Deoffshorization in Russia. CFC Law. Opinions.

On November 18th, the State Duma of the Russian Federation adopted a law titled "On Amendments to Parts One and Two of the Tax Code of the Russian Federation (regarding taxation of profits from controlled foreign companies and income of foreign organizations)" during its second and third readings. Although the term "deoffshorization" was not mentioned explicitly in the title or text of the law, in practice, this new legislation, following the example of laws in many other countries including the United States, aims to reduce capital outflow and redirect it towards the budget. While residents of the Russian Federation are still allowed to register companies in offshore jurisdictions, using an offshore company to pay taxes at a reduced rate offered by such jurisdictions has become significantly more complicated.

Essentially, deoffshorization is a global trend, and given the current context of sanctions, the falling ruble, and declining oil prices, adopting such a law seems logical as it would help channel money flows into the budget. Preliminary estimates suggest that thanks to this new law, the budget could receive an additional $5-6 billion annually. However, there is another side to consider. In the current environment of dwindling foreign investment and a weakening national currency, this increased tax burden may at least slow economic growth, while for some companies, it might even make it impossible to operate profitably after fulfilling all their new tax obligations.

Immediately after the adoption of the law, the Ministry of Finance announced plans to review options for softening the law by springtime. Nevertheless, businesses should currently orient themselves based on the existing text since it's uncertain when these promises will be fulfilled, if ever.

The new law will come into force on January 1, 2015, and requires physical and legal entities who control foreign companies to declare their incomes to fiscal authorities. The minimum profit threshold for 2015 is set at 50 million rubles, but over time, this limit will decrease—30 million rubles in 2016 and 10 million rubles after 2017.

Additionally, the law introduces two new concepts: "Controlling Person" and "Controlled Foreign Company." A controlling person is defined as a citizen who, together with his/her spouse and minor children, owns more than 50% of a company's capital. It also includes citizens who, along with their spouses and minor children, own more than 10% of a company's capital, provided that more than half of the company belongs to Russian tax residents. Similar rules apply to legal entities participating in the capital of foreign companies. Starting in 2016, the share of a controlling person in a foreign company will drop from 50% to 25%.

As for the concept of a controlled foreign company, it refers to an organization or structure without legal entity status that is not itself a Russian tax resident but is controlled by them.

Based on the above, if you (together with your spouse and minor children) hold 50% ownership of a foreign company, or 10% of a company where more than half belongs to Russian residents, you must report this information to the tax authorities.

If a citizen decides not to inform the tax authority about having a controlling stake in a foreign company, the new law proposes imposing a fine of 100 thousand rubles per company. This is in addition to the existing criminal liability for tax evasion, which the offender will not be exempted from.

Incidentally, I’d like to provide some figures to give an idea of the scale of the issue: approximately 36 trillion dollars worth of assets are held in offshore jurisdictions. This amount equals the total value of all dollar reserves held by central banks worldwide. It's greater than the combined GDPs of the USA and China. Of this sum, no more than one trillion dollars belong to Russians. While this isn't much compared to the overall asset pool, it’s significant for Russia.

Upon familiarizing oneself with the new regulations, the first thought might be: how will the fiscal authorities obtain information about non-residents? After all, while Russian law can obligate its citizens to submit information, it cannot compel foreign jurisdictions to disclose all beneficiaries and shareholders.

To some extent, this is true. However, in October, the 7th Global Forum on Transparency and Exchange of Information for Tax Purposes took place in Berlin, where representatives from 51 countries signed an agreement providing for annual automatic exchange of data on non-resident accounts. Russia expressed its intention to join this agreement. Thus, information will be provided automatically rather than upon request.

In addition, international agreements on cooperation in civil and criminal matters with numerous countries (such as Latvia, Lithuania, Estonia, Hungary, Cyprus, France, etc.) are already in effect. These agreements include provisions for exchanging information in combating violations of tax legislation. Furthermore, information sharing between states regarding beneficial owners can occur reciprocally, and leaks can also supply fiscal authorities with necessary data. Therefore, one shouldn't rely on simply ignoring the requirement to file information with the tax service to avoid responsibility and additional tax burdens.

Nevertheless, despite repeated attempts throughout history to close loopholes allowing the use of other jurisdictions for capital flight or tax minimization, ways have always been found to circumvent any legislation, no matter how strict, and this case is no exception.

Interestingly, the new law has unexpectedly benefited companies offering services related to obtaining a second passport. They propose registering non-resident companies under a second passport (e.g., St. Kitts, Grenada, Dominica, etc.). However, considering that the cost of such a passport starts at $500,000, we don't dwell on this option because suggesting a solution that costs more than what we're trying to avoid seems counterintuitive.

At present, there's no single universal way to bypass the consequences of the new law and the additional tax burden that would suit every activity in every jurisdiction. Numerous experts worked on this law to eliminate old algorithms, so it's unsurprising. But solutions exist even for the most complex situations; now each individual case needs to be assessed separately to find tailored resolutions. Legal firms specializing in registration, support of foreign companies, and tax planning can assist in finding suitable solutions for specific cases.

In conclusion, offshore jurisdictions have existed for many years, and the rules governing their activities and disclosure of information keep evolving and being supplemented. No country wants to lose financial flows to tax havens where they can't track them, yet adaptations to new rules always emerge.