Although
Russia has (or had) its own domestic 'offshore' in the
form of tax-haven territories which were much used by
manufacturing and extractive businesses in the early
1990s to shelter income from taxation, legislation has
now largely removed such possibilities, and in any case
the horrible fate of Yukos acts as a major disincentive
to any Russian company thinking of using home-grown
tax shelters.
That
is not to say however that 'offshore' is out of bounds
for Russian companies, or for foreign companies investing
in Russia. Far from it - almost any major exporter or
importer, whether of capital, goods or services, can
hardly do without the use of offshore international
financial centres (OIFCs) if they are not to commit
fiscal suicide. In this feature we will first examine
the characteristics of the Russian corporate taxation
system which govern the use of OIFCs, we will describe
the types of structure that can be used by Russian and
foreign investors, and finally we will survey key features
of some of the OIFCs which have been particularly used
for Russian business purposes.
The Russian Corporate Taxation System
A
fuller description of Russian corporate taxation will
be found in our Knowledge Base;
here we will just summarize those features of the system
that are most relevant to the use of OIFCs. In most
'high-tax' OECD countries, fiscal consolidation practices,
'Controlled Foreign Corporation' (CFC) rules and transfer
pricing legislation operate to constrain the use of
OIFCs. This situation is the result of 50 years of tangoing
between multinational businesses and national tax authorities.
As tax rates have risen and the multinationals have
become more adept at minimizing tax, so have the rules
gradually tightened. A typical Western multinational
will be unable to retain untaxed profits in its foreign
subsidiaries, will be unable to price international
sales so as to maximize profits in low-tax countries,
and will be unable to mix foreign profits and losses
at will in its home jurisdiction in order to reduce
its tax bill. This is not - yet - the situation in Russia.
Although there is no fiscal consolidation for business
groups in Russia - each permanent establishment remains
a separately taxable entity, and there are limitations
on loss carrybacks - there are no CFC rules at all,
and the transfer pricing legislation is virtually toothless.
A Russian-owned business is taxable on its world-wide
income, so that the income of a foreign subsidiary would
not as such be taxable in Russia - of course, income
received into the foreign bank account of a Russian
company is taxable, as are dividends received from a
foreign subsidiary. Foreign taxes paid on such income
is creditable against Russian tax only to the extent
that this is provided for in a tax treaty. For a foreign
company operating as a taxable permanent establishment
in Russia through a Representative Office - the usual
scheme for all but the most substantial businesses -
only income received by the Representative Office, whether
from Russia or abroad, is taxable. Its remittances abroad
will usually be subject to withholding tax, and will
fall under a tax treaty if appropriate. In fact, Russia
has 64 tax treaties, many of which have highly favourable
withholding tax rate provisions, and these are a key
part of tax-planning both for Russian international
businesses and for foreign investors.
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Russians Investing Overseas
We
are not concerned here with the complications of moving
money out of Russia. This is not easy to achieve legally
without incurring costs, sometimes substantial ones.
However, in one way or another many Russian individuals
and businesses have accumulated overseas assets, and
have the problem of how best to utilize them in a tax-efficient
way, whether that be by re-investing them in Russia,
or by investing them internationally. OIFCs play a key
role in intermediating both types of investment. Typically,
a Russian investor will use an OIFC company to hold
business operations or assets whether in Russia or abroad.
If the income-earning asset is abroad, there will of
course be the problem of local taxation, but gains or
profits once safely harvested by the offshore holding
company may remain untaxed perpetually due to the absence
of CFC rules, as long as they are not repatriated to
Russia. In the situation that a Russian investor has
an importing business, the lax transfer pricing rules
allow much of the profit inherent in the importation
of, say, an electronic device from Taiwan to Russia
to be harvested in an intermediate OIFC. Hong Kong springs
to mind. In the case of a Russian investor re-investing
overseas assets into Russia - much more frequent nowadays
than previously - the use of a holding company or financial
intermediary in one of the IOFCs with a good Russian
tax treaty - for instance Cyprus or Luxembourg - will
allow the remittance of Russian profits, royalties or
interest with minimal tax cost, and once again the money
is safely offshore. It is no coincidence that the early-1990s
saw a rush of Russian banks to Cyprus, in support of
schemes to expatriate Russian capital and profits, whether
legal or otherwise; later, Malta and Gibraltar became
popular for the same reasons. Now, Russian holding companies
or IBCs (International Business Companies) are to be
found in a wide variety of OIFCs.
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Foreign Investors In Russia
As
can be seen from the table of Russian
tax treaties, most OECD countries have such treaties,
and there is nothing to prevent an investor based in
any of those countries from investing directly into
Russia, and relying on the tax treaty to minimize Russian
withholding taxes on repatriated profits (dividends),
interest or royalties. Usually this will result in a
withholding tax rate of between 5% and 15% on dividends,
and between nil and 10% on interest or royalties. That
doesn't sound too bad, but then the income is in the
investor's high-taxing home jurisdiction. For this reason,
most foreign investors choose to use a holding company
in a low-tax OIFC through which to finance a Russian
involvement. Providing that capital injections to the
Russian operation have been correctly recorded by the
Russian authorities, repatriation of the capital will
be untaxed; in the absence of a tax treaty, the normal
rate of Russian withholding tax on a dividend paid by
a Russian company or Representative Office to its foreign
parent (if that parent is a company) is 15%, while interest
payments would be taxed at 20%. However, Cyprus and
Luxembourg both have tax treaties with Russia, making
them the favourite OIFCs for foreign investment into
Russia. In the case of Cyprus, the treaty rate of withholding
tax on dividends is 5% if the original investment was
greater than USD100,000, and 10% otherwise, while the
treaty rates for interest and royalty payments are nil.
With Luxembourg, the treaty rate of withholding tax
on dividends is 10% for a participation which is greater
than 30%, and 15% otherwise. The treaty rates for interest
and royalty payments are nil. Both Cyprus and Luxembourg
have local taxation regimes and corporate structures
that allow foreign income to be very lightly taxed or
untaxed if the beneficial owners of the holding company
are non-resident. Cyprus is therefore apparently the
best place in which to locate a holding company for
a Russian investment, and indeed very many such holding
companies exist. The best structure for any particular
foreign investment will however depend on complex factors
such as the tax domicile of the individual investor,
the nature of the business to be carried on, etc, and
other OIFCs or even OECD countries may have their place
in the structure. A number of European Union high-tax
countries nonetheless have very attractive holding company
regimes (see other countries in the offshore-onshore
section of lowtax.net) which taken together with their
Russian tax treaties may qualify them to be used in
a Russian investment structure. Denmark is the most
obvious example, but there are others.
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OIFCs Used In Russian Investment Structures
Cyprus:
Cyprus
is an independent democratic republic, and a member
of the Commonwealth. It is prosperous: GDP
USD27,000 per head. The economy is dominated
by services, with tourism particularly important. Unemployment
is low. The Cyprus Government has worked hard to create
a favourable offshore tax regime while at the same time
maintaining a normal-looking domestic economy, albeit
with rates of taxation that are low by international
standards. The success of this programme is attested
by the nearly 50,000 offshore companies registered in
Cyprus since 1975. However, the island's entry to the
EU in 2004 meant a restructuring of the tax regime,
which took place on January 1, 2003. Domestic and offshore
companies alike now pay 10% tax, although income from
foreign sources is exempt for non-residents. Cyprus
has double-tax treaties with 27 other countries, including
most major Western 'high-tax' countries, and most Central
and Eastern European states. This is unusual for an
international offshore financial centre and the effect
is that Cyprus is a very effective location for holding
and investment companies aimed at emerging markets.
Cyprus has a good, European-standard business infrastructure,
and English is widely spoken. However, it is a relatively
expensive jurisdiction for offshore operations, and
many documents need to be filed in Greek. The legal
system is predominantly based on English law, and provides
for various types of trust. The division of the island
into Greek Cypriot and Turkish Cypriot zones separated
by a UN buffer zone following the Turkish invasion of
1974 does not seem to impede normal commercial or offshore
operations, which take place in the Greek zone. In November,
2002, the United Nations presented a plan for a 2-state
federation under a common government intended to resolve
the problem before Cyprus's admission to the EU. Even
after the Copenhagen summit in December which confirmed
the island's admission to the EU in 2004, negotiations
between north and south continued; but they broke down
in early 2003 and the island signed its EU accession
treaty in April. The European Commission and the US
strenuously supported the United Nations' Annan Plan
for reunification, but it was rejected by a Greek Cypriot
referendum in April, 2004. Reunification, it if takes
place, may form part of Turkey's negotiation to join
the EU. The island's listing by the FATF in June, 2000,
as one of 15 offshore jurisdictions said to have inadequate
defences against money-laundering hastened a process
of adjustment to international standards of banking
supervision and information exchange. After
the EU finally agreed its Tax Directive in June, 2003,
Cyprus announced that it would implement the 'information
sharing' provision of the Directive on entry to the
Union in 2004. This means that information about savings
returns received in Cyprus by nationals of other EU
countries will be passed to the tax authorities in the
individuals' home countries. In late 2003 the government
also announced plans to weaken previously tight banking
confidentiality, although these were strongly attacked
by the banks. See the Cyprus
section of lowtax.net for a full description of
Cyprus's tax regime.
Luxembourg:
Luxembourg
is a constitutional monarchy, has a land area of about
1,000 sq miles, a population of 480,000, and is sandwiched
between Belgium, France and Germany. With Belgium and
the Netherlands, it forms part of Benelux, which was
a precursor of the EU. Luxembourg was a founder-member
of the EU and hosts many of the EU's financial institutions.
Languages spoken are French, German and English, with
Luxemburgish the everyday language of Luxembourgers.
Luxembourg's economy was dominated by steel production,
but since the Second World War the Government has successfully
encouraged development of a diversified financial sector.
Tourism is also important. In Europe, Luxembourg has
the second most extensive banking industry after London
(220 banks). The Luxembourg private banking industry
is possibly Europe's biggest. The Stock Exchange specialises
in collective investment funds and many of the 4,000
Luxembourg-registered funds are also listed there. According
to figures released by the World Bank in May, 2001,
Luxembourg was the richest country in the world in 1999
when it came to purchasing power per capita with an
average wage of USD41,230. Luxembourg was also listed
as the wealthiest country in terms of gross national
income (GNI) in 1999 at USD42,930 per head. With GDP
per capita now approaching USD80,000 it remains a wealthy
enclave. Unemployment is rising slightly but is less
than 4.5%, and inflation is on the European average
at 2%. Luxembourg
is a high-tax country, but has specialised types of
'holding' company which are tax-exempt (although these
are being phased out at the behest of the European Union).
There are 18,000 of these - they are suited to holding
international investments, but are not allowed to trade
themselves. UCIs (collective investment funds) are also
tax-exempt. As a member of the EU, Luxembourg finds
itself in an uncomfortable situation squeezed between
the EU/OECD attack on harmful tax competition and its
dependence on its successful 'offshore' sector. The
EU's Savings Tax Directive also threatens problems for
Luxembourg banks and UCIs, although after threatening
to veto the EU's plans at the end of 2002 because competitor
Switzerland had not offered 'equivalent' measures, the
country fell into line in January, 2003, and has applied
a withholding tax to non-residents' investment returns
since the Directive came into force in 2005.
After the OECD issued its final list of offshore jurisdictions
in April 2002, it made threatening noises towards Luxembourg,
and considered what sanctions could be imposed on the
country after its 2003 deadline for the removal of 'harmful'
tax practices. Income
Tax, Municipal Business Tax on Profits and a corporate
surtax give a combined corporation tax rate of about
30%; the rates for individuals are higher, and they
pay a wealth tax in addition. The tax system is mostly
based on German originals, apart from VAT which is of
course an EU-inspired tax. EU citizens have freedom
of movement in Luxembourg of course, but other nationals
need residence and work permits. See the Luxembourg
section of lowtax.net for a full description of
Luxembourg's tax regime.
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