Mar 03, 2010: Tax Reforms Towards the Creation of an International Financial Center in Russia

In December 2009 the Russian Parliament adopted important changes further

promoting the Russian holding companies regime. Starting from

January 1, 2011 Russian holding companies will no longer be required to

meet the present 500 million ruble threshold for investments made into

companies qualifying as “strategic investments” to receive tax benefits.

Under the amended rules, Russian holding companies will be exempt from

profits tax on dividends payable by foreign and Russian subsidiaries qualifying

as “strategic investments”, provided that, on the day the corporate decision to

pay dividends is taken, the following conditions are met:

(1) the recipient of the dividends has continuously held shares for not less

than 365 days;

(2) the recipient of the dividends owns not less than 50% of the shares in the

company paying the dividends; and

(3) the company paying the dividends is not located in a jurisdiction included

in a “black list” of offshore jurisdictions adopted by Order No. 108n of the

Russian Ministry of Finance, dated November 13, 2007 (the “black list”

includes most of the offshore low-tax jurisdictions and territories, including

Cyprus).

In the absence of a high investment threshold, structuring of both domestic

and foreign investments on the basis of a Russian holding company will not

be associated with additional tax costs on dividends. However, the Russian

holding companies regime does not extend to capital gains on sales of shares

in subsidiaries, which makes Russia less attractive than some of the typical

holding jurisdictions.

At the end of 2009 the Russian Parliament passed Federal Law No. 281-FZ,

dated November 25, 2009, introducing a number of important changes to the

tax treatment of securities and derivatives trading, repo transactions and stock

loans in Russia as well as other related laws (“Law 281-FZ”). The majority of

its provisions became effective as of January 1, 2010. The major amendments

affecting companies in Russia are discussed below.

Under the new rules, securities must have a market quotation calculated

within the three months prior to the transaction to be recognized as tradable

securities.

The procedure for determining the market price for securities has been

amended. The maximum period for determining the transactions included in

the pricing range for tradable securities (in the absence of trades on the

transaction day) is limited to three months. This decreases the risk of a

transaction price significantly deviating from the reference price in case of

high market volatility. For non-tradable securities the reference price can no

longer be determined based on the price of similar securities, which eliminates

the risk of the Russian tax authorities choosing undue comparables. If the

transaction price deviates by more than 20% from the reference price, the

profit/loss of a taxpayer is calculated based on the reference price and the

allowed deviation. The procedure for calculating the reference price for nontradable

securities is to be established by the Federal Service on Financial

Markets (“FSFM”) subject to approval by the Ministry of Finance.

Taxpayers are no longer allowed to apply the LIFO method in tax accounting

of securities trading. Companies that previously applied the LIFO method will

need to make amendments to their tax accounting policy.

Law 281-FZ defines derivatives by referring to a new concept of a derivative,

introduced in the Federal Law “On the Securities Market”. The list of

derivatives (including forwards, futures, options and swap-contracts) is to be

adopted by the FSFM. Derivatives that are not on this list will not be

recognized for tax purposes in Russia. Derivatives having an underlying asset

calculated based on changes in statistical information or environmental

indicators (e.g., weather derivatives) are not recognized as derivatives for tax

purposes in Russia.

The Tax Code literally establishes that contracts not subject to judicial

protection in accordance with Russian legislation are not to be recognized as

derivatives for tax purposes, which would disallow costs, in particular losses

on derivatives, from being recognized for tax purposes. This regulation refers

to Article 1062 of the Russian Civil Code, under which a number of derivative

contracts enjoy judicial protection. However, when a transaction is not

governed by Russian law, it is unclear whether it is sufficient for tax purposes

that it is subject to protection in accordance with some other law, and not with

Russian law, or whether it would be necessary that it has features that would

allow it to be protected under Russian law.

As previously, legal entities are entitled to combine financial results on

transactions with derivatives tradable on an organized stock exchange

together with the results of their ordinary operations. Financial results on

transactions with non-tradable derivatives form a separate tax basis which

cannot be combined with other financial results (exceptions are made for

banks and professional dealers), unless they qualify as hedging. The criteria

for transactions to be classified as hedging have been expanded: now it is

enough to prove that a derivative or a series of derivatives is aimed at

decreasing the taxpayer’s potential losses. Law 281-FZ has established a

procedure for recognizing financial results on hedging transactions in case of

early termination of an underlying (hedged) contract.

The new rules have clarified some previously unclear issues. In particular,

deliverable derivatives and contracts with differed maturity are not reclassified

as non-deliverable derivatives in case of netting; changes in prices, market

quotations, currency exchange rates, indexes or other indicators do not trigger

revaluation of tradable and non-tradable derivatives. The procedure for

determining the market price of derivatives has been amended in a way

similar to the procedure for determining the market price of securities.

The new rules have clarified the application of VAT to derivative transactions.

VAT is not levied on the sale of derivatives (but is levied on the delivery of

commodities subject to VAT). VAT is accrued on the value of the commodity

indicated in the deliverable derivative.

Law 281-FZ has introduced new detailed rules clarifying the tax treatment of

repo transactions (including cross-border repo transactions) and stocklending.

Law 281-FZ has also improved the tax regime of securities and derivatives

trading for individual investors. The law has introduced new rules for recording

financial results on transactions with different categories of securities and

derivatives for tax purposes. Individual investors have received the right to

carry forward losses on tradable securities and tradable derivatives for ten

years.

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