The end of the past year turned out to be a fruitful time for lawmakers, particularly in respect to taxation. To add, the majority of new laws took effect right as the celebrations unfolded, i.e. starting from January 1, 2024.

In this review, we will examine the main novelties in tax law which could have a meaningful impact on Russian business that has economic, corporate and other ties with foreign entities. That said, lawmakers were apparently guided by the principle of “leave no one behind” and addressed practically everyone, since the provisions we will examine here will affect not only persons with ties to so-called “unfriendly entities,” but also residents of other foreign states.

It appears that the reasons for such mass scale changes were not merely political ones (although in the case with suspended DTTs these reasons are at the forefront), but there is also effort being made to prevent money being funneled abroad under the guise of service contracts and other operations by, for example, inflating prices.

One should expect that the changes will cause not only increased financial burden for Russian business when dealing with foreign elements, but also increased administrative burden.

Below, we have addressed the most significant changes.

1. MAKE NEW FRIENDS, BUT KEEP THE OLD

One of the most discussed and, let's be honest, unprecedented events in international tax law is Russia's suspension of double tax treaties (DTTs) with “unfriendly states”: first based on Decree No.585 of the Russian President dated August 8, 2023 and then codified in Federal Law No.598 dated December 19, 2023. We wrote about the consequences of the suspension in an overview.

At the same time, the DTTs with Denmark and Latvia have been officially denounced starting from January 1, 2024 after the governments of these states sent official written notices. The provisions of these DTTs therefore no longer apply.

With that, no time was wasted and in the course of 2023 Russia was engaged in active negotiations about signing new DTTs with Middle East states, as a result of which on June 8, 2023 a DTT was signed with Oman, effective as of January 1, 2024.

It is assumed that in 2024 negotiations with new and old partners will continue, and the geography of the treaties will expand, though in a different direction, and some DTTs will be renegotiated (for example, Russia is in negotiations on amending the DTT with Malaysia). And expectations are that soon an agreement will be reached in respect to certain conditions of the treaty with the UAE, in particular, the main discrepancies concerned the taxation of royalties.

2. BUT A MOMENT IN TIME: FROM DTT SUSPENSION TO TAX ON FOREIGN ENTITIES

One of the more substantial new elements that can impact a large number of operations is the introduction of withholding tax starting January 1, 2024 on services rendered by foreign interdependent entities to Russian entities.

In particular, the Russian Tax Code was supplemented with Subclause 9.4 Clause 1 Article 309 under which income received by a foreign interdependent entity (irrespective of the “friendliness” of its state or residence) from rendering services (or performing works) on Russian territory to a Russian organization is to be taxed in Russia. For profit tax purposes, such services will be deemed rendered on Russian territory at the location of the buyer and will be subjected to Russian withholding tax at a rate of 15%.

Along with the actual expansion of the list of operations subject to withholding tax, lawmakers also attempted to mitigate the negative impact of the DTT suspension by excluding some operations from the list of taxable ones (Clause 3 Article 311 of the Russian Tax Code). To speak frankly, the list of exempted types of income is rather limited; moreover, in order to derive benefit from such exemption, other terms need to be fulfilled, which in the end, as we presume, will cause the overall financial burden for international structures from the effect of the withholding tax on services to increase.

3. TRANSFER PRICING

Major changes were also adopted in respect to transfer pricing. The changes concern transactions whose income and expenses are accounted for tax purposes starting from January 1, 2024. The changes are in effect aimed at expanding the scope of entities and operations that are subject to control in accordance with the transfer pricing rules, as well as at improving the control system as such, given that the main beneficiary of these “improvements” will be the state budget.

The key changes concerned:

3.1.   Expansion of the list of interdependent entities whose transactions are deemed controlled

Interdependent entities will be deemed a controlled foreign company (CFC) and its controlling entity, all CFCs of a person, as well as companies under the control of individuals who are relatives to each other.

3.2.   Change in the list of controlled transactions

Because the list of offshore jurisdictions has been expanded (see item 4 below), transactions with any independent entities that are on this list (e.g. with EU member states) will be deemed controlled if turnover for the transactions exceeds RUB 120 million in a calendar year.

Transactions with parties from states with which DTTs have been suspended can, subject to certain conditions, be excluded from the list of controlled transactions.

3.3.   New mechanism for secondary adjustment

The amount by which a price under a controlled transaction is adjusted to bring it in line with market prices will be deemed dividend income of the foreign entity, and the Russian entity will be obligated to apply withholding tax at the rate of 15%.

3.4.   More information to be provided

As part of the notice of a controlled transaction, companies will need to provide information on the terms of goods supply, the method for calculating the transaction price and subsequent chains for selling the goods.  In addition, new items have been added to the list of transfer pricing documents being submitted on request of the tax authorities.

3.5.   Greater tax liability

Fines for transfer pricing violations have been increased:

• For using non-market prices in transactions with foreign entities the fine will be 100% of the unpaid tax amount, at least RUB 500,000.
• For not providing a notice of a controlled transaction the fine has been increased to RUB 100,000.
• Not providing notices and documentation for an international group of companies can entail a fine of up to RUB 1 million.

3.6.   Expanding opportunities for entering into a transfer pricing agreement

There are now more types of entities that can enter into a transfer pricing agreement. A taxpayer can obtain approval from the Russian Federal Tax Service for the formula to be used when determining prices in transactions (traders of certain goods with annual turnover over RUB 2 billion will be able to use such agreements).

Once the agreement is signed, control over transactions that are subject to transfer pricing rules is exercised taking into account the provisions of the agreement, even if the laws or economic conditions change substantially.

4. DECLARED AN OFFSHORE

Starting January 1, 2024,[1] an expanded list of offshore jurisdictions took effect, based on Decree No.86n of the Russian Ministry of Finance dated June 5, 2023.

As a result of the changes to the list, now so-called “unfriendly” entities are deemed offshores (e.g. Spain, Germany, Netherlands, US, Japan, UK and many others). Notably, these states are in essence not offshores as such, since the level of taxation there is rather high.

This list being put in effect is, first of all, important for transfer pricing purposes, as we noted above (see item 3.2 of this review), but at the same time, it will impact other operations (e.g. the lack of possibility to apply a reduced tax rate when a Russian company receives dividends from a foreign subsidiary).

In order to soften the adverse effect of the expanded list of offshores, temporary rules[2] are adopted that presume the Ministry of Finance is to publish an “abridged” list of offshores which will be in effect when determining certain tax benefits in 2024-2026. However, as of today, the “abridged” list has not been adopted.

Our team is constantly on the watch  for changes to the tax laws and is prepared to assist your company with tax planning as the Russian laws transform.

We recommend noting of these changes and taking them into account when planning and conducting business. We will be glad to help with resolving practical issues that your business may encounter given these changes.