Law on Controlled Foreign Companies

One of the main features of countries that have "secured and protected" financial legislation is a well-established mechanism of deterrence and balances in the taxation sphere.

Among the countries which are guarantors of deoffshorization such European countries can be identified: Spain, Italy, Great Britain, Germany, Denmark, Sweden, and also such states as Israel, the USA, Canada, Japan. Now the list also includes the Russian Federation.

The signal for the foregoing was the adoption by the State Duma and the signing by the President of the Russian Federation of the federal law: "On Introducing Amendments to the First and Second Parts of the Tax Code of the Russian Federation (regarding the taxation of profits of controlled foreign companies and the incomes of foreign organizations)", dated November 24, 2014, No. 376-FZ.

It has another name, informally it is also called the "Law on Controlled Foreign Companies (CEC)", which is designed to bring order to the offshore sphere, because of which Russia receives less billions in its budget than one is due.

What are the main functions of this law?

First, it introduces tangible and explicit changes in the standards of the Tax Code of the Russian Federation on the taxation of income of foreign organizations, which can be noted in Chapter 25 of the Tax Code.

Secondly, it introduces certain restrictions on the actions of international agreements in terms of avoiding double taxation, taking as a basis the rule of "actual recipient of income", which can be read in Articles 7, 312 of the Tax Code.

Thirdly, this law significantly reforms the very procedure for recognizing the company as a tax resident of the Russian Federation.

Moreover, it reveals the mechanism within which the company's retained earnings are included in the taxable base of controlling persons-residents of the Russian Federation. It regulates the taxation on profits of controlled foreign companies registered and located in the Russian Federation. The law also provides for sanctions for breach of commitments, which is provided for in Chapter 3.4 of the Tax Code.

When establishing the tax base, the instructions that are contained in Chapter 3.4 of the Tax Code ("Controlled foreign companies and controlling persons") will be exercised in relation to the selected taxes of the foreign organization.

For a deeper analysis of the problem, it is necessary to understand what the term "controlled foreign company" or abbreviated “CFC” means.

Following paragraph 1 of Article 25.13 of the Tax Code of the Russian Federation, a controlled foreign company is a foreign organization that does not have the status of a tax resident of the Russian Federation, provided that such status is available to controlling persons.

A foreign entity that does not have a legal entity, but is controlled by legal entities or individuals that have received recognition from tax residents of the Russian Federation, is also considered to be the CFC.

It is possible to attribute an individual, who is in the territory of the Russian Federation during the period established by the law, to tax residents of the Russian Federation. Minimum term of stay in the territory of the Russian Federation is 183 calendar days within 12 months in a row.

But, it is worth noting that during his short-term period (up to six months) of traveling abroad in connection with education, training, treatment, and performance of labor or other duties connected with services or work in marine fields of raw hydrocarbon deposits, the period of stay in the territory of the Russian Federation will not stop.

In order to find out which organizations are recognized as tax residents of the Russian Federation, one should turn to paragraph 1 of Article 246.2 of the Tax Code.

Paragraph 7, clause 2 of Article 11 of the Tax Code of the Russian Federation defines that a foreign structure without the formation of a legal entity can be a form of an organizational type of activity that is established according to the norms of a foreign state, without registration of a legal entity. The foregoing can include a partnership, trust, fund or other type of collective investment or trust management. The given structure should carry out the chosen type of activity which is directed on reception of profit in interests of the founders, beneficial owners, shareholders, principals and other persons, according to the internal law.

In addition, we must define what exactly is meant by the "controlling persons" of the organization.

So, the controlling persons of an organization can be individuals or legal entities recognized as tax residents of the Russian Federation, as well as spouses or underage children, whose participation in the organization is at least 10%, provided that in this organization the percentage of participation of all persons that have been recognized as residents of the Russian Federation is at least 25%.

Also, individuals or legal entities are recognized as a controlling person of the company with at least 25% of their participation in the organization.

Article 105.2 of the Tax Code of the Russian Federation provides for calculating the percentage of participation of individuals or legal entities in other organizations, which also takes into account individual participation, participation with spouses, and children under the age of 18 years.  

Part 1 of Article 105.2 of the Tax Code states that for the purposes of the Tax Code, the share of participation of one enterprise in another enterprise can be calculated in the form of a sum, which is expressed as the percentage of direct and indirect participation of one enterprise in another enterprise.

It is also necessary to understand what is the share of direct and indirect participation.

This article stresses that the share of direct participation of one enterprise in another enterprise is recognized as belonging directly to one enterprise of some part of the voting shares of another enterprise or directly belonging to one enterprise of a part in the authorized (share) capital (fund) of another enterprise, and in case of impossibility of determining such parts - directly belonging to one enterprise of the part that is calculated in proportion to the number of participants in another enterprise.

The share of indirect participation of one company (enterprise) in another company is recognized that part (share), which is determined in the following order:

1) the participation of one company in another company is calculated according to the system through the direct participation of each previous company in each subsequent company in the appropriate sequence;

2) the share of direct participation of each previous company in each subsequent company of the corresponding sequence is determined;

3) the shares of direct participation of one company in another campaign are summed up through the participation of each previous company in each subsequent sequence.

Participation of individuals, as well as determining their percentage in the capital of companies are considered in court. The rules that are used and are important in determining the interest rate of participation of an individual in an organization are provided for in Article 105.2 of the Tax Code.

Until January 1, 2016, the percentage quota of participation of an individual or legal entity in the company was determined at the level of 50% in order to recognize such person as controlling.

If compared with the first drafts of the bill, it can be noted that now, in order to recognize the natural person or organization as the controlling person, the value of the management of a foreign company in this norm has been increased to 25%.

If the organization is owned by several Russian residents and their total share in the company is more than 50%, then 10% is enough to recognize the controlling person.

Also, referring to clause 5, article 25.13 of the Tax Code of the RF, it can be determined that the controlling persons are among others acknowledged as persons exercising management and control over the company in the personal interests or interests of children who have not yet reached the age of eighteen.

Hence, it can be summed up that such a concept as "control" is not standardized by the law as the definition of an exclusively interest rate in organizations.

Proceeding from all of the above, it is logically necessary to determine what is meant by "exercising control over the company"?

Exercising control over the company is direct or indirect participation in the company, as well as participation in an agreement or contract that considers the management of this company for the purpose of distributing the revenue received by this company, taking into account payment of all taxes.

Exercising or the possibility of exercising a decisive influence on the entity's performance, which implements management functions in relation to the assets of the organization and distributes the received financial funds (income), taking into account payment of all taxes, can be defined as the management or control over foreign organizations without a legal entity.

The exercise of control over the company is established not only with direct or indirect participation, but also in accordance with such norms of the law as clause 5 of article 25.13 of the Tax Code of the Russian Federation. Also, in other formats, there is a certain influence for the sake of controlling decisions and the company's actions in the sphere of making a profit.

Actions similar to the participation in the agreement regarding the management or control over this organization (for example, the agreement on provision of services), the relationship within the framework of the trust declaration (contract), and also in the situation when the nominee shareholder owns the company's shares, may also be a prerequisite to recognize this subject as controlling one.

From this provision, it can be concluded that not only the title owner of the shares of the company can be determined as the title person, but also the beneficial owner, who is managing the organization in another way.

This means that the framework for "exercising control", written out in normative acts, can be considered incomplete and not determining properly.

For example, if you strictly follow the letter of the law, you can make the erroneous assumption that the founders and beneficial owners of a private fund do not have the right to exercise control if they are legal entities in another state, if it is indicated in the constituent documents of the fund that they were dismissed from being able to influence decisions, which are associated with the distribution of profits.

This conflict in legislation can be the subject-matter of fierce disputes between state bodies and taxpayers during litigation.

Next, it is worth considering the conditions for excluding of taxation of the income of the CFC.

If one of the following conditions is met, the controlled foreign company is exempt from taxes on its profits in the event that the following conditions are met, in accordance with clause 7 of Article 25.13 of the Tax Code of the Russian Federation:

A) if the organization is non-commercial, that is, it is not interested in receiving income from its activities. Also, if the company does not take decisions that are related to the disposal or distribution of income between the founders and participants, as well as other subjects.

The so-called "Personal Law" was created for better interaction and control, specifically for legal entities. On the basis of the foregoing, a foreign organization has a chance to obtain a non-commercial status (including legal capacity and obtaining an organizational and legal form), provided that such was determined by the legislation of its country and its constituent documents. It is worth noting that, as a rule, business chambers, business leagues, clubs, professional associations, educational, charitable, religious organizations are referred to as non-profit organizations abroad.

B) in case the organization was established on the basis of the norms of the country's legislation, which is a member of the Eurasian Economic Union.

In addition to the Russian Federation, the countries of the Eurasian Economic Union include Kazakhstan, Belarus and Armenia. Hence, this law has no influence on the organizations that are on the territory of these countries, and controlled by residents from the Russian Federation.

C) Provided that organizations are permanently located in the territory of the state with which the Russian Federation has concluded an international treaty on taxation. Except for countries that did not provide information exchange with the Russian Federation.

The list of countries that did not provide the exchange of information for taxation with the Russian Federation was approved with the help of the federal executive body with the authority to exercise control and supervise the sphere of taxes and fees.

The weighted average tax rate on the company's tax profit (75 percent or more) is an effective tax rate for profits.

Based on subparagraph 1, clause 8, article 25.13 of the Tax Code, you can determine the tax rate for income (profit) of a foreign enterprise using this formula:

Steff = N / P

Where, Steff is defined as the effective tax rate on the profit of a foreign organization.

H is a general income tax, being excluded by a foreign company, as well as its separate subdivisions in accordance with its personal law.

P is the total income (profit) of the foreign company, which is calculated in accordance with paragraph 1, clause 8, article 25.12 of the Tax Code.

With the help of subparagraph 2, clause 8, article 25.13 of the RF Tax Code, it is possible to determine the weighted average tax rate on the profit of the organization.

Weighted average = (St1 x P1 + St2 x P2) / (P1 + P2)

P1 is the total income of a foreign organization, which can be determined with the help of paragraph 1, clause 8, article 25.15 of the Tax Code of the Russian Federation, excluding taxes calculated using subparagraph 1, clause 4, article 309.1 of the Tax Code. It should be taken into account that if the indicator P1 is calculated, when it becomes negative, then it is equated to zero.

P2 is the total profit of a foreign organization, which is calculated using subparagraph 1, clause 4, article 309.1 of the Tax Code.

St2 is the tax rate from the income of the organization established by subparagraph 2, clause 3, art. 284 of the Tax Code.

After January 1, 2015, this tax rate is 13 percent. Before that, Russian enterprises obtained a tax rate of 9% on dividends from Russian and foreign companies.

But, it is necessary to fulfill simultaneously two conditions, in order to use this provision:

  1. The country in which the organization is registered and where it is permanently established has already concluded an international agreement with the Russian Federation concerning taxation issues earlier. For example, a contract that excludes double taxation.
  2. Provided that the rate of "effective" taxation of the organization within the state where it was registered was at least 75% of the local "average" tax rate on the organization's income.

But, a foreign organization will not be exempt from income tax unless a tax exchange of information was provided between its "home" state and the Russian Federation, even if there is a treaty on the absence of a double taxation system with the Russian Federation.

The list of countries that can be identified as a "black list" is not yet available and has not been approved by the Federal Tax Service of the Russian Federation.

The Ministry of Finance adopted No. 108n "List of states and territories that provide preferential tax treatment of taxation and (or) does not provide for disclosure and provision of information for financial transactions (offshore zones)" on November 13, 2007, that is currently in force in the Russian Federation.

For example, it is used during the determination of controlled deals, as indicated in paragraph 1 of Article 105 of the Tax Code, or when determining the possibilities of applying zero tax on dividends (profit)- subparagraph 1, clause 3, article 284 of the Tax Code.

In addition, this list can be used for legislative purposes, for the sake of improving the rules on controlled foreign companies.

To better understand the situation, it is necessary to give an example.

Imagine that an enterprise registered in the territory of Cyprus is controlled by a resident from the Russian Federation, and receives profit only as a royalty.

To compare the effective tax rate in the territory of Cyprus and the weighted average tax rate in the Russian Federation, and also in connection with the calculation, will the income of a company located in Cyprus be exempt from taxes in accordance with subparagraph 3, paragraph 7, article 25.13 of the Tax Code of the Russian Federation? To determine, we shall use the following formulas.

First, we calculate the effective tax rate in Cyprus. Reporting indicates that the Dominican company's income amounted to 130 thousand euros for a set period of time.

Since the rate of the income tax is 12.5% in the Dominican Republic, but according to Cyprus law 80% of the royalty (income) is exempt from taxation, we can calculate the following.

Hence, the sum, which is 26 thousand euros, is subject to tax.

Steff = (26,000 x 12.5%) / 130,000 = 3250 / 130,000 = 2.5%

From which it appears that the weighted average rate on profits under the Russian tax will be equal to 19.19%. In Cyprus, the effective tax rate is about 13% relative to the Russian average weighted rate. But to exempt the income of foreign organizations from taxation, it must be at least 75%.

Summarizing the results of this example, we can conclude that, following subparagraph 3, paragraph 7, article 25.13 of the Tax Code of the Russian Federation the income of a Cypriot enterprise will not be exempt from taxes.

D) An enterprise that is permanently established within the territory of the country that has concluded an international agreement on taxation with the Russian Federation, where the conditions for avoiding double income tax are set, except for countries that did not provide exchange of information for tax purposes with Russia.

In the presented condition, two points must also be fulfilled:

- The country in which the enterprise is registered must conclude an international agreement with Russia, which provides for avoidance of double taxation.

- No more than 20% of the profit from the total income is a part of the passive profit. That includes dividends, income from the sale of shares, interest, royalties, property leasing or sublease, real estate sales, as well as revenues from such services as: advertising, consulting, engineering, accounting, audit, legal, marketing, as well as, which relate to information processing, research or development.

Which leads us to the fact that, according to this subparagraph, the company needs to gain profit from production, performance of works and rendering services (not counting the above), that is, from active activities.

This subparagraph does not apply to companies from those states that are included in the "black list"of the FTS and did not provide a tax exchange with Russia.

Let us give one more example. The Cypriot company earns most of its income through trade. And part of its income is royalty, that it obtains from a foreign company.

According to the financial statements of the Cypriot company, the share of profits in the form of royalties is more than 20% of its total income. Proceeding from these conditions, the profit of the company from Cyprus, which is managed by the resident of the Russian Federation, is exempt from taxes, since an agreement has been concluded between Cyprus and Russia on avoiding a double taxation system, and Cyprus is not included in the "black list" of the FTS and provides information to Russia for tax purposes.

It will be interesting to consider such an example. To begin with, we note that an effective convention is in force between the United Kingdom and the Russian Federation, which provides for avoidance of double taxation, and the Russian Federation receives information from Great Britain for tax purposes. Also, the UK is not included in the "black list" of the FTS.

The Scottish partnership (LP) or the English limited liability company (LLP), participate only in trading activities, which brings in revenue. Observing all the necessary conditions, all profits from the partnership, which is controlled by a resident from the Russian Federation, must be exempt from taxation.

It should be noted that neither LP nor LLP have the rights to use the benefits, as defined in the Anglo-Russian convention, which provides for the avoidance of a double taxation system. Therefore, they do not have the right to receive confirmation of the tax resident in their country, since they are not separate taxable entities.

E) The company is a foreign structure without formation of a legal entity, but which fulfills all the following provisions:

  • according to the company's charter documents, after its foundation, the powers of the founder of this structure can not be transferred to another entity, except for hereditary rights or by universal succession. In addition to the authority, the identification of the beneficiary (beneficial owner), the right to seize property and other powers are also not transferred;
  • the founder of the company, according to the statutory and constituent documents, has no right after its foundation to transfer the assets of this organization to its ownership;
  • the founder of this company has no right to direct or indirect profit, which is distributed between its shareholders, trustees, or other participants.

Indirect profit for a foreign company without registration of a legal entity can be recognized in connection with the receipt of the income of the organization through the interdependent person.

There are rules by which it is possible to determine whether a given foreign company is eligible, for example, to a discretionary trust from profit taxes. These rules are created for the given organization by the regional legislation, by means of them it is possible to find out accuracy and correctness of formulations for the statutory documents of the company in the field of belonging of distribution of incomes or assets, and also by means of them there is a determination of beneficiaries and order by which they are determined. If a foreign company was established in accordance with the conditions provided for by subparagraph 5, paragraph 7, then the profit of this company is exempt from taxation.

F) According to a personal law, the activity of an insurance organization or bank is based on license standards, as well as other highly specialized permits that focus on the performance of insurance or banking activities. Also, the company must be permanently located on the territory of the country with which the Russian Federation has an international agreement on taxation, apart from the territories of the countries that are included in the list, which is established in accordance with subparagraph 3 of the clause under consideration.

But, there are two additional conditions: First, a foreign company must have a banking or insurance license, and the state on which territory the company is located must have an agreement to exclude the double taxation system. Secondly, this provision does not apply to organizations that are registered on a permanent basis in the territories of those states which have not signed an agreement with the Russian Federation on the transfer and exchange of tax information. Those states that are included in the "black list" of the Federal Tax Service.

G) This entity is an organization that has the authority to make a profit in a percentage that is payable in relation to the bonds that are in circulation. This entity is also called an issuer of the trading companies.

In addition, if you take into account the application of this subparagraph, part of the profit that is documented within the period during which a report is compiled for the past financial year constitutes 90% or more of the total profit of this organization, according to the personal law of the enterprise. This implies that the activity of the organization, stipulated in the subparagraph, must be the main one for such a foreign organization.

H) The company participates in design works, relying on a production sharing agreement or following a service contract, similar acts on product sharing, at risk, or other similar agreements that are with government agencies or state enterprises that have similar powers.

According to the company's personal law, part of the documented profit for the period during which the financial statements for the financial year is compiled may amount to about 90% of the company's revenues for the specified period.

In this case, the profit of the enterprise itself is exempt from taxation, which takes part in concession contracts with public-law entities, for example, in the sphere of raw materials extraction. Such contracts are also called acts of public-private partnership.

It is also worth noting that the activity in question must necessarily be the main sphere of activity of this company.

I) It can also include a company that is the operator of a newly discovered offshore hydrocarbon deposit or if it is a shareholder of a company of this type.

Please note that from the list of companies that may be exempt from taxation under the rules on controlled foreign companies, "public companies" have been excluded - bond issuing companies that have been admitted to circulation on Russian stock exchanges, as well as stock exchanges of states that are included with List of foreign financial intermediaries and those who passed the listing procedure.

We should definitely highlight the facts that taxpayers are obliged to notify the tax authorities.

The Tax Code of the Russian Federation informs us that, based on Clause 3.1 of Art. 23, the persons that pay taxes on profits, undertake to notify the tax service:

  • if their share of participation is close to 10% in foreign companies;
  • when foreign structures are created without a legal entity and when there is an actual right to the income of this company, including those cases when the subject paying taxes is the creator of this organization, or the entity has the right to profit of this organization under condition of its distribution;
  • facts about controlled foreign companies, in relation to which they are controlling persons.

Also, in accordance with the norms of the Tax Code of the Russian Federation, foreign organizations and enterprises without registration of a legal entity, in which circulation there is the property recognized under Article 347 of the Tax Code of the Russian Federation to be subject to the tax system for property tax of organizations, are obliged in the manner and in cases described in the Tax Code or obligations prescribed in Article 23 of the Tax Code to inform the participants of this foreign organization in accordance with the location of the property object. And also for foreign companies without registration of a legal entity, it is necessary to inform about its founders, beneficiaries, and managers.

It should not be ignored that in accordance with the Tax Code of the Russian Federation, or more precisely paragraph 3, Article 347, the object of taxation for foreign organizations that do not carry out activities in the Russian Federation through permanent representations is recognized as located on the territory of the Russian Federation and belonging to these foreign organizations according to the property rights and real estate received under a concession agreement.

Establishing the forms and period for which taxpayers should notify the tax authorities

Paragraph 1 of Article 25.14 of the Tax Code of the Russian Federation informs us that taxpayers recognized as tax residents of Russia are obliged to apply to the tax service:

  • subject to participation in foreign organizations, when the share of such participation is more than 10%;
  • in the case of the creation of foreign structures without the registration of a legal entity, as well as the actual right to profit received by the enterprise. Considering the cases in which the subject paying taxes is defined as the founder or the one who has the right to distribute the income of this structure;
  • if they are controlled persons in relation to foreign companies.

The data on participation in foreign companies should be provided for a period of not more than 1 month from the date of establishment or change in the share of participation in such a foreign company, which is the reason for giving such information.

Data on controlled foreign companies must be submitted no later than March 20 of the future year, following the tax period, where part of the profit of the CFC must be taken into account by the entity that is responsible for controlling the company.

Also, taxpayers are required to give evidence about their participation in foreign companies and transmit information to the tax authorities about the CFC, which is on a permanent basis established or located in the place of residence electronically, in accordance with the procedure established by law.

Individuals - taxpayers can provide the necessary information also in paper form.

The Federal Tax Service of the Russian Federation, in accordance with the Ministry of Finance of the Russian Federation, determined and approved the procedure for completing notifications that provide data on the status of the entity in a foreign company.

At the moment, according to Article 23 of the Tax Code, only the format and form of notifications on the status of the entity in a foreign company are defined.

The following information on participation in a foreign company must be provided for in compulsory order:

  • the exact date of occurrence of the reasons for providing information;
  • the name of the foreign organization without registration of a legal entity (company name), information on participation or establishment of which by the taxpayer;
  • the registration numbers that were provided to a foreign company on the territory of the state, its registration (incorporation), the code (or codes) of the foreign organization as a taxpayer on the territory of the state of its registration (incorporation), as well as similar documents, subject to availability;
  • the percentage of participation of a taxpayer in a foreign company, his participation in the system of paying taxes in a foreign company, if there is an indirect participation with the provision of such information:

a) The information that is discussed above applies to all subsequent organizations, through which indirect participation in this organization is carried out.

b) The percentage of participation in each subsequent organization, through which indirect participation in a foreign organization is carried out.

- determination of conditions for declaring a taxpayer as a controlled person of a controlled foreign company

- selection and provision of data, which will be an excuse for exempting the profits of a controlled foreign company from taxes

The taxpayer bears the responsibility for reflecting inaccurate information in the notification, which is specified in Article 129 of the Tax Code, on the fact of providing data by the time the taxpayer found out about the disclosure of the case of this reflection by the tax service.

On the basis of all of the above, an urgent question arises: does the tax authority have the right and the necessary powers to recognize the taxpayer as the controlling person of a foreign organization?

Yes, it has. This is indicated by Clause 5 of Article 25.13 and Clause 8-12 of Article 25.14 of the Tax Code of the Russian Federation.

When the tax service of a foreign state provides information within the limits of data exchange with tax purposes in accordance with international agreements concluded with the Russian Federation, this information provides that the taxpayer is the controlling person of the foreign organization without legal entity registration (foreign company) that did not send a notification to the tax service. In this case, the tax service sends a notice to the taxpayer, in which an order is made to provide the required explanations after 20 days or to provide a notification within the deadline set by the tax service.

A taxpayer who sends explanations to the tax service about the facts and data that specify the requirements of state bodies also has the right, along with explanations, to provide documents in addition confirming acts of absence of reasons for recognizing the taxpayer as an entity that exercises control over a foreign organization.

In turn, the tax service undertakes to review the documents and explanations provided by the taxpayer.

In the event that during the consideration of the submitted information on the fact or its absence, the tax service may make amendments in order to recognize the taxpayer as a controlled person of a foreign company. The official of the tax service shall notify the taxpayer of the foreign organizations that he controls to recognize the person as controlling one.

If a person receives a notification from the tax service, then it can be challenged in the court process at the expiration of the period of three months, from the date of its receipt. Taking this into consideration, the subject informs the tax service about this fact within three days from the date of submission of the application to the court. It is worth noting that the person who received the notice can not be declared the controlling person of the foreign organization for the purposes envisaged by the RF Tax Code before the entry into force of the judicial act that was adopted by the court following the consideration of the appeal about the notification.

Subject is recognized as the controlling entity of a foreign company provided that he has not been able to challenge the received notification of foreign companies that it is under its control within three months from the date of receipt. At the same time, in relation to this subject, the conditions of the Tax Code of the Russian Federation regarding the controlling persons are being applied.

Also, you can ask the following question: how exactly is the income of controlled foreign companies taken into account in the course of taxation?

Profit, as well as loss of controlled foreign companies, is the total profit or loss of this company, which is calculated on the basis of Article 309.1 of the Tax Code of the Russian Federation. We will talk below about the features that are enshrined in this rule.

According to clause 2, article 25.15 of the RF Tax Code, the profit of the CFC is equal to the profits of the company or individuals received by the taxpayer, who was recognized by the relevant bodies as a controlling person of the CFC and is taken into account when determining taxes on the base of taxpayers recognized by persons controlling a foreign company in accordance with the norms of the Tax Code.

Clause 3, Article 25.12 of the Tax Code states that the income from a controlled foreign company is taken into account in order to determine the base of the taxpayer, that is, the controlling person who has a part of the income, which corresponds to the percentage of the person's participation in the CFC in the period that ends with the date of adopting decision on the distribution of profits.

The profit of the CFC is lower depending on the amount of dividends that were paid by the foreign company in the calendar year, which follows the year in which the financial report was compiled referring to the personal law of the company.

The income of the CFC, which is a foreign company without registration of a legal entity, decreases in proportion to the amount of dividends that were distributed in the interests of the controlling persons of this organization or in the interests of beneficiaries or other shareholders or members of this organization.

Nevertheless, it should be noted that the reduction occurs when all relevant taxes have been paid in the amount indicated by controlling persons, beneficiaries, shareholders, and other subjects.

In the event that a foreign organization does not have the opportunity to partially or fully distribute the income received during the period for which, according to the company's personal law, a financial report for the past year is compiled, then, because of the conditions established by the personal law of this organization, the functions of profit distribution between the participants (beneficiaries, shareholders and others) for the purpose of increasing the authorized capital will not take into account this profit when determining the tax base of the taxpayer of the controlling person.

According to the first paragraph of the first clause of Article 309.1 of the Tax Code of the Russian Federation, the profit or loss of the CFC will be the amount of profit or loss of the company before all taxes are paid based on information provided in its financial report in accordance with the organization's personal law for the past financial year and if in accordance with its personal law such a financial report is necessarily subject to audit, fulfilling the condition of the permanent location of this CFC in the territory of the country that has signed an agreement on tax issues with the Russian Federation provided for in Article 309.1 of the Tax Code of the Russian Federation.

If in those cases where in the indicated profits or losses of the CFC in paragraph 1 clause 1 of Article 309.1 of the RF Tax Code, the amount of the profit or loss of the given company was calculated in accordance with the provisions described in Chapter 25 of the Tax Code of the Russian Federation, without taking into account the specifics provided for in Article 309.1 of the Tax Code of the Russian Federation, not taking into account paragraph 3 of clause 2 of Article 309.1 of the Tax Code, which states about the total income of the CFC by means of "other documents", statements of settlement accounts, primary/initial documents, etc.

Hence, in order to calculate the revenues of the CFC, there are two options that are in accordance with the legislation of the Russian Federation:

  1. In the event that the company must provide financial statements that it has successfully passed the audit process, while with the state where the company is located an agreement has been concluded to exclude the double taxation system. In this case, the profit is calculated according to the data that is shown in the accounts formed according to the company's personal law, that is, the law of the country of registration, considering all the nuances that are given in Article 309.1 of the Tax Code of the Russian Federation.
  2. If to take as an example other cases, then the income of the CFC will be calculated as an example of general provisions that are contained in Chapter 25 of the Tax Code, based on documents, which allows you to calculate the total revenue submitted by the taxpayer.

According to paragraph 11 of Article 309.1 of the Tax Code of the Russian Federation, the general tax related to the profit of the CFC for the relevant period must be reduced in the ratio of the amount of tax with respect to this profit in accordance with the legislative base of foreign states or the legislative base of Russia. Also, the tax on the organization's total income accrued according to the income of the permanent representative of this CFC in the RF should be reduced.

The total amount of profit that is found in the consent of the norms of a foreign state must be documented, and in the event that this country does not have a signed agreement with the Russian Federation concerning taxation issues, certified by an informed service of a foreign state, and vested with the authority to control the tax area and carry out monitoring.

The norms of the legislation also take into account the option of offsetting the tax amounts paid in the state where the company is located in calculating the total profit related to the revenues of the CFC or if these amounts are paid in the RF at the location of the enterprise.

How to calculate the amount of income of the CFC with which it should be taken into account during the compilation of the tax base?

The income of the Controlled foreign company will be taken into account if, when calculating the tax base for the tax period for a certain tax, the amount of income that is calculated in accordance with Article 309.1 of the Tax Code of the Russian Federation is more than 10,000 rubles.

In 2015 and 2016, the CFC’s revenue threshold was defined as higher than in previous years. So, in 2015, it amounted to 50 million rubles, and in 2016, 30 million rubles.

The list of documents, which confirms the availability of income of the CFC

The subject itself that exercises control functions of the company, the taxpayer submits a tax return in accordance with which, in calculating the tax base, the entire profit of the controlled enterprise by that person of the foreign enterprise with the list of documents listed below is taken into account:

  • financial report of the CFC or, in case of absence, other documents related to the financial reporting of the company;    
  • an audit report on the financial reports of the CFC, if in accordance with the personal law of this CFC it was established on the mandatory audit process of this financial report.

It is mandatory that these documents or their copies in a foreign language should be translated into Russian.

Auditor's conclusions shall be submitted within the prescribed period, not later than one month from the day, which is indicated in the notification for the CFC as the date of creation of the audit report regarding the financial report. These audit findings are submitted if it is not possible to provide an opinion on the financial statements together with the filing of the declaration.

The second paragraph of Article 309.1 of the Tax Code states that the profit and loss of the CFC is calculated according to the data specified in the organization's financial report and expressed in foreign currency, which should be converted in rubles in relation to the exchange rate to the foreign currency established by the Central Bank of the Russian Federation for the period for which in the personal law of this enterprise the financial report for the last financial year is formed.

The total profit or loss of the CFC must be documented in the financial report, formed according to the organization's personal law for a certain period of time with the addition of financial as well as tax reporting.

In accordance with paragraph 2, clause1, Article 309.1 of the Tax Code, in determining the total income or loss, the total income or loss must be documented, which can determine the total amount of profit or loss. That is, it happens when the CFC is permanently located in the territory of the state that does not have an agreement with Russia regarding the tax base, and the financial report of this organization can not be subject to the audit process or is absent.

Such documents that help determine the total amount of profit or audit may be, for example, statements from the CFC settlement accounts and documents, which confirm the fact of the transaction in accordance with the rules of business turnover of foreign organizations.

What kind of revenues are important in accounting, when the profit of the CFC is determined?

When the process of forming the revenues of the CFC, the following sources of profit of this organization should be taken into account:

  • profit received during the distribution of the company's property, profits received in the distribution of income of others, their groups, including in the process of their liquidation;
  • dividends received by this foreign organization;
  • the profit received from a part of incomes of debt obligations of different kinds. Including bonds with the right to participate in the division of profits with convertible bonds;
  • profit received in the form of payments for the use of intellectual property rights: the right to use or transfer works of science, literature, art (including audio, video works), models or drawings of secret formulas, patents, as well as data relating to scientific, commercial or industrial experience;
  • income received from the sale of shares or the relaxation of rights in a foreign organization, which is not registered as a legal entity in accordance with foreign norms;
  • income from operations that are carried out using financial instruments of immediate transactions;
  • income received from the provision of personnel services;
  • income received from sales of real estate;
  • the profit received for the provision of rental or sublease services, including also the profit from leasing services, not taking into account the profit from leasing or sublease of transport, ships and aircraft, facilities or capacities that are used during air transportation;
  • income from sales of investment shares of unit investment funds, inclusive of redemption;
  • profit received in the course of audit, accounting, engineering, marketing, advertising, legal services, as well as the profit obtained from consulting, research, design or scientific work.

And also other profits from active and passive activities, which is similar to the one described above.

Sanctions that can be applicable because of violation of the norms of the Tax Code of the Russian Federation regarding the CFC

The sixteenth chapter of the Tax Code compared with the old legislation was supplemented by articles 129.5, 129.6, as well as paragraph 1.1 of article 126, paragraph 2.1 of article 129.1 which contain the following:

Article 129.5. Non-payment or incomplete payment of tax amounts as a result of not including the share of profits of a controlled foreign company in the tax base.

Full or partial non-payment by a taxpayer or a controlling person, a legal entity or an individual, of a tax due to the exclusion of part of the revenues of the CFC from the general tax base is punishable by a fine that is 20% of the unpaid tax in relation to the profit of the CFC, which should be included in the income tax base for individuals as controlling persons that are natural persons-taxpayers, the tax base for the corporate income tax for controlling persons of taxpayers-companies, but more than 100 000 rubles inclusive.

Also, it is worth noting that the sanctions provided for in Article 129.5 of the Tax Code in the process of ruling decisions on prosecution for tax periods 2015-2018 are not applied.

Only beginning from 2018, the conditions specified in Article 129.5 of the Tax Code are implemented when deciding on the involvement in tax liability for the specified tax period.

Article 129.6. Illegal non-submission of notification on foreign controlled companies, notification of participation in foreign organizations, submission of false information in the notification of controlled foreign companies, notification of participation in foreign organizations.

The absence of data submission without legal grounds for the CFC for a calendar year by the controlling person to the tax service upon the expiration of the required timeframes or submission by the controlled person of untrue information about the CFC to the tax service is subject to a fine of 100 thousand rubles for all controlling companies for which there were no data presented or in relation to which untrue information was provided.  

The absence of submission of a notification that should have been provided by the taxpayer to the tax service without legal grounds, or the provision of untrue information on participation in foreign organizations, is punished by the application of sanctions. More precisely, a fine of 50 thousand rubles in respect of all foreign organizations, information about which is not provided or if the data were not true.

Paragraph 1.1 of Article 126 of the Tax Code of the Russian Federation, which affects the failure to submit a financial report and other documents, including an audit report, states that in the event that the documents are not filed with the tax authority, the controlling person referred to in paragraph 5 of Article 25.12 of the Tax Code, as in the case of other deviations from the filing documents, or submission of documents with untrue information is punishable by imposing a fine in relation to the controlling person in the amount of 100 thousand rubles.

Paragraph 2.1 of Article 129 in relation to not providing information about members of a foreign organization that owns immovable property on the territory of the Russian Federation stipulates that:

Violation of the time limit or failure to provide information by a taxpayer that is a foreign company without registration of a legal entity to the tax service of the information specified in clause 3.2 of Article 23 of the Tax Code of the Russian Federation provides for the imposition of a fine of 100% of the total property tax of the organization calculated with respect to the property object that belongs to this foreign organization without registration of a legal entity in accordance with paragraph 3.2 of the Tax Code.

What, in addition to fines and other tax sanctions, can be applied in case of non-compliance with the provisions of the CFC law?

In addition to fines in the form of sanctions specified in the Tax Code for violation of the CFC rules, also in accordance with Article 198 of the Criminal Code of the Russian Federation, criminal liability may be applied for non-payment of taxes by an individual, as well as non-payment of taxes by an organization under article 199 of the Criminal Code of the Russian Federation in large and extremely large amounts.

According to Article 199 of the RF Criminal Code, the total debt or general fee is recognized as large, which is compiled for a period of three consecutive fiscal years and is more than two million rubles, subject to the condition that some of the unpaid taxes or fees are 10% of that amount of taxes or fees, which must be paid when the threshold of six million rubles is exceeded.

Extremely large sum is the amount of financial funds compiled for a period of not more than three years and not exceeding ten million rubles. At the same time, some of the unpaid taxes or fees should be more than 20% of the tax amounts or fees that had to be paid, or at the same time the amount should be more than thirty million rubles.

This penalty may also apply to the exclusion of the profit of the CFC for the relevant tax in the tax base. Also, in case of revealing facts of concealment or misrepresentation of information about the CFC, it is supposed to inscribe this as a particularly qualifying characteristic within the framework of Article 199 of the Criminal Code of the Russian Federation.

What kind of companies are tax residents of the Russian Federation?

Clause 1, Article 246.2 of the Tax Code states that the following companies are recognized as tax residents of the Russian Federation in accordance with the legislation:

  • Russian structures;
  • foreign structures, which, according to the international agreement on taxation, were recognized as residents of the Russian Federation;
  • foreign structures that are managed from the territory of the Russian Federation, unless otherwise stated in the international agreement on taxation.

What is the meaning of the term "place of actual management of a foreign entity"?

According to clause 2 of Article 246.2 of the Tax Code, the place of actual management of a foreign company is recognized as the Russian Federation, provided that at least one of the following provisions is complied with:

  • most of the meetings of the board of directors are held within the Russian Federation. It was proved that more company meetings were held on the territory of the Russian Federation compared to other countries;
  • the executive services of the organization act in relation to the represented company from the Russian Federation;
  • responsible subjects that occupy managerial positions in the company in more than half of cases conduct their activities as the governing body of a foreign organization.

Management of the organization is management that approves decisions or is responsible for other actions that have a relationship to the current activities of the organization, which is included in the list of responsibilities of executive management services.

In accordance with the third paragraph of Article 246.2 of the Tax Code, carrying out the following activity of a foreign organization on the territory of the Russian Federation is isolated and can not be regarded as the actual management of a foreign organization in the Russian Federation:

  • preparation and adoption of decisions concerning those issues that are submitted for consideration of the general meeting of shareholders of a foreign organization;
  • preparation for holding meetings of the board of directors of a foreign organization;
  • in the framework of the laws of the Russian Federation, performance of certain functions in the planning and control of activities carried out by a foreign company.

These functions include internal control and audit, budgeting, strategic planning, preparing and drafting a consolidated financial statement, approving, and reviewing methodologies, and policy standards, implementation of which can affect most or all of the subsidiaries of the company.

A foreign organization is considered to be a structure which management is performed from outside the borders of the Russian Federation, for example, if it carries out activities while using its own personnel and the assets of the country in which territory it is located on a permanent basis, provided that the country has signed an agreement with Russia regarding taxation. 

In addition, a foreign organization must document the fact of the implementation of these conditions.

But if in the case when not a single condition from the list is observed in respect of a foreign organization, what is enshrined in subparagraphs 1 and 2, clause 2, article 246.2 of the Tax Code of the Russian Federation, or only one condition is met, then recognition as the place of actual management of the company can be exclusively if one of the following instructions is observed:

  • not taking into account the preparation of the consolidated financial report, banking statements or accounting are carried out in the Russian Federation;
  • records management of the company is conducted in the territory of the Russian Federation;
  • the operational control of the working staff is being conducted on the territory of the Russian Federation.

Under what conditions can a foreign company separately recognize itself as a tax resident of the Russian Federation?

In the event that other is not fixed in the international tax agreement of the Russian Federation, and also in Article 246.2 of the Tax Code, a foreign organization located on the territory of another state with which the international tax agreement of the Russian Federation is concluded has the right to independently recognize itself as a tax resident of the Russian Federation if the foreign organization has already recognized itself as a tax resident of the Russian Federation and also deprive itself of the status of a tax resident of the Russian Federation.

When a foreign organization independently recognized itself as a tax resident of the Russian Federation and adhered to all indications of the Tax Code and other laws and regulations with respect to tax residents of the Russian Federation, this company will not be recognized as the CFC in accordance with 25.12 of the Tax Code.

Then the foreign organization informs on a place of location in tax service about a recognition of itself as the tax resident of the Russian Federation, according to the format approved by the Federal Tax Service of the Russian Federation.

Hence, the law gives an alternative. Not observing the rules of the CFC in relation to a foreign company - to recognize this organization as a tax resident of the Russian Federation, if it operates in the Russian Federation through another subdivision, and pays taxes on the territory of the Russian Federation, in accordance with the norms of the Tax Code of the Russian Federation, which are established for residents of the Russian Federation.

Is there a list of changes that are implemented in the order of the agreement on avoidance of a double taxation system?

The seventh article of the Tax Code was significantly changed, where, among other things, the rule of "the actual recipient of income" was introduced.

The subject that owns the rights to income, for the purpose of applying international tax rules by the Tax Code of the Russian Federation, is a person who can be involved in direct or indirect control and management of a company, or who, for other reasons, may dispose of the organization's revenues, or a subject in accordance with whose interests another entity, that is, a trustee has the right to dispose of these revenues.

In the process of determining a subject that has the right to dispose of the organization's revenues, functions that are performed by subjects described in the Tax Code of the Russian Federation are taken into account, as well as possible risks applicable to them.

When determining the norms of the international agreement of the Russian Federation, it was established that the use of reduced rates for tax, or the deprivation of the obligation to pay taxes on income from sources of the Russian Federation for foreign entities that are entitled to this income, foreign subject or in that case will not be determined as a person that has the right to dispose profit.

In the event that a foreign person has certain restrictive powers regarding the distribution of income amounts, and this subject exercises the functions of an intermediary in relation to this income, guided by the interests of another entity, without taking any other actions and bearing any risks.

This provision shows the desire of the legislature to combat the "transit" schemes at a higher level. After all, these schemes are used to pay royalties, as well as various relaxations and benefits with dividends, interest, referred to in the agreement to exclude the double taxation system.

In the letter of the Ministry of Finance of Russia dated 9.04.2014, No. 03-00-P3 / 16236, the following position was expressed.

Money from the received profit is paid to a foreign person: that is located on an ongoing basis in the territory of the country with which the Russian Federation has signed an international tax agreement; who does not have rights to this income; in the event that someone who carries out payment knows a subject that is entitled to part of the income.

The income in this case is taxed in the following order:

  1. If the subject that has the right to dispose of income is recognized as a tax resident in accordance with the Tax Code of the Russian Federation and taxes from its share of income are accrued in accordance with Chapter 2 of the Tax Code of the RF regarding residents.
  2. In the event that the subject that has rights to the entire amount of profit or a part thereof is a foreign person falling under the rules of the international tax agreement of the Russian Federation, and part of these norms cover the actions of the person that has the actual right to receive all income or part thereof, in accordance with the procedure specified in the international treaty of the Russian Federation.

The tax agent is obliged to indicate the permanent location of the foreign organization that receives income in accordance with the norms of international treaties of the Russian Federation with regard to excluding the double taxation system. Also, according to clause 1, Article 312 of the RF Tax Code, he can send a request to a foreign organization regarding confirmation of the fact that this organization has the right to receive an appropriate profit.

Until now, there is still no reliable information about exactly what data should be in the confirmation of the presence of the foreign company's rights to income, and in which particular format it should all be formalized.

As for the payment of dividends, Article 312 of the Tax Code of the Russian Federation provides for the following.

In the event that, in relation to dividends, a foreign company recognizes that it does not have rights to acquire them, while not referring to the norms of international agreements of the Russian Federation, the terms of the international agreements of the Russian Federation in this scenario may apply to another subject, if such person, directly or indirectly, is part of a Russian company that paid out a share of profits in the form of dividends, while providing the relevant securities specified in Article 312 of the Tax Code to a tax agent.

Rights for the implementation of the norms of international treaties of the Russian Federation are also present for such a subject, which is part of another subject, which recognized the lack of the right to dividends or other income in such a ratio that it meets such a share of participation.

When the subsequent subject recognizes the lack of rights for the execution of the dividend order, which the Russian organization paid him, then this right will be transferred to the next subject according to the list of participants in turn.

But in the event that the subject that has the right to receive dividends and take indirect participation in the organization that pays profit in the form of dividends is a resident of the Russian Federation, then tax rates regarding the receipt of profits from dividends may be applied to tax rates in accordance with subparagraphs 1 and 2 , Article 284 of the Tax Code, with the provision of the relevant documents to a tax agent that pays these dividends, in accordance with Article 312 of the Tax Code.

It is also worth paying attention to the use of the rate, according to clause 1, article 284 of the Tax Code of the Russian Federation, which is performed subject to the following conditions:

  • the percentage of participation of the Russian subject that has the rights to dispose of dividends in the relevant fund of the Russian entity that pays such dividends, as well as foreign organizations that afterwards participate in the capital of this Russian entity, which includes more than 50%, from the day of payment of dividends, before the closing of the tax period in the interval of which these dividends are paid;
  • the total amount of dividends, which is not less than 50% of all dividends, the rights to which belong to the Russian person;
  • paying the profits by the tax agent in the form of dividends in order to use the norms of the international treaty of the Russian Federation or the tax rates specified in the Tax Code of the Russian Federation, in addition to the documents described in paragraph 1 of Article 312. He can also request the following information from a foreign organization that received profit in the form of dividends and the subject that can dispose of dividends: facts that confirm:
  • documented information, which proves that the selected foreign company recognizes the absence of rights to this profit, and also does not make any claims about the implementation of the norms of international treaties of the Russian Federation;
  • information about the subject that was recognized as the recipient of income from the activities of a foreign organization.

Starting from January 1, 2015, the tax rate is used at the level of 13 percent, according to Article 224 of the Tax Code, but up to this period it was 9 percent;

In connection with the entry into force of the current Russian regulations on the CFC, which should be reviewed at first?

Russian companies, as well as subjects that represent their interests and use non-resident systems during business activity, now must significantly improve their control over personal tax risks or carry out their activities in accordance with the reformed legislation or completely postpone the use of non-resident schemes, where their action does not correspond to the norms of the CFC.

In addition, the Tax Code of the Russian Federation may determine the subject (person) as controlling one through the tax system of the Russian Federation, and guided by information received from abroad in accordance with clause 8, Article 25.14 of the Tax Code.

In consequence, despite all the obstacles, the international exchange of tax information will only be improved, and the tax processes will be developed.

The Russian Federation has ratified the OECD Convention, and the actions of its norms have entered into force in the Russian territory. Now its provisions extend to mutual administrative assistance affecting the tax sphere. In the future plans there is the approval of tax agreements on the exchange of tax information, including about the offshore zone.

There is also an improvement in control over the implementation of the application of benefits and exemptions, as indicated in the agreements for excluding the double taxation system. Foreign companies that make profits from Russian organizations are required to actually be present in the territory of the state where they are registered in order to confirm the rights to profits and the corresponding benefits under tax treaties.

Regarding the legislative framework that regulated the tax sphere of the CFC, it can be noted that it is far from its final version.

And with the new edition of the Tax Code of the Russian Federation, it is necessary to adopt a number of by-laws related to the list of countries that did not ensure the exchange of information about tax data with the Russian Federation, so called "black list".

Also it is necessary to approve the forms of notifications on participation in foreign organizations and data on the CFC.

But if you look at this law from another point of view, it immediately becomes clear that the implementation of its norms is not the simplest thing. To simplify all procedures and remove unnecessary questions, it would be a right step to approve methodological recommendations to the tax services regarding the use of Chapter 3.4 of the Tax Code.

Of course, the documentary explanations of the Ministry of Finance of Russia for taxpayers will soon follow, giving answers to relevant questions about the status and actions of the CFC. Next, there is the case for arbitration practice, which will put everything in its place.

If you have any questions, please contact our consultants who will provide you with the information that is of your particular interest.