New income taxation procedure for purchasing work or services from interdependent foreign entities

On 27 November 2023, the President of the Russian Federation signed Federal Law No. 539-FZ “On making amendments to Parts One and Two of the Tax Code of the Russian Federation and certain legislative acts of the Russian Federation and on recognising certain provisions of legislative acts of the Russian Federation to have ceased to be effective” (“Law”). The Law was officially published on the same day, 27 November 2023.

The Law makes significant changes to the Tax Code of the Russian Federation (“Russian Tax Code”), including numerous amendments to the transfer pricing rules, which we will cover in a separate legal alert.

The Law also makes amendments to the Russian Tax Code providing that, with effect from 1 January 2024, the remuneration for the work or services performed by interdependent foreign entities to Russian taxpayers shall be subject to the Russian withholding tax at a rate of 15% (amendments to article 284(2)(4) and article 309(1)(9.4) of the Russian Tax Code).

This provision is a derogation from the principle observed up to now whereby income from foreign entities’ active business operations is not subject to withholdig tax in the Russian Federation (article 309(2) of the Russian Tax Code).

The new rule will come as an unpleasant surprise to Russian companies which have connected companies in foreign jurisdictions if such companies perform work or services to an interdependent Russian company. It is no secret that, due to sanctions pressure, such contractor companies/service providers were registered in friendly jurisdictions with part of their Russian personnel being moved to such companies under relocation programmes.

Where there is a double tax treaty (“DTT”) with the jurisdiction of tax residence of the foreign company, the new rule will be less of a problem, as DTTs usually protect business profits from taxation in the source country (provided that the foreign entity has a substantial presence in the relevant jurisdiction, has no signs of a permanent establishment in Russia, etc.).

However, where there is no DTT in place with the state of incorporation or residence of an interdependent foreign supplier or service provider (such as the UAE or Georgia), payments to such jurisdiction will replenish the Russian budget with withholding tax at the rate of 15%.

The interdependence factor is also associated with the risk of challenge of the tax deduction of costs incurred in purchasing work or services from a foreign entity for the purposes of calculating the profits tax for a Russian customer company.