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04 December 2020
Federal Law 368 of 11 September 2020, which could significantly simplify the tax payment process for the owners of a large number of controlled foreign corporations (CFCs) and significantly reduce such taxes in some cases, was adopted in Russia in November 2020. It is fair to say that, in a sense, the new legislation introduces an alternative simplified tax system for CFC owners. However, the new tax regime will not be beneficial to all taxpayers.
The new law allows taxpayers (ie, physical persons (this option is not provided for CFC owners and corporate taxpayers)) to pay tax on a fixed income received from a CFC. The amount of fixed income for the 2020 tax period is Rb38.4 million (approximately $500,000). In subsequent years, the amount will be reduced to Rb34 million. It is important that this amount of fixed income does not depend on the number of CFCs controlled by the individual concerned, as well as the financial results of their activities. Thus, the total tax on this amount will be approximately Rb5 million. If one CFC has several controlling individuals who intend to switch to this tax regime, each of them will have to pay this tax of about Rb5 million. Therefore, the transition to this tax regime will not be beneficial to the owners of so-called 'dormant', low-activity and low-profit companies. However, if there are several companies which are profitable, the new CFC tax system may significantly facilitate the preparation and submission of CFC reporting to the Russian tax authorities and help to save on taxes in case of significant incomes.
To switch to a fixed income tax system under the 2020 tax base, applications must be submitted no later than 1 February 2021. Subsequently, for the next tax periods, it will be possible to switch to this tax regime until 31 December of the reporting year. In the event of the transition to the new regime, taxpayers will have to apply it for at least three years if such a transition occurs in 2020 or 2021 and at least five years if the transition occurs starting from 2022.
The new tax regime does not exempt the controlling person from filing CFC notifications (the deadline for filing such a notification for individuals is 30 April of the following year when the CFC earns income), but now there will be no need to file the CFC tax returns.
The advantage of the new tax regime is, first of all, in the simplicity of declaration. Taxpayers which control several CFCs located in different jurisdictions complain about difficulties in including information on the financial results of their foreign companies in the Russian declarations, especially when there are many such companies and, for example, the financial year in the country of their location does not coincide with the calendar year taken in Russia as the reporting period. The need to submit documents confirming the CFC tax base from the country of its location with translation into Russian to the Russian tax authorities may also become a problem. The new regime exempts taxpayers from all of the above.
However, the new regime also has obvious disadvantages. The first and main disadvantage is the impossibility to set off the paid-fixed tax against the tax payable on receipt of dividends from a CFC (such an opportunity is provided for the usual CFC tax regime by Clause 66 of Article 217 of the Tax Code). Thus, if the controlling person receives the main income from CFC activities in the form of dividends, the new regime will most likely not be beneficial to them, since both tax on dividends and tax on a fixed income will have to be paid.
The second obvious disadvantage is that it is impossible under this tax regime to use the mechanism for avoiding double taxation provided for by Clause 11 of Article 309.1 of the Tax Code. When paying a CFC income tax in the usual way, it is possible to deduct taxes withheld in the country of the CFC's location from tax paid in Russia. The new tax regime provides no possibility of such a deduction.
To sum up, a CFC fixed income tax regime may be beneficial to those controlling persons who have several CFCs in a country with a low taxation level and, mainly, do not receive the dividend income from these CFCs.
For further information on this topic please contact Valery Narezhniy at Gorodissky & Partners by telephone (+7 495 937 6116) or email (firstname.lastname@example.org). The Gorodissky & Partners website can be accessed at www.gorodissky.com.
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