Structuring ownership of a Russian company through a chain of foreign companies still remains very popular among Russian business people. However, since 2015 anti-offshore measures have consistently been introduced in Russia. This has substantially limited the use of such chains for reducing tax burden and concealing ultimate business owners. Meanwhile, such structures are still being actively used for a number of reasons, such as convenience for making deals with shares in foreign companies; meeting requirements of contracting parties from non-Russian jurisdictions and maintenance of them in business structures just because this has become traditional.
Most of such foreign companies are used as purely “technical layers” between a Russian business and its beneficiaries, having no qualified personnel for business operations or management. Accordingly, they cannot demonstrate their eligibility for beneficial tax rates on income from a Russian source, as they have no beneficial ownership of income (“BO”) according to the Russian tax law and approaches of Russian tax authorities. Applying beneficial rates by such companies entails significant risks, and for some jurisdictions (Cyprus, Malta, Luxembourg) such beneficial rates cannot be applied since 2021 as they are totally excluded from the relevant double taxation treaties.
The current Russian tax laws allow for achieving tax neutrality in using foreign companies as a business ownership tool. In other words, such companies create no eligibility for tax benefits under treaties between Russian and jurisdictions where such companies are registered. That said, they can be used to apply certain mechanisms preventing an increase of tax burden as compared to a simple business ownership structure, which is direct ownership of a Russian company by its Russian beneficiary.
Pass-Through Taxation
The most obvious mechanism is a so-called pass-through basis. It means that interim foreign companies are disregarded for tax assessment and a Russian company applies to income payments from Russia a tax rate that would otherwise apply if such payments were made directly to the ultimate beneficiary.
To apply such mechanism, a Russian company paying dividends should obtain from all its interim foreign companies evidence that they are not beneficial owners of income. It also has to receive from the ultimate payment recipients – whether individuals or legal entities and whether Russian residents or non-residents – evidence of their BO.
Although being simple, this mechanism has its drawbacks. For instance, some foreign companies receiving dividends were not declaring their having no BO, while applying beneficial tax rates under the relevant treaties with Russia. A sudden declaration of lack of BO by a foreign company may draw attention of tax authorities to it. So, before implementing the pass-through taxation, one should thoroughly assess whether or not approach could create the risk of reviewing the tax rates for the previous periods by tax authorities.
Voluntary Resident
Until recently, there has been an opportunity to use another mechanism allowed by the Russian Tax Code: Russian and foreign beneficiaries voluntarily acknowledge that an interim foreign company holding shares in their Russian joint business is a Russian tax resident. This allows applying the zero tax rate to dividends paid by a Russian company. However, starting from 2023, this mechanism will not longer be afforded, and foreign companies being Russian tax residents will have to pay the 15% tax. So, it will bring about an additional taxation of dividend flows. During the transition period until 2023, business owners should be able to re-organize their business ownership structures by liquidating their interim foreign companies or withdrawing their tax residency in Russia.
New Opportunities for Individuals
From 2021 Russian individual taxpayers can declare that dividends paid through interim foreign companies have been received directly from a Russian company. The tax withheld by the Russian company on dividend payments to its interim foreign company is to be set off against the tax payable on income of the individual. For this purpose, however, the relevant foreign company should be registered in a jurisdiction having a double taxation treaty with Russia and maintaining information exchange with it.
This mechanism in fact opens opportunities for Russian beneficiaries, which are similar to the pass-through taxation, i.e. it can be used to limit the Russian dividend tax on the overall structure to 15%. One should still be aware that the procedure for evidencing eligibility for such taxation has been introduced for the first time. It is rather complicated and likely to bring about certain methodological disputes in the upcoming years.