A ‘permanent establishment’ (PE) is not an organizational form of business structure, but rather a taxable status of a foreign business operation in another country, in this case in Russia. The term is defined in the Russian Tax Code (art. 306) and in many double taxation treaties. A business may be considered as a permanent establishment when activities in Russia are carried out by a foreign firm through any fixed place of doing business: the office, branch, headquarters, business partner or agent of a foreign company.

The concept of a permanent establishment is often confused with the concept of representative Office (RO), as the Russian terms for them are very similar. Representative office in Russian is predstavitelstvo’ and permanent establishment is “postoyannoye predstavitelstvo’. However, the existence of a RO does not determine if the business is taxable or not.

RO itself can either form or not form a PE depending on the actual nature of the business. Even an Agent or merely a Russian business partner based on the real circumstances can be deemed to form a de facto PE for the foreign entity with all the corresponding obligations to register as a separate taxpayer, file Tax Returns and pay taxes. A PE even without a specific organizational form in Russia is subject to all of the above.

The primary source of law for determining whether the presence of a foreign legal entity (FLE) creates a PE is in the Tax Code articles 306–308 (chapter on profit tax). However, double taxation treaties (DTT) concluded between Russia and other states take preference over the provisions of national law in determining the rules applicable for permanent establishments.(For details on DTTs see chapter Double Taxation Treaties). A detailed interpretation of this concept and related issues can be found in the recommendations of the tax authorities (Order of the Ministry of Taxes and Dues No. BG-3-23/150 of 28 March 2003.

Criteria for permanent establishment

According to the Tax Code, the activities of a foreign company create a PE in Russia if the following conditions are met: 

1)      The Foreign Legal Entity has a place of activity in Russia;
2)      The place of activity is intended for carrying out a regular activity;
3)      The activity is essentially of a commercial (business) nature;
4)      The activity is not auxiliary or preparatory.

All four criteria have to be satisfied in determining that a PE is evident.
A place for activity in Russia can be a branch office, a representation office, an office (or bureau), an agent, a business partner or any other subdivision or a Place of Activity.

Dependent Agent

A foreign legal entity is also to be considered as having a PE, if it acts within the territory of Russia through a ‘dependent agent’ and the activity of the agent constitutes activities of a PE as outlined above. The relationship of dependent agency can be formed in the following ways:

(i)                 a foreign legal entity enters into a formal agreement with an agent
(ii)               A Russian entity functions as a de facto agent based purely on the circumstances of the business relation or business dealings.

Such an agent may be deemed to have formed a PE for the foreign company if the agent is not acting as an independent agent (art. 306.9, Tax Code).

A dependent agent represents a foreign legal entity and acts in its interests within the territory of Russia; is authorized to conclude agreements or negotiate material provisions of contracts in the name of the FLE; and uses such authority to create legally binding obligations for the FLE in Russia.

Independent agents (or representatives) are, for example:

  • Brokers and other professional participants of the Russian securities market
  • Any person acting in the ordinary (habitual) course of its business in the de facto capacity of an agent

The decisive factor is whether the activities of the Agent are performed in the course of its normal business, i.e. if the Agent usually performs the services in question.

Whether the Agent is affiliated (or “related”) to the foreign entity or not should not be decisive in considering if the agency forms a PE or not. Again, the general rules of determining if a PE is at hand should prevail and, specifically, the agency through an Affiliated Person would equally be considered against the rules regarding Independent and Dependent Agents.

Activities Giving Rise to Permanent Establishment

To qualify for a PE, the activities must be carried out on a regular basis. Therefore, one-time transactions limited in time and extent should not fall under the criteria.

The law (art. 306.2, Tax Code) defines what is to be considered as conducting business from point of view of forming a PE, as outlined below.

PE criteria for Conducting Business:

  1. Usage of natural resources
  2. Contractual work in construction, installation, maintenance and the like
  3. Sale of goods from warehouses in Russia
  4. Other work, services or activities which are not specifically excluded from criteria of forming a PE

However, the last item in the list effectively encompasses all kinds of business activities, except for those specifically excluded.

The activities excluded from the definition are those of a preparatory and auxiliary character. The law gives an open list of what is meant by preparatory and auxiliary activities (art. 306.4, Tax Code).

Preparatory and auxiliary activities are:

  • Using the Place of Activity solely for storage, display and delivery of goods
  • Maintenance of stock solely for the purpose of storage, display and delivery
  • A place kept solely for the purpose of purchasing goods
  • A place solely for collecting and distribution of information, accounting, marketing, advertising or market research sold by the foreign entity, if the said activity is not the sole or regular activity of the foreign entity
  • Keeping a Place of Activity for the sole purpose of signing contracts in accordance with detailed written instructions of the foreign organization

The lists of preparatory and auxiliary works, foreseen by the majority of Russia’s Double Taxation Treaties are similar to the above list and to the OECD Model Tax Treaty, despite the fact that Russia is not an OECD member. However, it happens that Russian courts consider the activity meeting the criteria of “preparatory” or “auxiliary,” as giving rise to a PE. For example, in 2010 Moscow Commercial Court ruled that the collection of information by Bloomberg LP‘s representative office in Moscow resulted in the creation of a PE under Russian law and the double taxation treaty between Russia and the United States., Bloomberg LP produces information products, including analytical databases. Between 2006 and 2007 it maintained a representative office in Moscow, where the employees gathered information to be incorporated into its databases. Under the Russian Tax Code as well as under the US – Russia DTT, the collection of information is considered a preparatory and auxiliary activity. However the court held that collecting information and selling products based on such information in fact falls within the ambit of Bloomberg’s core business, and by this criterion they were said to create a PE in Russia.  The Court of Appeal in 2011 did not revoke the decision of the first instance.

Preparatory and auxiliary services performed for third parties may create a taxable activity. If this is the case and no payment (or consideration) is recorded or reported for the said services, the tax can be deemed as the equal amount of 20% of the expenses of the PE connected with the activity in question (art. 307.3, Tax Code).

The ownership of assets in Russia does not as such give rise to a PE. Thus, for example, a subsidiary of a Russian entity is not considered to be a PE of the parent company by the fact of its mere existence. However, if the subsidiary in addition to the business that it carries on through its own balance sheet also performs above-mentioned functions in favor of the parent company, it may be deemed to form a PE for the parent.

A PE is deemed to exist from the moment of commencement of those activities that fall under the definition of a PE. The date of registration of the Branch or Representative Office as such is not regarded as the start of the activities of the PE (special rules apply to PE involved in usage of natural resources). Correspondingly, a PE ceases to exist from the moment of discontinuing such activities (art. 306.3, Tax Code).

Conclusion of a joint activity agreement (or simple partnership agreement) does not in itself imply that the underlying business forms a PE (see art. 306.6, Tax Code). Therefore, in considering the taxable status of such an agreement, the business in question should be materially reviewed against the whole set of general rules on PE. If the business in reality would meet all the criteria of a PE, then the Joint Activity Agreement would be deemed as forming a PE, not otherwise.

According to article 306.7 of the Tax Code, the provision of personnel (seconded) by a foreign entity to a Russian entity does not as such give rise to a PE. Nevertheless, in accordance with the general rules on PEs, the seconded person shall, hereby, act solely in the interests of the Russian entity to which he is seconded. In the case that the seconded person acts in the interest of the foreign entity that seconded him, then the general rules on PEs may become applicable.

To some extent the rules regarding PEs can be seen as anti-avoidance rules. Therefore, it is recommended that whenever a company actually wants to have a taxable presence, it is advisable to register some kind of Russian presence. 

Tax Consequences for Permanent Establishment

The profits derived by a FLE through a PE are taxed in Russia at the usual profit tax rate (currently 20%). Generally, the principles of taxation applicable to a PE are the same as those applicable to Russian legal entities. All of them are subject to profit tax, VAT, corporate property tax, and other applicable taxes. They are also all subject to Russian accounting and reporting rules.

In its recent decision, the Federal Commercial Court of the Moscow Circuit addressed how foreign companies operating in Russia through a PE should determine the taxable income and deductible expenses. A UK resident law firm, CMS Cameron McKenna, which provides legal services to clients worldwide, was determined to act in Russia through a branch which created a PE. Both Russian and British lawyers were involved in the production of services and the fees for the work of all lawyers were included in the invoices issued to clients by the Russian Branch. As the branch included the British lawyers’ fees in its taxable income, it accordingly deducted the corresponding expenses from the taxable base. The lower court upheld the position of the branch, because it deemed it in line with article 7.2 of the Russia-UK DTT, according to which the income of a PE shall cover  all the income that it would have derived if it were a stand-alone entity independent from the parent company. The higher courts, however, ruled in favor of the tax authorities, claiming that the British lawyers were not acting independently when working on the projects of the Russian Branch and both the head office and the Branch were acting as a single entity. The higher courts concluded that the deduction of the British lawyers’ fees was therefore unjustified (Ruling of 9th Appellate Court of 09.06.11 No. 09АП-10460/2011-АК; Ruling of  Постановление Territorial Commercial Court of Moscow Area  of 09.09.11 on А40-138835/10-118-799; Resolution of Supreme Commercial Court of 10.01.12 No. ВАС-16887/11).

Jon Hellevig, Anton Kabakov, and Artem Usov.