Amendments to the Tax code of the Russian Federation regarding the taxation of income of controlled foreign companies
The provisions of the Federal law №32-FZ have entered into force on 15 February 2016 and provide amendments of the rules for taxation of income of controlled foreign companies.
In this article we present review of major changes in the legislation on controlled foreign companies (CFC).
1. A person having actual right to income
There have been amended provisions which define a person having actual right to income, and such person may also be a foreign structure without forming a legal entity.
For the purposes of applying international agreements on avoidance of double taxation there is a need to submit documentary evidence of the actual right to income by the person applying for exemption of tax or reduction of tax rates.
2. Notification of participation
The provisions of the law, regarding notification of participation was supplemented with the following:
– The obligation to notify about establishment of a foreign structure without forming a legal entity is put on the founder (beneficiaries and other persons are free from this obligation).
– Trustees — tax residents of the Russian Federation in case of establishment of foreign structures without forming a legal entity or a foreign company should notify about it if the property (object of the asset management) was transferred to the capital of these foreign structures or companies.
- Notification of participation in a foreign entity or CFC is not required if the participation is implemented through the Russian public company.
– The term for notification was increased from one to three months from the date of the occurrence/cessation of participation.
– There have been set a special rule in the notification of participation in case a person have not been tax resident of the Russian Federation for a period of one year, but was recognized as resident by the end of the year- in this case the period for notification is set till 1st of March of the following year.
– A person who owns more than 10% of the share capital (and is recognized as controlling person due to the fact that in the aggregate tax residents of the Russian Federation own more than 50% of the share capital) and who haven’t submitted a notification on participation in the CFC because of the lack of information about the other participants — tax residents of the Russian Federation, can be
exempted from liability.
3. The order of calculation of the income of a controlled foreign company
One of the most important and anticipated amendments are those provisions concerning the determination of CFC's income. CFC income is defined in the following ways:
1) according to its financial statements prepared in accordance with the domestic law of such company for the financial year. In this case, the value of the company's profit before taxation is recognized to be CFC income;
2) according to the rules established by the Chapter 25 of the Tax code of the Russian Federation «Corporate Income Tax» for taxpayers — Russian companies.
In this case, the CFC income based on the financial statements could be determined if one of the following conditions is met:
(i) if the CFC is located in a state with which the Russian Federation has an international Treaty on tax issues, with the exception of countries (territories) that do not provide the exchange of information for tax purposes with the Russian Federation (Switzerland, Austria, UK, Malta have been excluded from the List of the Federal tax service as of 01.02.2016, but Brazil remained);
(ii) if there is an audit report to the financial statement of CFC, which does not contain negative opinion or refusal to express opinion.
For these purposes the unconsolidated financial statements are used
in accordance with the standards set by the domestic law of the CFC or by the International financial reporting standards.
These changes mean that the income of the CFC - an offshore company, may be determined according to the financial statements if the audit report be provided.
Determination of income on the basis of the Chapter 25 of the Tax code of the Russian Federation is made if the CFC income could not be confirmed by the financial statements in accordance with the set requirements, or by the desire of the taxpayer.
In this case this method of determination of profit (according to the Chapter 25 of the Tax code of the Russian federation) shall apply for
When calculating the CFC's income there should be made an adjustment on the sum of revaluated securities and other financial instruments, on the amounts of reserves and amounts of
profit/loss of subsidiaries.
The amount of loss according to the financial statements can be carried forward to the future periods without restrictions.
The CFC's income is reduced on dividends paid, and concerning foreign structures without forming a legal entity - is reduced on the amount of distributed profit (moreover not just in favor of controlling persons).
The CFC’s income is recognized (i) as of the date of the decision on profit distribution, and if the decision has not been accepted, (ii) on December 31 of the year following the tax period the period of the controlling person.
4. The elimination of taxation
The amendments specify the list of passive income and the way to determine their share, which is one of the grounds for recognition the exemption of the CFC's income from tax.
If a controlling person has paid the tax on CFC's income, so while
distributing dividends to the controlling entity the tax would not be paid. In this case there is a need to confirm with documents the fact of payment of tax on CFC's income.
If the foreign company pleaded itself as a tax resident of the Russian Federation, it has the right to apply the rate of 0 percent on dividends received (in the process of forced recognition of such state this right won’t be granted).
The amendments established special rules on transfer of property of the structures without forming a legal entity:
– transfer of the property into such a structure does not lead to taxable income;
– income of individuals from such structure in the frames of previously made investment is not subject to taxation (except the situation when the structure has undivided profits at the time of distribution of income);
– the reallocation of rights of control over such structures within one
family or close relatives is not recognized as the receipt of income.
5. Tax-free liquidation
Transfer of CFC securities to the controlling person (or its related parties) will be treated as a tax neutral event for this CFC, and also for the controlling natural person (he/she will not be charged with material benefit).
By the further disposal of such property, the shareholder is entitled to reduce income from the sale at the lower of the two values:
- documentary confirmed value of property stated in the books of the liquidated organization or,
- market value of the property.
Preferential tax treatment upon liquidation of foreign companies and structures without forming a legal entity is valid if the corresponding CFC would be liquidated before January 1, 2018 (previously 1 January 2017).