What is it about?
Taxpayers who are controlling persons of CFCs are proposed to be able, at their discretion, to use a special tax regime: under this regime, a fixed tax of RUB 5 million is paid on the profits of a controlled foreign company, regardless of the actual amount of such company’s profits. Users of this regime will be exempt from the obligation to submit reports on their CFCs to the Russian tax authorities. The new regime may be applied as early as the current tax period, but once elected, it must be maintained for at least 3 years.
Let us try to understand the details.
In detail
To switch to the fixed tax regime, an application must be filed with the tax authorities by December 31 of the year in which the taxpayer plans to switch to the regime.
The regime applies for at least 5 years (if the application is filed during 2020 or 2021, application for 3 years is possible).
A controlling person may pay a single fixed amount of RUB 5 million on the profits of all their CFCs (if they have several).
If the taxpayer ceases, during the tax period, to be a controlling person in respect of all of their CFCs, no tax is payable for that tax period.
If, during the period of the regime (3 or 5 years from the date of transition), the amount of the fixed tax is increased by the legislator, the taxpayer has the right to terminate its use earlier than the expiry date.
Controlling persons under the regime are exempt from the obligation to provide CFC financial statements, including upon request by the tax authority.
According to the text of the draft law, the regime may be applied starting from the 2020 period — in that case, the application to switch to the new regime for 2020 must be filed by February 1, 2021. Thereafter, the application must be filed by December 31 of the relevant year
Is it really tax-efficient?
Use of the regime does not provide an exemption from taxation of dividends distributed thereafter. Accordingly, when receiving dividends, the controlling person will be required to pay personal income tax at a rate of 13%:
The current version of paragraph 66 of Article 217 of the Tax Code of the Russian Federation provides that CFC profits recognized as income of the controlling person and later distributed as dividends will not also create “dividend income” for the controlling person. This therefore eliminates double taxation of essentially the same amounts — first as CFC profits, then as dividends. Under the draft text, paragraph 66 of Article 217 will be amended so that users of the special regime will pay tax on dividends.
In fact, a fixed payment is not charged for each CFC; rather, the controlling person is deemed to have CFC profits, and the tax is calculated on that fixed profit. Notably, the profit amount is RUB 38,460,000 for the 2020 tax period (which corresponds to a 13% personal income tax rate) and RUB 34,000,000 for subsequent tax periods starting from 2021 (which corresponds to a 15% personal income tax rate). It is important to take into account that when applying the regime for periods after 2021, the fixed CFC profit will cover the threshold of income taxed at the 13% rate for an individual (Draft Law on 15% personal income tax No. 1022669-7); thus, all other income of the controlling person will be taxed at 15%.
During the period of use of the regime, CFC losses cannot be taken into account. However, losses may be used after exiting the regime.
The draft will eliminate the possibility of offsetting foreign tax assessed in respect of CFC profits (or Russian tax). The current version of paragraph 11 of Article 309.1 of the Tax Code of the Russian Federation allows double taxation of income by two states (or by Russia twice, or, for example, where withholding tax is applied at source) to be avoided — the draft will make offsetting impossible for users of the special regime.
And what is the “bonus” for those for whom the regime is not suitable?
Amendments are being made to Article 25.15 of the Tax Code of the Russian Federation: financial statements and an auditor’s report must now be submitted regardless of whether there is an obligation to include income in the form of CFC profits in the controlling person’s tax base for the relevant tax. The fine for failure to submit such documents will increase from RUB 100,000 to RUB 500,000.
The Tax Code is supplemented with new Article 25.14-1, “Requesting from individual taxpayers who are controlling persons documents (information) concerning foreign companies they control.”
The subject of the new type of request may be the submission of supporting documents for the CFC profits exemption, as well as financial statements and an auditor’s report. The look-back period is three years prior to the date the request is sent. After receiving the request, the taxpayer is given 30 days to provide the information. A fine of RUB 1 million is предусмотрено for failure to provide the documents. At the same time, the fine does not apply when using the regime for payment of a fixed CFC tax amount.
Conclusions
The draft law has passed three readings in the State Duma and is currently before the Federation Council. In its current version, the fixed-amount regime may be beneficial in two cases:
When a CFC (one or several) consistently generates net profit of RUB 38 million or more per year,
When the controlling person would not want to disclose the financial statements of their CFC(s).
At the same time, in each individual case, at least the following aspects should be considered and calculated:
The amount of the controlling person’s tax burden upon receiving dividends from the CFC,
The amount of tax on the CFC in the jurisdiction where it is located (this tax will not be creditable in Russia when using the new regime),
Where losses are incurred at the CFC level, the procedure for taking them into account for Russian tax purposes.
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