International business partnerships in Russia

By Maxim Popov30 March 2004

Russian Investment Climate:

PROVES CHANGING FOR BETTER

Snapshot of changes

Gasoline line

His parents received this bread in place of

wages

1998: need to access your account in this

bank?

Line at the Children’s Store

2001: Moscow CityTower

Internet café in Samara

IKEA’s flagship store in Moscow

One of BP’s landmarksin Russia

Business center

The Name of the Game

Any typical approach characterising a successful investment?

• Apply same care and diligence as in other countries

• Conservative Feasibility Study• Backing Top Management• Home Office People on the

Ground• Ensure Compliance with local

rules from Day One• Selection of Russian

Management• Emphasis on Distribution Network

Specific issues for foreign investmentsTo invest or not to invest:

Yes Russian market Manage environment Local competitor Low up-front investment Long return on investment

No Export market Stable environment Foreign competitor High up-front investment Short return on investment

Specific issues for foreign investmentsAre Russians really afraid/hostile of foreign companies/control?• Not afraid but unwilling to give away control• Foreign ownership often means transparency• Perception – foreign management does not automatically mean

success

Specific issues for foreign investmentsIf you have 5 million USD to use for:• 76% of shares in a small size plant in Russia• 51% of shares in a medium size plant• 26% of shares in a big plant• Something else

What would be your choice?

Create a 100% controlled subsidiary

Specific issues for foreign investmentsWays of minimising risk/downside when establishing

a company• Contractual relationship is preferable compare to ownership

participation• Avoid JVs unless there is a good business reason to

enter into one• Tight cost control• Build personal relationships• Make sure all formalities are complete

Specific issues for foreign investmentsMinimum requirements/measures for an agreement/business deal if JV is required:

• “Waterproof” contracts, by-laws, etc.

• Availability of home office resources to support

the deal especially at the early stage

• Strong local support from advisors

• Existence of the general (but flexible) plan

• Maximum ownership control (at least have a

blocking vote)

• Financial control

• Staff control

Legal Issues

• Options for Establishing Presence in Russia

• Major Operational Legal Issues

Operating in Russia

• formal registration in Russia may or may not be required depending on extent of operations in Russia

• may need to be registered in Russia for tax purposes if have a permanent establishment in Russia

• establishing a legal presence in Russia may be necessary for operational reasons and legal recognition

• a number of options for establishing a legal presence in Russia

Options for Operating in Russia

Limited Liability Company ("LLC")

open JSC closed JSC

Joint Stock Company ("JSC")

Russian Subsidiary

Separate Legal Entity

Representative Office Branch

No Separate Legal Entity

Branch Office or Russian Subsidiary?

Branch/Rep Office

• branch office and representative office often used for same purposes

• less regulatory control• bookkeeping simpler

Russian Subsidiary

• may be necessary for joint ventures

• certain operations may require Russian entity

• tax planning• limiting liability of non-

Russian parent

LLC vs. JSC

General Features of LLC:• based on French model• simpler management

structure and greater flexibility (e.g. fewer management bodies required)

• more private form of company

General Features of JSC:• similar to common law

system• an open JSC must make

public its annual report, balance sheet and profit and loss statement

• subject to regulation under the Federal Law on the Securities Market

Joint Venture Associated Risks

• Always risk when enter into joint venture with other partners

• Russia has historically posed some significant joint venture risks, many due to problems with corporate governance, including:

– dilution of shareholdings through issue of new shares– violation of shareholders rights on corporate reorganizations– asset stripping (moving profitable assets to other companies

and leaving existing shareholders with liabilities)– transfer pricing: including funneling off funds to corporations

not owned by all shareholders

Dispute Resolution

Dispute Resolution• still major problem for foreign investment in

Russian:• court system can be slow and corrupt• Russian laws have many holes and uncertainties which

makes resolution of disputes more difficult• will require major revision

• arbitration is preferred route for most western parties using recognized arbitration rules

• Russia is a party to the New York Convention which permits enforcement of foreign arbitration orders from Convention members

Tax highlights

• Assets Received from the 50% Shareholder Are Not Subject to Profits Tax

• Income Gained From the Sale of Shares by Foreign Shareholder Is Not Subject to Withholding Tax (Except When More Than 50% of Assets Is Immovable Property)

• Reorganizations Are Not Taxable Events (Mergers, Associations, Split-ups, Spin-offs)

Dividends

• Withholding rates:– 6% for Russian organizations and resident individuals– 15% for foreign organizations– Double tax treaties

• Dividends paid to Russian recipients to extent received from other entities are tax free (Russian holding structures are possible)

Contact information

Maxim Popov, attorney-at-law

Internet: www.maximpopov.com

E-mail: me@maximpopov.com

Tel: +7(812)9340975

Fax: +7(812)2349396