Chapter 25 of the Tax Code regulates taxation of corporate profits in Russia. Both Russian legal entities and foreign ones acting through permanent establishments must pay profit tax (generally defined as gross income minus allowable expenses). Any expenses to be deducted must be documented and economically justified; such expenses have to be incurred in connection with generating income.
These entities pay profit tax for their worldwide income if they engage in commerce in Russia. A foreign legal entity that generates income in Russia without creating a permanent establishment is subject to withholding tax (or source tax) for its Russian income.
However, certain types of businesses are exempt from profit taxation. These are usually companies involved in quite specific activities, such as those associated with the upcoming Sochi Winter Olympics and with the recently created Skolkovo Innovation Center.
Both the general rate for corporate profit tax and the withholding tax for non-residents are set at 20%, while dividends from Russian entities received by non-residents are taxed at 15%. There are a number of lower rates related to dividends, securities, and international transport costs. Furthermore, taxpayers may be able to take advantage of special tax regimes and concessions.
Dealing with Income, Expenses and Other Assets
A taxpayer’s income is divided into two major groups: sales income (i.e. from sale of goods, works, services or property rights), and non-sales income. There is also a list of 40 different forms of excluded (non-taxable) items.
Expenses are also divided into two major groups, according to the same principle as income: sales expenses (connected with production and sales) and non-sales expenses. Sales expenses are further divided into direct and indirect.
Although expenses are deductible, their deductibility is affected by different factors. In order to be deductible, expenses have to be economically justifiable; serve the function of generating income; and be substantiated by documentation. The requirements for documentation can be found in Article 252 of the Tax Code. One does not need to prove a direct linkage between income and expenses in order to deduct expenses. Losses can also be classified as expenses if brought about by unfortunate circumstances, such as labor stoppages, natural disasters, and bad debt.
With regard to depreciation of assets, those considered depreciable have a minimum useful life of longer than 12 months and an initial value of at least 40,000 rubles. Depreciable property includes both fixed and intangible assets. There are certain types of assets that are not subject to depreciation: these include natural resources (like land and water); securities and derivatives; inventory and goods; and some others. The Tax Code’s Article 258 divides all types of fixed assets into 10 depreciation groups, based on their useful lives.
The Tax Code permits the making of certain reserves for future or doubtful expenses. These include such things as reserves for warranty servicing; bad debt reserve; vacation salary reserve; and reserves for future R&D expenses and commercial activities. In addition, losses from previous tax periods may be carried forward and deducted from future profits (Article 283).
Interest paid on any debt liabilities is recognized as deductible. Such interest is however restricted to the comparable average interest rates charged in the market (arm’s-length principle). Nevertheless, certain deviations have been enacted to the Tax Code, permitting differences in the maximum deductions, so that there are different rates for loans in foreign currency and in Russian rubles (depending on when such loans were made).
The Tax Code contains thin-capitalization rules, which aim to prevent tax evasion on the part of foreign companies by repatriating profits in the form of excessive interest on debt instruments rather than taxable dividends. A thinly capitalized entity is defined as one whose assets are funded by a high level of debt and relatively little equity. Application of thin-capitalization rules is based on the ratio between the net assets of the Russian entity paying interest and the debt provided by the foreign owner and its Russian affiliates (controlled debt). The law provides a formula to calculate the limit of deductibility of the controlled debt.
Some experts have mentioned the possibility of contesting the applicability of thin-capitalization rules due to the non-discrimination clauses contained in double taxation treaties. However, a ruling by Russia’s Supreme Commercial Court has upheld the rules, concluding that the standards of non-discrimination clauses do not restrict the applicability of thin-capitalization rules.
All kinds of securities, both publicly traded and not, fall under the rules of taxation. Both interest on securities and expenses and costs associated with the issuance of securities are deductible.
A large area for deductibility is payment of labor (payroll expenses). Here, the law in principle permits all such expenses to be deducted, whether paid in cash or in kind. However, in practice, there are a number of non-deductible expenses; and the line between the two is not always clear due to exceptions to the rules, and the general rule of the Tax Code which allows one to deduct all justifiable expenses.
Many other items are deductible in principle. Compulsory payroll-related insurance, as well as employers’ mandatory social contributions, are fully deductible. Expenses related to business trips are fully deductible, provided they are properly documented and economically justifiable. All expenses on compulsory insurance of property are deductible, though subject to Russian courts’ restrictive interpretations.
In a new development, there is now a right to deduct research and development costs, regardless of any success they might yield. This is designed to stimulate investment in commercial research and development.
Deductibility of expenses for representation and entertainment in the course of business activity (representation expenses) remains restricted to their amount and nature. Such expenses must have been incurred in connection with doing business, as the law otherwise excludes entertainment and recreational expenses from deductibility. Other business-related expenses that may be deductible include those connected to training of personnel and advertising.
Finally, it is important to note that deductions permitted in principle are sometimes challenged in practice, and that many restrictions and conditions apply to the provisions described above. For these reasons, any company that needs to deal with the Russian Tax Code in all its complexity should do so with the help of experienced tax lawyers.
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