article on russian tax system

Corporate Tax 2008

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The International Comparative Legal Guide to:

ACCURA AdvokataktieselskabArnold Bloch LeiblerArthur CoxAvanzia Tax AdvisorsBarros & Errázuriz AbogadosBC Toms & Co.BMR & AssociatesBredin PratBugge, Arentz-Hansen & RasmussenBustamante & Bustamante Camozzi Bonissoni Varrenti & AssociatiCárdenas & CárdenasCastrén & Snellman Attorneys Ltd.Delchev & PartnersDespacho de Abogados miembros deMacleod Dixon, S.C.Dorda Brugger Jordis

Elvinger, Hoss & Prussen EubeliusG. BREUERGencs Valters Law FirmGide Loyrette NouelGoodrich, Riquelme y AsociadosHendersen TaxandHerzog, Fox & NeemanJuridicon Law FirmKilpatrick StocktonKim & ChangKyriakides Georgopoulos & Daniolos IssaiasLaw FirmLaw Office Aivar PilvLaw Office Jadek & PensaLenz & StaehelinLinklaters LLPLOGOS Legal ServicesLovells LLP

Machado, Meyer, Sendacz e Opice AdvogadosMacleod DixonMichael Kyprianou & Co.Nagashima Ohno & TsunematsuPachiu & AssociatesP+P Pöllath + PartnersPaul, Weiss, Rifkind, Wharton & Garrison LLPPepeliaev, Goltsblat and PartnersPrijohandojo, Boentoro & Co.Salans LLPSalans D. Oleszczuk Kancelaria Prawnicza Sp. k.Slaughter and May Van Doorne N.V.Werksmans Inc.White & Case WongPartnershipZaid Ibrahim & Co

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Pepeliaev, Goltsblat and Partners

Russia

1 General: Treaties

1.1 How many income tax treaties are currently in force inyour jurisdiction?

Russia currently has 67 tax treaties in force. Among them aretreaties with West-European countries (the United Kingdom,Germany, the Netherlands, France, Switzerland, Sweden, Irelandand others), treaties with countries of Eastern Europe, Asia, treatieswith the USA and Canada. There are also treaties with the formerSoviet Republics.There was no serious activity in 2007 concerning the establishmentof new treaties or amendment of the old treaties - only the Russian-Belarusian treaty was amended. However, two tendencies of 2007 should be recognised:1) The Ministry of Finance pronounced several times that they

were going to revise the provisions (which were generallythe part of the tax treaty) or to establish agreements in regardto the exchange of “tax information”. This should be done inthe frame of an anti-offshore campaign (see question 7.1below).

2) Tax authorities concentrated on the interpretation problems.One of the most noticeable questions in case-law (courts'enforcement practice) concerned the head office expensestransferred to Russian branches. Tax authorities still insistthat Russian branches should prove with sufficientdocuments not only the fact of transferring and themechanism of distributing the expenses but also the fact thatthe head office really carried out this expenditure.

1.2 Do they generally follow the OECD or another model?

Yes, they generally follow the OECD model and, although Russiais not a member of the OECD, the courts, when deciding a taxtreaty issue, could follow the interpretation given by the OECDin its Commentary.It should be noted, however, that tax treaties do not generally followthe OECD model word for word, as shown below:(a) a tax treaty could lift a ban or limitation established by Russiannational law (Tax Code). Some treaties (e.g., those with Germany,the UK and France) allow certain expenses to be fully deducted,notwithstanding restrictions under the Russian Tax Code (e.g.,advertising expenses);(b) the articles on dividends, royalty and interest could differ;(c) the clause concerning the expenses being distributed from ahead office to subdivision could be worded in a different mannerand, therefore, it could entail or not entail the negative

consequences described in question 1.1. above;(d) treaties could include or not include anti-treaty shopping rules(see question 1.4 below). Anti-treaty shopping rules could differ.There could be other peculiarities and a taxpayer, when evaluatingtheir situation, should follow exactly the treaty that should be applied.

1.3 Do treaties have to be incorporated into domestic lawbefore they take effect?

The international treaties of Russia are a component part of theRussian legal system. The treaties may only take effect, however, once ratified.“Ratification”, according to Russian law, means that a special federallaw should be promulgated. Each treaty includes a clause under whichit takes effect after an interchange of notifications that each of thecontracting states has ratified it. Several years might pass from thesigning of an agreement to the end of ratification procedures.

1.4 Do they generally incorporate anti-treaty shopping rules (or“limitation of benefits” articles)?

Most of the treaties do not include anti-treaty shopping rules(“limitation of benefits” articles). Some treaties do, however, haveanti-treaty shopping rules (e.g., the treaties with the UK and the USA).Some treaties are interpreted as including the rule that only abeneficiary company could use the treaty benefits (e.g., Russia -Cyprus treaty in the part concerning the dividends). However, theterm of “beneficiary” is fairly blurred and is hardly applicable unlessthe strong provisions in regard of exchange of tax information isintroduced and tax authorities start using them. In any case, tax treaties do not allow taxpayers to benefit from shamactivities (i.e., those that are not actually carried out). On 12 October 2006, the Supreme Commercial Court issued aguideline on “what might be deemed tax evasion and avoidance”. The purpose of business, said the Court, should not be the taxbenefit though said benefit may accompany transactions that havereal business purposes, because a taxpayer is free to achieve adesired economic result with a minimum tax burden. A tax benefitresulting from transactions that are economically or commerciallyunreasonable is an “unjustified tax benefit”.The tax authorities will probably undertake attempts to apply thisguideline to cases when the taxpayer derives a tax benefit on the basisof the treaty (when the company is established in a country with amore favourable taxation not for “real business” but for tax benefitpurposes and leads no real business activity in this offshore zone).

Vadim Zaripov

Tatiana Vasilieva

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Pepeliaev, Goltsblat and Partners Russia

Once tax authorities succeeded in fighting against “inner offshorezones”, which allowed taxpayers paying less tax without realactivity within offshore.

1.5 Are treaties overridden by any rules of domestic law(whether existing when the treaty takes effect orintroduced subsequently)?

No. The treaty overrides any rules of domestic law.However, the taxpayers should be very careful when applying thetreaty, because anti-avoidance rules being not listed in the treatycould be established right in the Russian Tax Code. In such casesthe claim of a taxpayer that “domestic rules conflict with treatyrules” will be not taken into account. The chance of winning sucha case, even if a taxpayer insists on mechanical and formal characterof national anti-avoidance rules, is quite small. Example:

2 Transaction Taxes

2.1 Are there any documentary taxes in your jurisdiction?

State Duty is the documentary tax in Russia.All cases when state duty is imposed are listed in Chapter 25.3 ofthe Russian Tax Code. These include:

when applications are submitted to the Constitutional Court,to courts of law, arbitration courts or to a justice of the peace;when applications are submitted for notarisation;when applications are submitted for an apostille; andwhen applications are submitted for performance of legallyrelevant actions.

Some examples when opening business in Russia:The state duty for certification of constituent documents oforganisations is 500 roubles (about 14 EUR).State duty shall be paid at a rate of 2,000 roubles (57 EUR) for stateregistration of a legal entity. The state duty for accrediting foreign organisations established onthe territory of the Russian Federation is 60,000 roubles (1,700EUR) for each branch.Some examples when having a dispute with Tax Office andapplying to a court:The usual taxpayers' petition to the court is to declare the taxdecision be invalid. In this case the stamp duty is 2,000 roubles (57EUR). However, if the claim is “material”, e.g., to force the TaxOffice to return a tax, the stamp duty should be calculated as acertain percent from the sum of claim. The maximum stamp dutyis 100,000 roubles (2,800 EUR).

2.2 Do you have Value Added Tax (or a similar tax)? If so, atwhat rate or rates?

Yes, the Russian tax legislation stipulates Value Added Tax. The rates are determined in Article 164 of the Tax Code and are asfollows:

the standard rate is 18%;the reduced rate is 10%. This is applicable to operations withcertain goods (e.g., meat, milk, sugar, salt, children's anddiabetic foods, children's beds, school exercise-books, toys,printed periodicals, science and culture books, medicationsand other goods listed in Article 164 of the Tax Code); andthere is a 0% rate. Taxation is imposed at the 0% rate on theexport of goods, as well as on the provision of certain worksand services (including transportation services) related toexport and in some other cases.

2.3 Is VAT (or any similar tax) charged on all transactions orare there any relevant exclusions?

The main items, the sale of which is subject to VAT are goods,works and services and the importation of goods into the Russiancustoms territory.The transfer of goods on a gratuitous basis is deemed a sale, and thesame applies to works and services. There are five groups of exclusions:1) Where “the place of sale” is not Russia. There are special rulesin the Tax Code about “the place of sale of goods and the place ofsale of works (services)” (Articles 147 and 148 of the Tax Code). Examples: If a foreign company provides legal services to aRussian company, these would be subject to VAT, because the“place of sale” is determined in this case as a “place of thecustomer's activity”.2) Where “the place of sale” is Russia, but the operation is notrecognised as being subject to taxation. Example: transactionsinvolving the sale of land plots or shares thereof.3) Operations that are not taxable (exempted from taxation). Therelevant exclusions are stipulated for certain medical products andservices, public transport services, bank services, shares, securitiesand many others.4) Release from taxpayer obligations. Organisations andbusinessmen have the right to relief, if the sum of their proceedsdoes not exceed a total of 2,000,000 roubles (about 57,000 EUR)for the three preceding calendar months in a row.5) Organisations and persons who are not taxpayers for VATpurposes. For example, advocates do not pay VAT because they arenot deemed to be businessmen. Organisations and businessmen whoapply the simplified system of taxation are not VAT-payers either.

2.4 Is it always fully recoverable by all businesses? If not,what are the relevant restrictions?

Under the Russian Tax Code, the sum of the deduction is estimatedas the amount of VAT presented to the taxpayer when purchasinggoods, works or services or paid by the taxpayer when importinggoods on to the Russian customs territory. Since 1 January 2006,the tax deduction has been based on the VAT-invoice.There is a list of situations when the Tax Code prohibits taxdeduction:1) when the organisation or businessmen who buy goods (works,services) are not VAT-payers (e.g., advocates, organisations andbusinessmen who apply the simplified system of taxation);

Provision of Russia - UK treaty. Anti-avoidance rules, established by theRussian Tax Code, Article 308.

A building site or construction or installation project constitutes a

permanent establishment only if it lasts more than 12 months.

(a) the period of time spent by thesubcontractors on carrying out the worksshall be seen as the time thus expended

by the general contractor itself.(b) supposing the works are finished and

the acceptance report is signed by thecustomer, but after this the works are

continued, the term of “new” works andthe interval between the works should beadded to the total term of the existence

of the construction site if:- the territory of the works is the same

or a closely adjoining one;- the contractor is the same of their

reciprocally dependent person.

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2) if the goods (works or services) are acquired for the purposes ofcarrying out activities that are not subject to VAT (see question 2.3above; there are five occasions). The unrecoverable VAT isdeductible as an expense for corporate profit tax purposes;3) in some cases, the tax amount accepted for deduction shall beliable to refunding (this rule took effect on 1 January 2006). Thosecases include, e.g., the case of transfer of property as a contributionto authorised capital of companies; and4) the VAT deduction is limited if there is a limitation on the costsfor corporate tax purposes (e.g., in cases of business trips andentertainment expenses).Tax deduction will be declared by tax authorities and courts to beinvalid in the cases when:(a) taxpayer is a participant of a sham mechanism of VATreimbursement;(b) taxpayer knows (for example, in case of affiliated companies)that their supplier is performing infringement transactions to shelterthe VAT;(c) taxpayer acts imprudently when concluding and fulfilling thecontract with bad-faith supplier and at the same time the bad-faithcharacter of the supplier is obvious.These provisions (a-c) are listed in the Plenary Ruling of the HigherArbitration Court No. 53 dated 12 October 2007.It is difficult to define the current enforcement practice based onthis Ruling as definite and mature: tax authorities still exercise theposition that “if a supplier has not paid VAT to the budget, thetaxpayer, in any case, has no right to recover VAT” and there are hotdebates still going in the courts.

2.5 Are there any other transaction taxes?

There are no other transaction taxes in Russia. The excise taxes asindirect taxes exist (see question 2.6 below). Also, customs duties are generally payable on a wide range ofimported goods and on a number of exported goods.

2.6 Are there any other indirect taxes of which we should beaware?

Excise taxes. The Russian tax legislation stipulates excise taxes for:sale on the territory of the Russian Federation of excisablegoods (e.g., ethyl alcohol, some alcohol-containing products,tobacco products, cars, petrol, petrochemical products) bythe producers;transfer of excisable goods produced by persons from theclients' raw materials, transfer of excisable goods within thestructure of the organisation for subsequent production ofnon-excisable goods and certain other transactions;receipt of denatured ethyl alcohol by an organisation holdinga certificate for production of alcohol-free products; andcertain other operations.

3 Cross-border Payments

3.1 Would there be any WHT on royalties paid by a localcompany to a non-resident?

There is a 20% WHT on royalties paid by a Russian company to anon-resident (30% for a non-resident individual who is a licensor).If a treaty establishes other rules, the rules of the treaty shall apply.If royalties are attributable to a permanent establishment in Russia

of the non-resident licensor, they would be taxable at the 24%corporate tax rate. In this case, the tax treaty's provisionsconcerning permanent establishments are applied.

3.2 Would there be any WHT on interest paid by a localcompany to a non-resident?

There is a 20% WHT on interest paid by a Russian company to anon-resident (30% for a non-resident individual who is a lender).If a treaty establishes other rules, the rules of the treaty shall apply.If royalties are attributable to a permanent establishment in Russiaof the non-resident lender, they would be taxable at the 24%corporate tax rate. In this case the tax treaty's provisionsconcerning permanent establishments are applied.Special rates are established with respect to interest on municipal andstate securities (15%, 9% and 0%, depending on the type of security).

3.3 Would relief for interest so paid be restricted by referenceto “thin capitalisation” rules?

Yes. Under the Russian Tax Code, the rules of “thin capitalisation”are applied with respect to interest (i.e., interest on any kind of debtliability: credits; commodity and commercial credits; loans; bankdeposits; bank accounts; or other borrowings) to be paid by a localcompany to a non-resident if:1) the foreign company that, directly or indirectly (see theexplanation below), owns over 20% of the authorised capital of theRussian debtor-company is: a) the creditor of that Russiancompany; b) an affiliated company of another Russian companythat is the creditor of the given Russian debtor-company; or c) thewarrantor of the given Russian company's debt (this also applieswhen an affiliated Russian company is a warrantor). The last twoconditions ('b” and “c”) have been in operation since 1 January2006; and2) the amount of debt (so-called “controlled debt”) is more thantreble (or 12.5 times - for banks and leasing companies) thedifference between the sum of assets and the amount of liabilities ofthe Russian debtor-company.If there are such conditions, only the limited sum (the ultimateamount) could be included in expenses by a Russian borrower. Thesum in excess of this is deemed to be a dividend of the foreigncompany, not interest. So, the article of the treaty concerningdividends, not interest, will apply. The ultimate amount of the interest is defined by dividing the sumof the interest in the reporting tax period by the capitalisationcoefficient. The mechanism of calculating the coefficient isdescribed in Article 269 of Tax Code. There exist a lot of disputable issues in regard to the 'thin cap' Article(even including disputes concerning calculation of the thin capcoefficient) and their covering usually takes 2-3-hour seminar, so, as afirst step, we want to draw an attention of companies to 2 problems:1) “Thin cap” and non-discrimination. Tax authoritiesperiodically try to apply Article 269 even in situation when foreigncompany is established in the country which has bilateral treatywith Russia and such treaty has the non-discrimination clause. In itsLetter No. 03-08-05, dated 20 December 2006, the Ministry ofFinance indicated that the thin cap rules should apply in any case,irrespective of the non-discrimination rules in the international taxtreaty. That Letter concerned the treaty with the Netherlands. Bynow, the courts ruled in favour of taxpayers. 2) “Sisterly” companies. We should note that “indirectownership” according to the Tax Code means “ownership through

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the succession of other companies”. Thus, “sisterly” companiesshould not be deemed as controlled companies. By now, the courtssupport this position.

3.4 If so, is there a “safe harbour” by reference to which taxrelief is assured?

See question 3.3 above.The “safe harbour” is available when:(a) the coefficient of thin capitalisation is exactly within the framesestablished by Article 269 of Russian Tax Code; or(b) even if the coefficient could be outside the frames of Article269, but the foreign company and Russian debtor are independent(directly or indirectly) from each other; or(c) even if the coefficient outside the frames of Article 269 and theforeign company and Russian debtor are interdependent, but thereis a tax treaty with the clause of non-discrimination and there are nosigns and evidence of sham (pretended) transactions. In this lastcase the dispute between taxpayer and Tax Office could arise, but ifthe dispute will not be ruled in the pre-trial order, the court shouldrule the case in favour of taxpayer.

3.5 Would any such “thin capitalisation” rules extend to debtadvanced by a third party but guaranteed by a parentcompany?

Yes, see question 3.3 above.

3.6 Is any withholding tax imposed on dividends paid by alocally resident company to a non-resident?

There is a 15% WHT on dividends paid by a Russian company to anon-resident (30% for a non-resident individual shareholder).If a treaty establishes other rules, the rules of the treaty shall apply.According to the Russian Tax Code, if dividends derive from apermanent establishment, they would also be taxed at the rate of15%. However, according to the “non-discrimination” principle,dividends deriving from a permanent establishment should be taxedat the rate of 9% as are Russian dividends. The “non-discrimination” principle should be stipulated in the internationaltax treaty. The taxpayers, most likely, will be obliged to defend theirposition in court.It should be noted that beginning from the 1st January 2008 taxpreferences for Russian recipients of dividends are in force. Such newrules are caused by the policy of supporting investments and strivingfor creating the status for Russia as the holding companies centre. Thedistributor of dividends could be both Russian and foreign.The WHT on dividends being received by Russian companies is 0%if:

the term of share ownership is no less than 365 days by theday of establishing the decision of distributing the dividends;andthis term was not interrupted; andthe share is not less than 50 %; andthis share gives the right for receiving no less than 50 % ofthe whole sum of dividends; andthe cost of share acquiring was more than 500,000,000roubles (about 14,000,000 EUR).

Under the Tax Code, the Ministry of Finance is going to prepare alist of countries with favourable regime of taxation and (or) theregime of which does not provide for the disclosure of information

concerning financial transactions. A Russian company will not beable to apply a 0% rate on dividends if it receives dividends fromsuch a country.

3.7 Does your country have transfer pricing rules?

The Russian Tax Code does contain rules about adjusting pricesapplied by contracting parties to the market prices. Moreover, theMinistry of Finance is finishing their work on the new transferpricing rules that will be orientated on international experience andwill regulate international transactions involving countries withfavourable tax regimes to a greater degree than internaltransactions. The approximate date when the draft of the lawshould be approved by the Government is November, 2007. Hence,it could be expected that the law will be passed through the StateDuma (legislative body) within the first half of 2008 and will beenacted on 1st January 2009.At first, we will shortly describe the current legislation:The tax authorities can correct the price and calculate additionaltax and a penalty when the price applied by the parties to atransaction deviates upwards or downwards by more than 20%from the market price.The tax authorities can, however, check and correct the price onlyin a limited number of cases; for example, in the event of atransaction between related persons, in the event of a bartertransaction or in the event when, within a short period of time, thetaxpayer applies a price differing by more than 20% from the pricesapplied by said taxpayer to identical goods (works, services). The main problem of current legislation is the weakness of taxauthorities when calculating the market price level: there are nosufficient official information on prices and no effective means toget this information; there is no debugged mechanism ofexchanging financial information with foreign states (this processwas stated to be debugged approximately 1 year ago), etc. In thesecircumstances, Tax Offices are unable, practically, to prove adeviation from the market prices.The future amendments planned are, among other things:

to specify the list of “related persons” in more detail;to make the taxpayer responsible for proving the appliedprices and establishing the requirements on the list ofdocuments which a taxpayer should provide;to specify, expand and provide a closed list of controllabletransactions, including, in particular, such controlledtransactions as conclusion of a contract with companies thatare taxpayers in a low-tax jurisdiction (by now, the Ministryproposes including in the list several countries, e.g., the BVI,Cyprus, Ireland (Dublin and Shannon), Malta, the Isle ofMan, etc.);to introduce a new procedure for calculating market priceand a market price interval (NB. a market price is one thatfalls within the limits of said interval);to provide additional methods for calculating the marketprices; andto establish the institute of preliminary agreements on pricing(advanced tax rulings).

4 Tax on Business Operations: General

4.1 What is the headline rate of tax on corporate profits?

The headline corporate tax rate is 24%. The profit tax at a rate of 17.5% is paid to the budget of the constituent



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entity of the Russian Federation, and the government of theconstituent entity of the Russian Federation may reduce its 17.5% ratein order to attract investment. The tax rate may not be less than 13.5%- this is the so called regional incentives. As a rule, regional incentivesinclude reduced rate of profit tax and property tax, but the mostconsiderable incentive is the property tax incentive. The 24% rate applies to the income of a foreign company when theincome derives from a permanent establishment.The headline rate of the profit tax on a foreign company's incomenot deriving from a permanent establishment is 20%.There are special rates applicable to certain incomes. For example,there is a special rate for dividends (15% on the foreign company'sdividend income not deriving from a permanent establishment).

4.2 When is that tax generally payable?

Generally, the tax is payable on or prior to 28 March of the yearfollowing the tax period (the calendar year from 1 January to 31December).Within the tax period, a taxpayer should pay advance payments.

4.3 What is the tax base for that tax (profits pursuant tocommercial accounts subject to adjustments; other taxbase)?

There are special separate rules for calculating profit for taxpurposes. It may be that a certain income is deemed an income fortax purposes but not for financial accounting purposes, and viceversa. The same applies to costs. In fact, “daughters” of foreign companies keep three types ofaccounting books:

accounting books according to national accountingsstandards;books being filled on the basis of International accountingstandards (IAS);and tax books,

although the Ministry of Finance carries out the works to approachall the accounting rules to each other. The tax base is determined as TAXABLE INCOME minus COSTSthat meet the requirements of Article 252 of the Russian Tax Code. INCOME. The Tax Code contains a closed list of incomes that arenot deemed to be an income for tax purposes (Article 251). COSTS. There are some requirements for costs to be deductible fortax purposes. These costs must be documented and economicallyjustified. The requirement for “economic justification of costs” wasone of the most disputable questions before the Decision of theRussian Constitutional Court No. 320-O-P dated 04 June 2007.The Constitutional Court ruled:

“Economically justified costs” means “the costs connected tobusiness and profit”;the Tax Office is not allowed to evaluate whether the costsare expedient or not (only the owner of business could decidethe question of costs' expediency); andthe burden of evidence lies on the Tax Office.

There are two types of non-deductible expense:expenses that are not documented or economically justified;andexpenses listed in Article 270 of the Tax Code (e.g., a penaltypaid to the government).

4.4 If it otherwise differs from the profit shown in commercialaccounts, what are the main other differences?

The main difference is that there is a separate rule for calculating profitfor tax purposes (see question 4.3 above). Taxpayers maintainindependent Analytical Tax Recording Registers for tax purposes. The main differences are:

there is a list of non-deductible expenses in the Tax Code;some expenses (such as certain advertising expenses) may beallowed within certain limits;some incomes are not incomes for tax purposes;the rules of depreciation for accounting purposes and for taxpurposes are different (e.g., there is no depreciation for taxpurposes when a taxpayer hands over property for free use bysomebody); andcosts for tax purposes may be allowed in another period infinancial accounting, etc.

4.5 Are there any tax grouping rules? Do these allow for reliefin your jurisdiction for losses of overseas subsidiaries?

There are no special tax grouping rules in the Tax Code. The rulesdo not allow a parent company to record the losses of itssubsidiaries in its own accounting independently of the type ofsubsidiary - home or overseas.Each company estimates the tax base independently. There are, however, some current rules:à) if the ownership interest in a subsidiary is more than 50%,

property received free of charge from one company toanother would not be treated as profit;

b) the tax authorities are entitled to check the prices applied in thetransactions between a parent company and a subsidiary (seequestion 3.7 above);

c) since 1 January 2007, three-months` tax arrears of a subsidiarycan be collected from the parent company if this parentcompany receives the profits of the subsidiary into its ownbank account and vice versa; and

d) a Russian receiver of dividends could apply 0% tax under certainconditions (see question 3.6 above).

The planned amendments concern a “consolidated taxpayer”. TheTreasury is discussing the idea of a “consolidated taxpayer”. Inparticular, this would make it possible to sum the profits and lossesof “parents” and subsidiaries and to solve the transfer pricingproblem for holding companies, but only within Russia.

4.6 Is tax imposed at a different rate upon distributed, asopposed to retained, profits?

The Russian profit tax rate is applied to a Russian corporatetaxpayer's taxable profit, regardless of whether that profit isdistributed or retained.

4.7 What other national taxes (excluding those dealt with in“Transaction Taxes”, above) are there - e.g. property taxes,etc.?

There is a closed list of taxes that can be imposed in the RussianFederation (those listed in Articles 13, 14 and 15 of the Tax Code).These are:

Nine federal taxes: VAT; excise taxes; tax on personalincomes; uniform social tax; tax on profits of organisations(corporate tax); tax on extraction of minerals (severance tax);

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water tax; fee for the right to use fauna and aquatic biologicalresources; and state duty.Three regional taxes: tax on property of organisations; tax onthe gambling industry; and transport tax.Two local taxes: land tax; and individual property tax.

We have already mentioned some federal taxes.As for the other major taxes, the tax on personal incomes is leviedat a rate of 13% for residents and 30% for non-residents. As for theunified social tax, payments to an employee or an individualcontractor who is not registered as an individual entrepreneur aresubject to the unified social tax. The rate of this tax is regressive;the maximum rate is 26%.

4.8 Are there any local taxes not dealt with in answers toother questions?

As mentioned above, there are three regional taxes and two localtaxes.Recently, an experiment in one region of Russia (VelikhiyNovgorod) of replacing property taxes (tax on property oforganisations, individual property tax and land tax) with a realestate tax came to an end. Information about property taxes:Tax on property of organisations. The property recorded infinancial accounting as fixed assets is subject to this tax. Themaximum rate is 2.2%.Individual property tax. Real estate (e.g., flats, houses) is subjectto this tax. The rate is progressive (from 0.1% to 2%).Land tax. A person (organisation or individual) that owns land (orhas the right to use it, except for by lease) has to pay this tax. Themaximum rate is 1.5% or 0.3%, depending on the land category.

5 Capital Gains

5.1 Is there a special set of rules for taxing capital gains andlosses?

Companies. There are no special rules for calculating capital gainsand losses. A net capital gain must be included in the tax base. The gains and losses from selling certain goods (for example,securities) are, however, calculated separately. Such losses cannotreduce total profits. Individuals. There are special rules for calculating capital gains.For example, income from the sale of property can be reduced bythe so-called “property deductions”. The amount of the incomedepends on the category of the property and the time the taxpayerhas owned the property. Instead of using “property deductions”,taxpayers may reduce their income by the actual costs incurred inpurchasing the given property. The rules are similar to theseapplied in regard to securities.

5.2 If so, is the rate of tax imposed upon capital gainsdifferent from the rate imposed upon business profits?

There is no separate rate for capital gains. The general 24% profittax rate for organisations is applicable.

5.3 Is there a participation exemption or relief forreinvestment?

There is no such relief in Russia.

6 Branch or Subsidiary?

6.1 What taxes (e.g. capital duty) would be imposed upon theformation of a subsidiary?

Russia does not impose taxes on incorporation of a subsidiary.State duty will, however, be imposed in cases when, under Russianlaw, applications have to be submitted to state authorities (seequestion 2.1 above).

6.2 Are there any other significant taxes or fees that would beincurred by a locally formed subsidiary but not by abranch of a non-resident company?

The essential advantage of the subdivision (branch) againstsubsidiary (“daughter” company) is the absence of taxation undertransferring money and other property from the head to subdivisionand back.There are no other significant differences between taxation of alocally formed subsidiary and a permanent representative office ofa non-resident company in the Russian territory.For VAT purposes, a non-resident company should be registered asa VAT-taxpayer at the location of its branch (permanentestablishment); otherwise VAT is withheld and paid by a fiscalagent; the non-resident company may not deduct this VAT.

6.3 How would the taxable profits of a local branch bedetermined?

The profit deriving from a permanent establishment. Theprovisions according to which the branch will be considered apermanent establishment are very similar to those of Article 5(“Permanent establishment”) of the OECD Model Tax Convention. The taxable income of a foreign company operating through apermanent establishment (branch) will be:

income received as a result of operating in Russia through apermanent establishment, reduced by costs incurred by thepermanent establishment;income from possession, use or disposal of the assets of thepermanent establishment, reduced by costs connected withreceiving this income; orother incomes from Russian sources (including interest,royalty and others) to the permanent establishment.

Deductible costs are generally determined by taking into accountthe same cost deductibility rules as apply to Russian companies.The head office expenses could be deducted. It is important to know that the tax base and the tax are calculatedseparately by each branch of a foreign company and cannot beconsolidated. Yet, the tax base of branches operated within a singleproduction process (and in similar cases) is calculated jointly. If a foreign company has a branch because it engages in “preparatoryand auxiliary” activities for the benefit of third parties and does notreceive any remuneration, the foreign company is deemed to havetaxable income equal to 20% of the branch's expenses.



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6.4 Would such a branch be subject to a branch profits tax (orother tax limited to branches of non-resident companies)?

There is no special branch profits tax in Russia.

6.5 Would a branch benefit from tax treaty provisions, or someof them?

No. Generally, the profit of a non-resident company receivedthrough a branch is taxed in the same way as the profit of a Russiancompany. This applies to interest paid to a permanentestablishment, royalty and so on. Usually, Russia - Foreign countrytreaty provides that “if the profit is related to a permanentestablishment in Russia, the taxes should be imposed in Russia”. Atthe same time, the head office expenses could be deducted whencalculating tax base of permanent establishment.

6.6 Would any withholding tax or other tax be imposed as theresult of a remittance of profits by the branch?

There is no dividend withholding tax or any other type of “branchlevel” tax upon the remittance of branch profits to a foreign headoffice.

7 Anti-avoidance

7.1 How does your jurisdiction address the issue of preventingtax avoidance? For example, is there a general anti-avoidance rule or a disclosure rule imposing a requirementto disclose avoidance schemes in advance of thecompany's tax return being submitted?

At present, Russia has two types of measures that are being used inpreventing tax avoidance:1) the anti-avoidance legislation:

general rules (transfer pricing rules and the rule on the right oftax authorities to reclassify the deal and charge extra taxes);special rules applicable in certain situations (namely, thincapitalisation rules, rule of calculating the term of excisingthe construction site, etc.).

We described anti-avoidance provisions of Russia in questions 1.1- 6.6 above. 2) the anti-avoidance court doctrine had been in the process of

formation for several years (a long time courts used the“bona-fide” concept) and completed in Plenary Ruling No.53 of the Higher Arbitration Court of Russia that put intopractice the term “unjustified tax benefit”.

We described how anti-avoidance doctrine was applying with regardto VAT in question 2.4. However, Ruling No. 53 which replaced the“bona fide” concept is applied in regard to all taxes. The Ruling isbased mainly on two doctrines: (a) the doctrine of the prevalence ofsubstance over form; and (b) the doctrine of business purposes. The Court ruled that:1) officials should prove the circumstances on which their

decision was based;2) tax benefits can be recognised as unreasonable, in particular,

when: (a) for taxation purposes, operations are notconsidered according to their economic sense; and (b)operations have not resulted from justified economic or otherfactors (purposes of a business nature);

3) tax benefits cannot be considered as an independent businesspurpose, though a benefit may accompany transactions thathave a real business purpose, because a taxpayer is free toachieve a desired economic result with a minimum taxburden; and

4) the fact in itself of infringement of the tax duties by thepartner of the taxpayer is not proof that a tax benefit isunreasonable.

There are still no requirements for the taxpayer to disclose anavoidance scheme. In practice, if a taxpayer applied a tax avoidancescheme, a Tax Office should prove this (usually, taxpayers do notagree with the claim and the dispute is transferred to the court), andif the Tax Office succeeds, the taxpayer should pay the tax, interestand penalty (20% from the unpaid tax).The coming changes seem to be more effective:On December 2006, the plans of the Ministry of Finance wereannounced. They concerned:a) transferred pricing rules (see question 3.7 above);b) rules concerning the consolidated taxpayer. These rules shouldresolve the problem of inner (within Russia) transfer pricing;c) CFC rules (controlled foreign companies), which would allowtax authorities including the profit of a subsidiary offshore companyinto the profit of the Russian parent company under certainconditions;d) revising and establishing the agreements on exchanging offinancial information; ande) the establishing of the “rule of resident”. The Ministry of Financeis going to change the term “Russian legal entity” with the term“Russian resident”. This should mean that a foreign companycompletely controlled and managed by a Russian company wouldbe deemed to be a Russian resident and would be taxed in Russia.

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Vadim Zaripov

Pepeliaev, Goltsblat & PartnersKrasnopresnenskaya Nab.Entrance 7, World Trade Center-IIMoscow 123610Russia

Tel: +7 495 967 0007Fax: +7 495 967 0008Email: [email protected]: www.pgplaw.ru

Vadim Zaripov specialises in the sphere of tax law, professionalcontacts with state authorities and non-government organisations.He is a tax expert with the Chamber of Commerce and Industry ofthe Russian Federation, Russian Union of Industrialists andEntrepreneurs, Delovaya Rossiya Association and the Chamber ofTax Consultants. He is also Deputy Chairman of the Presidium of theRussian Association of Tax Law and a member of the InternationalFiscal Association.For over 10 years, Vadim has been providing tax advice to leadingRussian companies; he has accumulated extensive experience insolving complex taxation issues, developing tax security systems forcustomers and defending major taxpayers in arbitration courts.As an expert, Vadim Zaripov has taken part in summarizing judicialpractice pertaining to the issues of tax benefits, reimbursement ofVAT, substantiation of expenses; in developing initiatives forimprovement of legislation relating to tax administration, VAT, profittax and other taxes, simplified procedures for declaring individualincome; and in elaborating draft laws aimed at enhancing the taxtreatment of business activities in certain industries.

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RussiaPepeliaev, Goltsblat and Partners

Tatiana Vasiljeva

Pepeliaev, Goltsblat & PartnersKrasnopresnenskaya Nab.Entrance 7, World Trade Center-IIMoscow 123610Russia

Tel: +7 495 967 0007Fax: +7 495 967 0008Email: [email protected]: www.pgplaw.ru

Tatiana Vasiljeva focuses on Tax and Investment law. After severalyears of working for an Advocacy Office and being a member of theExpert Council of one of the leading auditing Russian companies,she joined Pepeliaev, Goltsblat and Partners. She provides tax advice to Russian and non-Russian clients.For non-Russian clients: application of international treatiesconcerning avoidance of double taxation; advice on setting up asubsidiary or permanent establishment in Russia or other country ofthe CIS; advice on federal and regional incentives in Russia,Economic zones in Russia and the CIS etc.For Russian clients: advice on Russian tax and corporate law;comparative analyses of foreign law systems when the client is goingto start business in a third country; application of internationaltreaties; advice on cross-border activities; application of theviewpoints of the ECHR and the European Court of Justice inarbitration and constitutional proceedings.She has successful and extensive court practice in both taxation andadministrative spheres. Tatiana represents clients in the arbitrationcourts (their tax subdivision), in High Arbitration Court and theConstitutional Court of the Russian Federation (retroactiveapplication of tax laws). She has close relations with a lot of law companies in the CIS andEurope and enjoys working in cooperation with them. Thecooperation allows her to provide high quality advice in a sphere ofcomparative law.

Combining a western-oriented approach with local know-how Pepeliaev, Goltsblat & Partners is the leading full-service,largest independent law firm in Russia. Today the company has more than 120 attorneys based in Moscow and St.Petersburg and a total staff of over 200 people. The accomplishments of our Corporate Practice have played asignificant role in solidifying our reputation as being one of the premier law firms. We take great pride in the value webring to the corporate needs of our clients and offer expertise in the following fields:

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Legal Entities, Branches, Representative Offices / Joint Ventures Complex Transactions

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Legal Audit / Due Diligence

Securities

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Complex Transactions

We offer our clients both consulting services on current issues arising in the course of their business and assistancewith complex projects.

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