Running on the rake: why Russia will not be able to become an alternative to offshore

One of the first measures to support Russian businessmen, who were included in the expanded U.S. sanctions list in early April, could be the creation of offshore zones in Russia. However, this could violate the international obligations that the country has previously undertaken

In April, Russian officials talked about plans to create offshore zones in Russia similar to Cyprus and the BVI (British Virgin Islands). They are supposed to appear on the islands of Oktyabrsky in Kaliningrad and Russky in Vladivostok. Two months later, on June 15, a draft law was introduced in the State Duma, which, in fact, provides for creation of internal tax-free regimes for holding companies. At the end of June, sources close to Oleg Deripaska’s EN+ #50 and its shareholders said that the company was seriously considering a move to Russian jurisdiction. The reason given was that “all necessary conditions for comfortable business conduct” have been created in Russia. It was Deripaska’s companies, EN+ and US Rusal, which were put on the US sanctions list along with their owner, that were initially the main applicants for Russian offshore residency.

Altogether Bill No. 488869-7 “On Amendments to Part One and Chapter 25 of Part Two of the Tax Code (in terms of creating a tax regime for international holding companies)” provides for three incentives, changing existing ones or establishing new ones for Russian holdings:

1) reducing the threshold for owning a foreign subsidiary from 50% to 15% for exemption from taxation of dividends received;

2) expansion of the so-called participation exemption – exemption from taxation of income from strategic participation and income from the sale of shares in subsidiaries with a minimum ownership share of 15%;

3) reduction of the withholding tax rate on dividends from 15% to 5% for redomiciled (changed jurisdictions) public companies.

Each of these measures and all of them together are extremely positive and help increase the attractiveness of Russian holding companies as an investment vehicle… But only if they were available to all Russian companies.
Discriminatory tax benefits

Unfortunately, all the positive effect is offset by the fact that only former foreign companies, in reality offshore companies, whose beneficiaries were such as of January 1, 2017 and decided to transfer them to Russia, can take advantage of the new benefits. In fact, this discriminates against law-abiding Russian business.

First of all, the principles of legitimacy of such tax exemptions according to OECD standards are violated, because they will not be available to those market participants who are in comparable conditions. There will also be no practical effect of restrictions on this regime by former offshore companies, as there are still many uncovered offshore companies that existed on January 1, 2017. Their beneficiaries retroactively, i.e. retroactively before the effective date of the law, can be written down by anyone, which will provide such instruments to everyone for many years to come.

The loss of benefits in case of a change of beneficiaries within a year after the redomiciliation of a foreign company in Russia is just as difficult to explain in terms of economic feasibility of benefits: they should not have a personal nature and form a privileged class of taxpayers, who were lucky to be the beneficiaries of such companies on January 1, 2017.

Accordingly, by introducing restrictive discriminatory measures, Russia will not get a real restriction on the scope of benefits, but will violate OECD standards, for example in terms of Standard 5 of the BEPS Plan, adopted by Russia as part of its obligations to join the BEPS standards. This is a plan of action designed to combat the erosion of the tax base and the withdrawal of income/profits from taxation. BEPS Plan 5 explicitly refers to the criteria for impermissible preferential treatment in the 1998 OECD report Harmful Tax Competition An Emerging Global Issue.

In addition, the proposed exemptions would encourage ordinary businesses to buy offshore entities that existed on January 1, 2017, which would greatly complicate the deoffshorization process the government has been declaring for the past few years.
Running on the rake

The experience of creating domestic offshore and low-tax zones in Russia began to be applied almost immediately after the “collapse” of the USSR in late 1991. Already in 1994, the first “offshore” zones were created in Ingushetia and Kalmykia. It was assumed, or at least declared, that this would lead to increased investment in the regions and accelerate their development.

However, these plans did not materialize. The special tax regime in Ingushetia was abolished already in 1997, although it was supposed to last much longer – companies registered there were given 20-year guarantees that the tax regime would not change. According to economists, no development of the territory took place – of all the companies registered within the preferential regime, only 1% worked directly in Ingushetia. The rest worked in other regions, that is, in fact, tax losses were borne by other regions, while Ingushetia received practically nothing.

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