No surprises or how the Federation Council ended its spring session last Saturday
The Federation Council completed its spring session on July 28, 2018 as expected by approving a number of important and widely debated tax bills. We have briefly reviewed below the changes approved by the Federation Council that are, in our opinion, the most important.
1. Control over transfer prices
Major changes have been introduced to the list of transactions subject to transfer pricing rules (so-called controlled transactions)[1]. These changes affect both domestic and foreign trade transactions. Once signed by the President, the changes will enter into force on January 01, 2019.
Foreign trade transactions
From 2019 onwards, transactions with foreign related parties will be subject to control only if the turnover under such transactions exceeds RUB 60 million per year whereas these transactions are currently subject to control regardless of their turnover.
Domestic transactions
From 2019 onwards, domestic transactions will, as a rule, not be subject to transfer pricing rules whereas such transactions currently are subject to control if their annual turnover exceeds RUB 1 billion.
There are naturally a number of exceptions to this rule. Domestic transactions will continue to be deemed controlled transactions if they meet any of the following conditions:
- The parties to the transaction apply different profit tax rates to the profit derived from the transaction[2];
- A party to the transaction is exempt from profit tax, but not the other;
- A party to the transaction pays mineral extraction tax calculated on the basis of set percentage, or a party to the transaction pays tax on additional income from hydrocarbon production[3];
- A party to the transaction applies a single agricultural tax or a single tax on imputed income;
- A party to the transaction is a research corporate center as specified in Skolkovo law;
- A party to the transaction applies investment tax deduction for profit tax.
The transactions listed above are now deemed controlled transactions as soon as their turnover exceeds RUB 60 million and, in certain cases, RUB 100 million per year, but this threshold will increase significantly and amount to RUB 1 billion per year starting from 2019.
What does this all mean?
Are these changes positive? On the one hand, the number of transactions for which it will be required to submit transfer pricing documentation and report to tax authorities will significantly decrease, and this will undoubtedly simplify the life of taxpayers.
On the other hand, the prices under such transactions will by all means still remain subject to tax control. Tax authorities will continue monitoring them by applying general tax evasion rules, such as so-called unjustified tax benefit rules, but the guarantees provided to taxpayers by transfer pricing rules will not apply in this case. The right to corresponding adjustments, the right to negotiate transaction pricing with tax authorities beforehand (pricing agreement), the right to exemption from penalties for non-payment of taxes when transfer pricing documentation is available, and a number of other rights will be among these “lost” guarantees.
These changes will therefore have a more negative than positive effect at least as long as tax authorities attempt controlling prices under “uncontrolled” transactions.
2. 20% VAT and other VAT changes
The Federation Council has approved a 2% increase in VAT so from 2019 the VAT rate in Russia will be 20% instead of 18%[4]. The good news is that the preferential VAT rates of 10% and 0% will remain for goods and services of social importance.
This measure is supposed to bring in additional funds that will be used to fulfill the so-called “May Decrees”[5] issued by the President of Russia.
We recommend taking into account this change when negotiating contracts and making price offers for 2019.
To make up for it, the period for VAT desk audits have been reduced down from 3 to 2 months with possible extension up to 3 months if there are any signs of tax violation[6]. This should speed up the VAT refund process.
The number of entities entitled to apply for simplified (so-called declarative) VAT refund[7] has also been extended. Previously, taxpayers with a total amount of payable tax of RUB 7 billion could apply for such simplified VAT refund. This threshold has now been decreased down to RUB 2 billion[8]. The requirements for guarantors have also been reduced along similar lines.
3. Corporate tax on movable property
From 2019 onwards, movable property will no longer be subject to corporate property tax[9]. We are in favor of this change as we consider that it will have a positive effect on the investment climate in the country. Tax on movable property is rightly so considered to be a tax on investments as the more taxpayers invest in production and fixed assets, the greater the amount of tax on movable property they need to pay.
4. Right of regions to set preferential rates for the regional part of profit tax
From 2019 onwards, the regions of Russia will be entitled to provide only the preferential rates for the regional part of profit tax expressly listed in the Tax Code[10]. Taxpayers will be able to apply the regional preferential profit tax rates already in place as of January 01, 2018 until their expiration date but no later than 01, 2023.
We consider this change to be very negative as it limits the regions’ ability to decide which benefits are worth for business given the social and economic situation in the region. Moreover, since this change will result in a decrease in the regional profit tax benefits already provided, it will have an adverse effect on investors that had already taken into account the existing regional benefits when they assessed the profitability of their project and decided to invest.
5. Fixed rate for pension contributions
Currently, employers pay pension contributions for their employees as follows:
- 22% on salary payments up to a certain set threshold for individuals, i.e. RUB 1,021,000 in 2018;
- 10% on salary payments over this threshold.
These rates should have been effective until 2021[11], and starting from 2021, employers would have been supposed to pay social insurance contributions at a rate of 26% on salary payments up to the set threshold and nothing on salary payments over this threshold. Bill 489169-7[12] has abolished the transition to the new procedure for payment of pension contributions starting from 2021 by providing no time limit for the existing mechanism for accrual of social insurance contributions.
6. Tax control
The Tax Code, as a general rule, prohibits conducting 2 field audits for the same period and the same tax. There are exceptions to this rule, in particular, when taxpayers submit a revised tax return with a smaller payable tax amount. In this case, tax authorities are entitled to conduct a second field audit. However, if previously tax authorities could re-check the entire period for which a revised tax return is provided, now they can only check the revised indicators resulting in a decrease in the previously calculated tax amount (loss increase).
If you have any questions or would like to discuss this matter further, please write to Anton Kabakov.
Truly yours,
[1] Bill 249505-7
[2] Exception introduced by bill
[3] Exception introduced by Federal Law N 199-FZ dated July 19, 2018 effective from January 01, 2019
[4] Bill 489169-7
[6] Bill 249505-7
[7] A simplified procedure whereby VAT is refunded before completion of tax audit
[8] Bill 249505-7
[9] Bill 249505-7
[10] Bill 249505-7
[11] Article 426 Tax Code
[12] Bill 489169-7