Is there a future for foreign structures of Russian business

In 2022, the functioning of foreign structures of Russian business became significantly more complicated due to the introduction of restrictive measures by a number of foreign countries. Opportunities and prospects for working with banks and local providers were under attack, and new financial and legal risks emerged, including the risk of losing assets. Retaliatory restrictions on the part of Russia led to additional difficulties. All these factors prompted business to restructure foreign structures. Group partner B1 talks about the key opportunities for transformation, the benefits and challenges associated with it Marina Belyakova.

How foreign structures worked before

It is no secret that many Russian groups of companies prefer to structure their foreign operations using foreign subsidiaries. The distribution of business functions helps to improve the operational and sometimes tax efficiency of the business. For example, until February 2022, foreign trading companies were often created by Russian businesses in jurisdictions such as Switzerland and Singapore. In addition to good geography, business infrastructure and traders from all over the world, these countries also offered tax advantages.

In particular, before the 2019 reform, the activities of trading companies in Switzerland a special regime (“mixed company regime”) could be applied, providing effective tax rates on income from foreign sources in the range from 8% to 11%. And even after its cancellation, Switzerland retained its attractiveness for Russian investors due to the potential possibility of tax-free distribution of dividends and the admissibility of preliminary coordination with the tax authorities of a number of issues by obtaining a tax position (“ruling”). AT Singapore there is also a so-called global trading program, which allows for a certain period to reduce the effective tax rate on a trader’s income to 10% (sometimes up to 5%).

In turn, in order to own foreign assets, create joint ventures with partners and attract financing, Russian groups included companies from countries such as Cyprus, Luxembourg, the Netherlands, Hong Kong and Singapore. All of them, as a rule, provided favorable conditions for the taxation of dividends and interest on loans, while having a wide base of international tax treaties.

New reality: from “unfriendly” countries to “friendly” ones

In early 2022, with the expansion of sanctions, everything changed. A number of large providers refused to provide accounting, tax, legal and other services to businesses associated with Russia. Many companies have faced the freezing and closing of bank accounts, the risks of asset confiscation have increased, and it has become impossible to quickly make corporate decisions.

Russia also introduced retaliatory measures, which further complicated the situation. For example, it became more difficult to distribute dividends to countries that were deemed “unfriendly”.

This list includes almost all those popular states that were used by Russian business in structuring.

In response, business began to “reshape” its foreign structures – transferring them to new jurisdictions, restructuring commodity and cash flows, and rethinking management systems. In practice, there is the greatest interest in relation to the UAE, Hong Kong, Turkey, Armenia, Kazakhstan, Uzbekistan, Qatar, Bahrain, Mauritius. Each of the listed jurisdictions has its own characteristics, and the choice of a particular country is determined by a number of factors, including the type of business being transferred, the possibilities of interaction with banks, the specifics and geography of counterparties and sales markets.

The leader among the new sample is UAE due to its attractive tax system (no income tax and personal income tax). However, do not forget that the UAE has VAT (5%). In addition, the UAE is divided into a common (mainland) and free economic zones (free zones): if the tax-free status of free zones is maintained subject to the statutory conditions, then in the territory of the common zone from June 2023, the introduction of corporate income tax (9%) is expected . The regulation in free zones differs depending on the specific zone. So, when transferring assets, you should pay attention to:

• zone location,

• infrastructure,

• requirements for registration and licensing,

• system of law.

For example, for holding companies, the Dubai Commodity and Commodity Center (DMCC) is of interest, while for logistics companies, the Dubai Airport Free Zone (DAFZA) may be suitable.

It is important to consider that the current tax agreement between Russia and the UAE does not apply to private business.

That is, it will not work to take advantage of the majority of preferential tax rates and exemptions in relation to cross-border transactions. In early November, the Ministry of Finance announced its intention to revise the tax agreement with the UAE in order to reduce the cost of attracting direct investment from UAE residents. But the UAE is included in the Russian lists of “offshores”, which further limits its use in structuring (in particular, it makes it difficult to apply the rules of controlled foreign companies; CFCs).

In other “friendly” countries, the tax burden is somewhat higher. Thus, the income tax rate in Turkey is 23% (20% from 2023), in Kazakhstan – 20%, in Armenia – 18%, in Hong Kong – 16.5%, in Uzbekistan – 15%. But since taxes are not the only selection criterion, interest in these countries is also consistently high. In addition, some of these jurisdictions provide special tax regimes: in Hong Kongfor example, there is a territorial taxation mechanism in which only income received from sources in Hong Kong is subject to income tax (this preferential treatment may be reviewed in the near future), and registration in the Financial Center Qatar (QFC) allows you to exempt company profits from taxation, while providing shareholders with the opportunity to tax-free repatriation of profits.

AT Turkey in addition to a gradual reduction in tax rates (from 23% to 20% in 2023 the income tax rate will be reduced, and in December 2021 the tax rate at source was reduced from 15% to 10% when distributing dividends to non-residents), a deduction mechanism is provided “ notional interest deduction, which allows you to deduct 50% of the amount of interest accrued on the value of the so-called new capital. But in order to take advantage of the benefits, it is necessary to correctly think over the structure of the business, analyzing in detail all the circumstances.

And if you return to Russia?

Another option is the redomiciliation of a foreign company to a special administrative region (SAR) on the territory of the island. Russian (Primorsky Territory) or about. Oktyabrsky (Kaliningrad region).

To move to the SAR, it is necessary to accept investment obligations in Russia and fulfill some other conditions.

A redomiciliated company receives international status by changing its personal law to Russian law. For tax purposes, such a company receives the status of a Russian company, but at the same time, being a tax non-resident, it can make transfers of foreign currency and rubles both with other non-residents and with currency residents from/to the territory of Russia (subject to the current sanctions and counter-sanctions restrictions, and also the general provisions of the currency legislation).

By fulfilling some additional conditions, one can obtain the status of an international holding company (IHC), which opens up access to tax benefits.

So, you can enjoy reduced tax rates of 5% on passive income (for example, interest), more favorable taxation rules for dividends and income from the sale of shares and shares, relaxations under CFC rules and some other benefits. Thus, the holding regime envisaged for MHK seems quite attractive and, in certain cases, can become a more effective alternative to transferring assets to a “friendly” jurisdiction.

There is an exit

So what to do if foreign assets remain in an “unfriendly” state?

Consider redomiciliation from an “unfriendly” jurisdiction to a “friendly” one or to Russia. But the mechanism of redomiciliation assumes that both the state of exit and the state of entry must allow such a move. For example, to transfer a company from Netherlands to Russia directly will not work. We will have to resort to the mechanism of the so-called transit redomiciliation (in practice, such moves are made through Cyprus). Bahrain and China, on the contrary, do not allow the “entry” of foreign companies in the order of redomiciliation. At the same time, Russian business has a positive experience of redomiciliation from Cyprus in UAE.

Another important point that should not be forgotten is the exit tax provided in individual countries.

For example, when transferring abroad the legal address or place of effective management of a Swiss company, you will have to pay exit tax at the general income tax rate in respect of assets that move out of Switzerland.

Another option is to consider the transfer of assets, for example, Russian shares, shares, claims under contracts, from an “unfriendly” jurisdiction. But it must be taken into account that many transactions with Russian assets require permission from a government commission. Transactions with counterparties from “unfriendly” countries may be exempted from this procedure in situations where their ultimate beneficiaries are Russian persons or if control is not transferred as a result of the transaction. The applicability of these exceptions must be analyzed on an individual basis, however, law enforcement practice, including positive ones, is already being formed.

What’s next?

Of course, the world around us is changing rapidly. In order to adapt to new conditions, businesses need to be flexible and keep in their arsenal various, including spare, options for further actions. And to ensure their reliability and effectiveness, you need to carefully analyze all possible options from a legal, financial and tax point of view.