Draft changes to Tax Code approved by Russian Federation Council

On 30 October 2013 ,the Federation Council, the upper house of the Russian Parliament, approved draft law "On Amending Part One and Two of the Tax Code of the Russian Federation and Certain Legislative Acts of the Russian Federation".

The draft law is to introduce changes that shall clarify and elaborate on the taxation procedures related to receiving income entitlements under Russian securities by foreign investors.

The amendments were drafted in line with the already introduced "cascade" payment process of income entitlements under Russian securities (coming into force for dividend payments in 2014), whereby, effectively, the issuer is expected to pay dividend income entitlements to the nominee holders (CSD and Russian custodians) and local trust managers within 10 business days after the dividend record date and to the securities owners recorded in the shareholders register within 25 business days.

Russian custodians have an obligation to transfer the income to their clients. Essentially, the document implies that local custodians shall perform tax agent functions (such as tax calculation, tax withholding and tax payment) when distributing income entitlements under Russian securities safekept on custody accounts of foreign organisations in its books.

Accordingly, local custodians are expected to act as tax agents on income entitlements under the following Russian securities safekept on custody accounts of foreign investors, as well as foreign nominee holder, foreign authorised holder or depositary programmes account:

• State federal, sub-federal and municipal bonds;
• Corporate bonds, registered after January 1, 2012;
• Equities.

The new draft law also provides for the information disclosure requirements set towards foreign nominee holders, foreign authorised holder and depositary programme custody account holders.

The following generic information on legal entities and individuals (underlying securities’ owners) is expected to be disclosed to the local custodian on an aggregate geographical basis for tax calculation purpose:

• Aggregate number of Russian securities per tax domicile;
• Ground for tax exemption (with reference to a particular Double Taxation Treaty (DTT), if available).

Overall, foreign nominee holders, foreign authorised holders and depositary banks shall provide the aggregate information on those underlying securities’ owners who will furnish them with respective information for tax benefits application.

The aggregate information is the only basis on which Russian custodians exercise their withholding tax agent duties with respect to the above-mentioned custody account holders. Consequently, the provision of certificates of tax residence (COTRs) for particular securities’ owners disclosed as such within the respective tax domicile groups by the foreign nominee holders, foreign authorised holders and depositary banks shall no longer be required. At the same time, the tax pre-clearance procedure for owner accounts of foreign investors shall not change and the submission of COTRs will still be necessary.

According to the document, generic information on the underlying securities’ owners per tax domicile, as summarised above, must be presented by foreign nominee holders, foreign authorised holders or depositary banks within certain deadlines, as follows:

• For equities – within seven days from the dividend record date;
• For bonds – within five days from the date on which the CSD publishes information on a transfer of funds to its client (in practice, on the date the CSD effects such transfers).

Furthermore, the disclosure of information on underlying securities’ owners must be submitted via one of the following means of communication:

• Hard-copy document, duly signed by the authorised persons of the foreign organisation;
• Electronic document, encrypted by digital signature in accordance with the law “On Electronic signature”; or
• SWIFT message.

The draft law establishes that the information required by the tax agent must be presented to the Russian custodian in time, in full detail and correct format, on a voluntary basis; otherwise, income entitlements under Russian securities would be subject to the 30% tax rate. At the same time, information disclosure is not required for tax-exempt Russian securities holdings that currently comprise state federal, sub-federal and/or municipal bonds.

The proposed amendments also establish the possibility of receiving income entitlements only with respect to “unconditional beneficial” tax rates set for foreign investors by the relative double tax treaties.

Note: According to selected DTTs (for example, Canada, Cyprus, Germany, Luxembourg, U.S.A. etc.), “special conditional” tax rates imply compliance with additional requirements (for example, investment over a certain amount or of a certain stake of shareholders’ equity) and, consequently, the submission of supporting documentation. Tax relief under “special conditional” rates is obtained only via the tax reclaim procedure.

Furthermore, the draft law envisages that the tax agent is obliged to pay the amount of withheld tax to the budget by the 30th calendar day starting from the day on which the tax was withheld. If the generic information on the underlying securities’ owners is supplemented or corrected before the 30th calendar day, the tax agent calculates adjusted tax amounts and pays/reclaims cash funds based on the updated information. Tax agents may also choose not to calculate adjusted tax amounts if the new details have been presented within less than five days before the 30-day expiration period (that is, starting from 26th calendar day onward).

Important note:

According to the document, the tax agent has limited liability and is not responsible for tax miscalculation resulting from the provision of incomplete or unreliable information by foreign nominee holders, foreign authorised holders and depositary banks and/or in cases when such clients decline to present the required information on demand from the local tax authorities during tax audit.

Hard-copy documents related to the confirmation of tax status and eligibility for reduced (or zero) tax rates for parties who received income under securities may be requested by the Russian Tax authorities on an ad-hoc basis for the purpose of validating tax calculation and withholding.

According to the proposed amendments, such documents shall be generally provided to the tax authorities within three months.

Tax authorities may also extend the said period for provision of requested documentation for an extra three months.

The draft tax law also introduces changes to the tax reclaim procedure, requiring the provision of the following in addition:

• Document confirming the applicant's right for income entitlement as of the record date;
• Document confirming the amount of cash funds that was actually paid to the applicant;
• Document including data on custodian(s) that, directly or through third parties, distributed income in favour of a foreign organisation acting on behalf of the applicant;
• Document confirming compliance of the applicant to additional requirements established in a relevant DTT for a “special conditional” tax rate.

Finally, the draft law clarifies that foreign nominee holders, foreign authorised holders and depositary banks may choose to appoint an authorised representative to deal with their custodian or CSD acting in the capacity of tax agent. This basically means, in particular, that ICSDs and foreign CSDs that establish foreign nominee holder accounts at the Russian CSD may interact with the latter through their agents under taxation matters.

These amendments are another step in the implementation of the foreign nominee concept in Russia and are in line with the "cascade" income payment process already introduced in legislation and coming into force for dividends in 2014.

Once approved, draft amendments shall lay the basis for the application of a tax relief information disclosure procedures set towards the foreign investors.

Furthermore, tax agent functions shall be transferred to Russian custodians on all income entitlements, including dividend payments starting from 1 January 2014. It shall allow for simplification of tax pre-clearance procedures for the underlying clients of foreign nominee holders, foreign authorised holders and DR owners, since no additional documentation and no interaction with issuers will be required. With regard to foreign investors having own custody accounts, the process does not change.

As long as information disclosure is expected to be done on a tax domicile basis, it is possible to optimise the process of such disclosure by means of opening foreign nominee holder or foreign authorised holder custody accounts on a per tax domicile basis.

The draft law establishes that the information required by tax agents must be presented on voluntary basis and non-disclosure shall have no impact on the right of receiving income entitlements under Russian securities itself. However, in such cases, a higher (30%) tax rate shall be applied, except for tax-exempt Russian securities (coupon income on state federal, sub-federal and municipal bonds).

Also, the amendments introduce new requirements towards documentation that can be requested by local tax authorities on an ad-hoc basis and for the purpose of tax reclaim procedures.

However, the list of documents is not explicitly defined and leaves room for interpretation; for example, the format of respective documents, notarisation/appostilisation procedures etc. are not specified. In these circumstances, there are uncertainties regarding the set of documents to be provided.

In addition, the draft law does not establish whether foreign intermediaries may be subject to any sanctions as a result of failure to provide information on underlying securities’ owners following ad-hoc requests initiated by local tax authorities.

Finally, the draft law has a negative impact on shareholders entitled to “special conditional” tax rates. Such tax benefits shall no longer be available in the course of tax pre-clearance for clients of foreign nominee holders, foreign authorised holders or DR owners, who will thus be required to follow the lengthy tax reclaim process.

Note: To become effective, the draft law must be further signed by President Putin and officially published.

We continue to monitor the progress of this draft law and will provide further information as it becomes available.