Never ever yet here they are again: Tax changes from the President
“We agreed that there would be no tax increases for six years until 2024. And this position will be held firmly.[1]” – First Deputy Prime Minister and Minister of Finance Mr. Anton Siluanov
The President of Russia addressed the nation once again on June 23, 2020 and announced, among other things, that we are to expect important tax changes in 2021.
What are these changes?
- An increase in personal income tax rate of up to 15% on income exceeding 5 million rubles per year. According to the President, this should redress social justice and increase the budget by about RUB 60 billion per year;
- The imposition of a fixed tax of RUB 5 million per year on the income of so-called controlled foreign companies (further “CFC”). The payment of this fixed amount, as envisioned by the President, should be the ground for exempting the Russian beneficiaries of CFC from the obligation to pay taxes on CFC retained earnings and submit complex and confusing CFC reporting.
- Tax maneuver for the IT industry. The total social insurance contribution rate is expected to decrease to 7.6%, and the profit tax rate down to 3% (instead of 20%), which should increase Russia’s attractiveness for IT business.
Let’s try to figure out how these measures will work and what really is behind them.
15% personal income tax and CFC grace
The President pointed out that raising personal income tax up to 15% for income exceeding RUB 5 million per year is a measure aimed, first and foremost, at redressing social justice. This is a kind of attempt to introduce a progressive taxation scale: the more you get, the higher the tax rate. There is indeed a certain fairness in that wealthy people will have to pay more taxes than those who can barely make ends meet, but will this measure redress social justice? It seems that it might fall short of that aim:
- A progressive taxation scale often comes hand in hand with a set minimum income exempt from tax. So, those who receive the minimum wage or less do not pay tax at all or very little. For example, 23.4% of the population in Russia receive an average income of RUB 14,000 per month[2]. In his address, the President did not unfortunately announce a tax-free minimum income or measures to reduce the tax burden on low-income workers.
- According to the Federal Statistics Service, only 11.9% of the population earn an average income of more than RUB 720,000 per year[3], and there are even fewer people getting more than RUB 5 million per year. This measure will therefore not have a significant effect and looks like a formal rather than actual attempt to introduce a progressive taxation scale.
A taxpayer may have several sources of income, while entities required as tax agents to withhold tax when paying income to the taxpayer may be the source of income. So, the question arises as to who and how will this additional 2% (difference between 15% and 13%) will be paid. It would seem that taxpayers will have to calculate their total income at the end of the year and pay the additional 2% on their income exceeding RUB 5 million.
Grace for CFC
The President also proposed replacing the payment of taxes on CFC retained earnings with the payment of a fixed amount of RUB 5 million. According to the President, this will give “incentives to develop modern, responsible business, especially in Russia.”
A foreign organization or structure is deemed to be a CFC if it is controlled by a Russian tax resident (individual or organization known as “controlling entity”). Russian tax residents must report to Russian tax authorities any CFC they control, and under certain conditions, CFC retained earnings may be recognized as taxable income of the CFC controlling entity. In such case, it is important that the amount of dividends distributed by CFC be deducted from the retained earnings recognized as the controlling entity’s income subject to tax in Russia.[4] These rules prompt controlling entities not to hold CFC profits in accounts abroad and distribute profits to their beneficiaries in Russia.
Having CFC is usually a costly and complex process, and only very wealthy individuals can afford to use CFC in their tax planning. If the income of wealthy individuals is such that payable income tax exceeds RUB 5 million, then it will be profitable for them to redirect such income to CFC and pay a fixed tax of RUB 5 million. It follows that the introduction of this fixed tax of RUB 5 million will not translate into incentives to “develop modern, responsible business, especially in Russia”, but on the contrary it will contribute to the outflow of funds from Russia.
Moreover, this measure clearly contradicts the idea of social justice which underpins the introduction of a progressive taxation scale in Russia as for the most affluent individuals it replaces personal income tax – the payable amount of which is dependent on the amount of income – with a fixed tax amount.
Tax maneuver for the IT industry
The introduction of tax treatment for developing the IT industry in Russia can only be welcomed, especially given the mobility of entrepreneurs in this industry (IT entrepreneurs can indeed move their businesses to other countries easily). The reduction in social insurance contribution rate to 7.6% for IT therefore seems justified, as well as the reduction in profit tax down to 3%.
The Russian government is also discussing at the moment whether they should cancel the VAT exemption on the sale of exclusive rights and software rights which is still currently in place.[5]
Taxpayers pay VAT to the budget on the difference between so-called output VAT (received from customers upon sale of goods, work, or services) and input VAT (paid to suppliers upon purchase of goods, work, services). IT companies usually have small input VAT as their main expenses are personnel costs which are not subject to VAT. So doing away with VAT exemption could end up being a turnover tax for IT companies selling their software, which will more than cover the income tax benefits that the President proposes to introduce.
It should be noted that only services rendered in Russia are subject to VAT. The Tax Code sets out formal criteria to determine where services are provided and sold. According to these criteria, the sale of software rights is subject to VAT in Russia only if the buyer is in Russia (regardless of where the contractor/seller is located)[6]. If the buyer is abroad, then Russian VAT does not apply.
It follows that the cancelation of VAT exemption on software will hit primarily Russian software buyers and companies that sell software in Russia.
It is too early to say how these proposals will be reflected in the law. We will monitor the situation and provide updates as and when necessary.
If you have any questions or require further information, please contact Anton Kabakov, partner at Forte Tax & Law.
Yours truly,
The Forte Tax & Law Team
[1] https://ria.ru/20191022/1560089492.html
[2] https://www.gks.ru/free_doc/doc_2019/rusfig/rus19.pdf (page 125)
[3] https://www.gks.ru/free_doc/doc_2019/rusfig/rus19.pdf (page 125)
[4] Article 25.15(1) Tax Code
[5] Article 149(2(26)) Tax Code
[6] Article 148(1(4)) Tax Code