay 50% of the registration fee, but in practice the purchaser usually bears all of these costs.

Value-added tax
The sale of land plots and apartments is exempt from value-added tax (VAT). The sale of other properties, in particular buildings, is subject to VAT at 18% if the vendor is generally liable for VAT. Thus, VAT usually applies to contracts between legal persons and between a legal person as vendor and an individual as purchaser. For sales by individuals, VAT does not usually apply.

VAT is included in the amount payable by the purchaser. Since the purchaser must transfer the VAT directly to the state, it must be shown separately in the purchase agreement. The amount of VAT can be reclaimed later as prepaid tax by the purchaser if it is VAT registered and paid.

Land tax
A land tax applies to owners of land and an asset tax to owners of other property. It is payable yearly by the landowner. The rate is set by the municipalities and may not exceed 0.3% (for agricultural land) or 1.5% (for all other land) of the land's cadastral value. The cadastral value is stated in the cadastral certificate of the land and is often less than the market value.

Asset tax
The owner of a building or other installation is liable for this tax, the rate of which is specified by the state: it may not exceed 2.2% of the value of the property for a legal person or 2% for individuals. Legal persons pay the asset tax quarterly to the state, while individuals may pay semi-annually. The tax base for the asset tax is often less than the market value of the property.

Income and profit tax
Income derived from transactions involving real estate is subject to corporate profits tax, personal income tax or taxation at source, depending on the details of the transaction. No double taxation relief is available for such transactions. For taxation purposes, expenses incurred in acquiring the real estate may be deducted from the income, provided required documentation is supplied, although Russian-resident individuals may claim expenses of up to one million roubles without documentation. Income is taxed at the rate of 20% for corporate entities, 13% for individuals who are Russian tax residents and 30% for individuals treated as non-residents for tax purposes.

Russian-resident individuals may also enjoy full exemption, provided that the real estate is owned continuously for at least three years before a transaction to alienate the property.

For further information on this topic please contact Elena Frolovskaya at Noerr by telephone (+7 495 799 56 96), fax (+7 495 799 56 97) or email (elena.frolovskaya@noerr.com).

Endnotes

(1) The same restriction applies to Russian legal persons with a foreign participation of more than 50%.