Russian authorities started working on the new List soon after the Russian Federation was included in the EU list of non-cooperative jurisdictions adopted by the Council of the European Union. As a result, the Russian Ministry of Finance captured as ONCT all unfriendly jurisdictionsApproved by Order of the Government No. 430-r dated 5 March 2022 together with administrative units, overseas and other territories under their control. In particular, the current version of the Order has expanded the List from 42 jurisdictions and territories to 91. It currently includes, for example, such jurisdictions and countries (previously very common for structures involving Russian business) as Cyprus, the Netherlands, Singapore, Switzerland, etc.
It is worth noting that, despite certain positive steps taken by the Russian Ministry of Finance to develop and agree on a more comprehensive double tax treaty with the UAE, the UAE so far remains on the current version of the List and is therefore qualified for Russian tax purposes as an ONCT jurisdiction.
What are the tax consequences of a jurisdiction being included on the List?
The Russian Tax Code imposes a number of restrictions disqualifying tax preferences or incentives for transactions where one of the parties is an ONCT resident. The inclusion of such country or territory on the updated List will effectively mean:- the impossibility of (i) applying a 0% profits tax rate (including by a qualifying international holding company) or (ii) claiming the personal income tax exemption for capital gains earned on the sale of shares in foreign companies that are ONCT residents (clause 4.1 of article 284, article 284.2, article 284.7 and clause 17.2 of article 217 of the Russian Tax Code);
- the inability for a Russian company when receiving dividends (including a qualifying international holding company) to apply the 0% profits tax rate to dividends distributed by a foreign company that is an ONCT resident (sub-clause 1 of clause 3 of article 284 of the Russian Tax Code);
- a restriction on applying the profits tax exemption for property and property rights received gratuitously, if the transferor is an ONCT resident (sub-clause 11 of clause 1 of article 251 of the Russian Tax Code);
- the impossibility for a qualifying international holding company acting as a tax agent to apply reduced withholding tax rates in respect of certain types of income (eg interest, royalties) paid to ONCT residents (sub-clause 4 of clause 4 of article 284 of the Russian Tax Code);
- the impossibility, in a number of cases (eg from the perspective of the effective tax rate test), of applying income tax exemption for a controlled foreign company (CFC) that is an ONCT resident (sub-clause 7 of article 25.13-1 of the Russian Tax Code);
- for transfer pricing purposes (“TP”), transactions (or a group of transactions) with ONCT residents in excess of RUB120 million will be recognised as controlled transactions regardless of the existence, as such, of interdependence between the parties to such transactions.
What are the non-tax consequences of a jurisdiction being included on the List?
In addition to tax, it is also important to note a number of non-tax (industry-specific) restrictions imposed on interaction with ONCT residents. Specifically, such persons may not directly or indirectly (including under various agreements and corporate instruments for the exercise of management rights) control more than 10 percent of shares (participation interest) in the following organisations:- microfinance organisations (clause 1 of part 1 of article 4.3 of the Federal Law “On Microfinance Activity”);
- insurance organisations (clause 6 of part 8 of article 32.1 of the Federal Law “On Organising Insurance Business”);
- management companies of investment funds (clause 1 of part 1 of article 38.1 of the Federal Law “On Investment Funds”);
- organisations carrying out activities of a trade organiser (clause 1 of part 1 of article 7 of the Federal Law “On Organised Trading”);
- clearing organisationsA 5% threshold applies to clearing organisations – an ONCT resident may not control five or more percent of the votes attributable to the voting shares (participation interest) constituting the share capital of a clearing organisation. (clause 1 of part 1 of article 7 of the Federal Law “On Clearing, Clearing Activities and Central Counterparty”);
The problem of applying the List over time for tax purposes
For many taxpayers this practical issue is extremely important. Despite the fact that Order of the Ministry of Finance No. 86n expressly contains an indication of the date of its entry into force from 1 July 2023, various experts reasonably express the view that from a tax perspective this provision will not be consistent with the legal positions of the Constitutional Court regulating how the tax legislation should apply from a timing perspective, since the enactment of the List from 1 July 2023 leads to the “splitting” of the income tax period in half.In particular, since Order No. 86n of the Russian Ministry of Finance (“Order No. 86n”) was adopted in accordance with sub-clause 1 of clause 3 of article 284 of the Russian Tax Code, Order No. 86n is an act of legislation on taxes and levies and should, by virtue of clause 5 of article 5 of the Russian Tax Code, enter into force under the same rules of article 5 of the Russian Tax Code. In accordance with paragraphs one and five of clause 1 of article 5 of the Russian Tax Code, acts of legislation on taxes enter into force no earlier than one month after the date of their official publication and no earlier than on the first day of the next tax period for the relevant tax.
The rule on the entry into force of tax legislation within the terms expressly provided for by these acts, but no earlier than the date of their official publication, applies only to acts (i) abolishing liability, (ii) establishing additional guarantees, or (iii) otherwise improving the position of taxpayers or abolishing tax obligations. This is in line with the position of the Constitutional Court of the Russian Federation expressed in Ruling No. 1837-O dated 29 September 2016, in which the Constitutional Court indicated that, depending on the specific content of a regulatory act, the general rule – “upon expiration of one month and no earlier than on the first day of the next tax period” – shall be applied taking into account the special regulation in respect of acts improving the situation of taxpayers: such acts may enter into force on the dates expressly provided for by these acts, but no earlier than the date of their official publication (clause 1 of article 5 of the Russian Tax Code). There is no doubt that in the tax sense Order No. 86n, on the contrary, entails a worsening of the taxpayers’ position, and therefore should enter into force from the first day of the next tax period, ie from 1 January 2024.
It is important to emphasise that the Russian Constitutional Court in its Resolution No. 17-P dated 2 July 2013 specifically noted that taxpayers in order to organise the planning of economic activities should be aware in advance of the composition and content of their tax liabilities, so as to be able to take into account in advance the related costs as part of the costs of economic activities. The costs of fiscal payments should not be of a sudden nature, acting as an insurmountable obstacle to the implementation of economic freedom.
Therefore, in order to properly determine Russian income tax consequences of transactions and financial operations performed after 1 July 2023, a further in-depth review and consideration are required to ascertain specific conditions of the executed transactions and assess potential risks involving the application of Order No. 86n.
Key findings and practical aspects
The key point is the fact that the List has more than doubled and includes jurisdictions, which in the conventional sense have never been used in practice to minimise taxes. Since the updated List is assumed to be applicable from 1 July 2023 and onwards for existing business structures and/or when conducting regular transactions, and/or transactions significant in terms of amounts, with ONCT residents, it is necessary, as quickly as possible:- To analyse existing business structures, the legal entities involved and their business operations for possible restrictions due to the expansion of the List. As part of this task, it is important to correlate Russian tax and legal risks with foreign ones in order to develop outweighed and balanced ways of solving arising tax and non-tax problems (eg the possibility of declaring a “look-through” approach in Russia for Russia-sourced dividends channelled through a foreign structure to a Russian ultimate beneficiary shareholder with justification of the economic substance of a foreign holding company – in an ONCT jurisdiction).
- To determine the types of income and subject composition of transactions potentially affected by the tax rules arising from the expansion of the List, as well as the need and the very possibility of restructuring current business structures to minimise the negative consequences and, in general, the possibility of conducting certain types of activities in Russia.
- To consider possible ways of restructuring and working out solutions aimed at tackling tax issues (in particular, to avoid dry tax charges when changing corporate participation in the structures and determine sources of financing to cover Russian domestic costs associated with such restructuring);
- To pay special attention to TP compliance related to the preparation of documentation justifying the arms-length standard of the pricing used in transactions between Russian group companies and ONCT residents.
Denuo’s tax team is ready to assist on the abovementioned issues, assess the impact of these changes on current structures and transactions involving ONCT residents, and provide support on transfer pricing issues using international databases of comparables.
