Historically, representative offices (ROs) were established to perform an "eyes and ears" function for a foreign legal entity (FLE) which would not lead to a taxable presence for the FLE in Russia. In time, the activities of ROs in Russia have increased with the result that ROs can now be both taxable and non-taxable.
Various Registrations of a RO in Russia
In order to obtain certain customs duty and VAT exemptions, as shown below, a RO should be accredited with one of the Russian authorised accreditation bodies. Accreditation is a separate process to tax registration and is effective for a period of 1 - 3 years, after which, a new application is required.
According to Article 83 of the Tax Code of the Russian Federation FLEs operating in Russia should be registered with the tax authorities irrespective of whether their operations are subsequently acknowledged as subject to taxation or not. The procedure of such registration is established by Regulations No. AP-3-06/124 of the Ministry of the RF for Taxes of 07 April 2000 "On Peculiarities of Foreign Organisations with the Tax Authorities". These Regulations are effective from the beginning of July 2000.
Taxable Presence of a FLE in Russia
As you may be aware, a FLE operating in Russia will only be subject too Russian taxes if it is both a permanent representation pursuant to Russian domestic legislation and a permanent establishment (PE) pursuant to the terms of an applicable double tax treaty between Russia and the country of tax residence of the FLE.
Although a permanent representation may be deemed to exist under Russian domestic legislation, it may be possible that due to the provisions of an applicable double tax treaty no PE may be deemed to exist.
Permanent Representation According to Article 1.4 of Instruction No. 34 of the State Tax Service of the Russian Federation of 16 June 1995 On the Taxation of the Profits of Foreign Legal Entities, a "permanent representation" is defined as a branch, division, bureau, office, agency, or any other permanent place for regular activity, connected with rendering of services and the performance of other activities involved in the receipt of income in the territory of the Russian Federation or abroad.
Pursuant to Article 1.4 (as expanded by Article 1.5) of Instruction No. 34, a FLE shall also be regarded as having a permanent representation if it is engaged in business operations in Russia through a Russian organisation or natural person (agent), who on the basis of contractual relations with the FLE represents its interests in Russia, acts on its behalf and has the power to conclude contracts in the name of the given FLE or has the powers to specify the essential terms of contracts. Where such an agent carries on this activity within the framework of its usual activity, such an agent shall not be regarded as a permanent representation of the FLE. However, if this agent, fulfilling his usual activities, also has the power to conclude contracts and represent the FLE, this additional activity shall constitute a permanent representation of the FLE.
Permanent Establishment There are 44 Double Tax Treaties between Russia and foreign countries, therefore we use in this article, as example, the Russia - UK Double Tax Treaty.
Pursuant to Article 5 of Convention Between the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the Russian Federation for the Avoidance of Double Taxation and Prevention of Tax Evasion to Taxes on Income and Capital Gains of 15 February 1995 (UK Treaty), the term "permanent establishment" (PE) means any branch, office, agency or other fixed place of business situated in Russia through which a resident of the UK wholly or partly carries on any commercial activity. However, a PE does not include:
a building site, construction or assembly project, providing it lasts for not more than 12 months;
the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the UK resident;
the maintenance of a stock of goods or merchandise belonging to the UK resident solely for the purpose of storage, display or delivery;
the maintenance of a stock of goods or merchandise belonging to the UK resident solely for the purpose of processing by another person;
the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting and disseminating information, for the UK resident;
the maintenance of a fixed place of business solely for the purpose of carrying on, for the UK resident, advertising, marketing or other activity of a preparatory or auxiliary character.
Consequently, if any of the abovementioned activities (b) to (f) are carried out for a third party, including other group companies, other than the head office, a PE may be created.
A UK tax resident would also be deemed to have a PE in Russia if it conducts its activity here via an agent which:
is not an agent of independent status acting in the ordinary course of its business;
acts in the interest and on behalf of the UK resident;
has and habitually exercises an authority co conclude contracts in the name of the UK resident, unless the agent carries out those commercial activities mentioned above, for the UK resident.
However, the existence of a PE in Russia does not automatically result in Russian tax liabilities. Pursuant to Article 7 "Profits from Commercial Activities" of the UK treaty, profits derived by a UK resident from carrying on commercial activities in Russia are not taxable in Russia if such profits are not attributable to the activities of a PE in Russia. For example, no profits may be attributed to a PE by reason of the mere purchase of goods or merchandise for the UK resident.
Profits Taxation of PE
If FLE's RO is deemed to constitute a PE and its profits attributable to the PE, it would be liable too profits tax on a net basis.
Pursuant to Article 2 of Law No. 2116-1 of 27 December 1991 On the Taxation of the Profits of Enterprises and Organisations, profits subject to taxation are calculated on a net basis, i.e. the difference between income received by an enterprise reduced by certain allowable deductions.
Pursuant too Article 4.3 of Instruction No. 34 the profits of RO from its activities in Russia, are determined as the difference between the sales proceeds of goods (work, services), excluding VAT and excises, less expenses directly related to the operations of FLE in the Russian Federation, including management and general administrative expenses borne both in the Russian Federation and abroad (in certain cases) plus other incomes.
The detailed composition of deductible expenses applicable in determining taxable profit in Russia is provided by Regulations No. 552 On the Composition of Production and Sales Costs of Goods (Work, Services), Incorporated inn the Cost of Goods (Work, Services) and on the Procedure for Forming Financial Results Considered During the Taxation of Profits.
The deductibility of certain expenses is either permitted or restricted and these include, mainly:
certain management, technical or professional services fees
advertising, training and entertainment expenditure in excess of certain limits.
If it is not possible to calculate the net profit of the RO using the direct basis method, the tax payor (FLE) may estimate the profits based on imputed methods. These methods are as follows:
firstly, based on 20% of the gross income of the FLE received in relation to its operations in Russia
secondly, based on a proportion of the worldwide income of the FLE using a ratio of RO staff to worldwide staff; this figure should be considered the gross income and a rate of 20% imposed to arrive at taxable profit
thirdly, based on 25% of the costs related to the activity of the FLE in Russia
These methods of imputing income can only be applied in the order outlined above. However, the selection of the method of profit calculation depends on the particular situation.
Pursuant to Article 5 of the profits tax law, federal tax is levied on profits at a rate of 11% and in general, the various regions are entitled to collect tax at rates of between 0% and 19%. The combined maximum profits tax rate is therefore 30%.
For enterprises involved in intermediary transactions, the regions are entitled to collect tax at rates of between 0% and 27%. The maximum profits tax may thus be established at the higher rate of 28% for certain activities of an enterprise, namely any intermediary activities.
If a legal entity conducts activities subject to profits tax at different rates, it should keep separate accounts of these activities.
A RO is required to calculate and pay profit tax advance payments every month and file its profits tax declaration on an annual basis before 15 April of the year following the reporting period.
Profits Taxation of non-PE
If the Russian tax authorities of FLE itself do not consider FLE's RO to be a PE nor its profits in Russia to be attributable to such a PE (if one exists), RO will be liable to profits tax on Russian source income.
Article 10.1 of the Profits Tax Law and Article 1.10 of Instruction No. 34 provide that FLEs earning Russian source income, unrelated to their operations in Russia through a PE shall pay Russian tax (withholding tax) on that income.
Pursuant to Article 5.1 of Instruction No. 34, a FLE earning Russian source income (unrelated to a PE) is taxable on the income at the source of payment. Although Russian legislation does not specifically define Russian source income, Article 5.1.11 of Instruction No. 34 provides that Russian source income includes "other income, the receipt of which is not connected with the activity through a permanent representative office, in particular, for works and any services, performed and rendered in the territory of the Russian Federation."
However, as a result of the lack of clarity in the legislation, we understand that the Russian tax authorities may currently deem any income received from Russia as Russian source income. The rate of Russian profits withholding tax applicable to such income is 20%.
Pursuant to Article 5.2 of Instruction No. 34, the payor of the Russian source income must withhold tax from payments to the FLE and remit such tax to the budget. These withholding taxes may be reduced or eliminated if treaty relief is available.
Relief from profits withholding tax may be available pursuant to the terms of UK treaty, unless such activities are carried on in Russia through a PE.
In order to obtain prior treaty relief from withholding tax, the FLE should file (with the Russian tax authorities) treaty relief claim form No. 1013DT, as provided in Instruction No. 34, certifying its country of tax residence and eligibility for treaty relief. Unless in the possession of an approved form No. 1013DT, the payor of the income, as tax agent, is required to withhold tax at source and remit same to the Russian tax authorities. Article 5.4 of Instruction No. 34 provides that where payments are made without withholding the required taxes, the amount of taxes that should have been withheld are to be collected from the tax agent i.e. the payor.
It should be noted that Article 6.4 of Instruction No. 34 provides that prior tax treaty relief from withholding tax will however, only be available if the income is "regular and uniform". This provision would seem to introduce an additional requirement that must be satisfied in order to gain tax treaty relief over and above the qualification requirements that are set out in any particular tax treaty.
If tax is withheld at source, such tax can be claimed back using treaty relief refund claim form No. 1011DT as provided in Instruction No. 34, providing relief is available under an applicable treaty. This form needs to be filed with the Russian tax authorities within one year from the time payment is received, otherwise the claim for treaty relief will not be eligible to be considered by the tax authorities. In addition, it should be noted that, in practice, it is very difficult to receive tax refunds from the State Tax Service due to government budgetary restraints.
Value Added Tax (VAT)
General In general, the Russian VAT system is modeled on the EU system. However, the treatment of some items differs which may create difficulties for foreign investors. We should however mention that in the last four years many changes have been implemented into Russian VAT Law and these changes have generally been in line with EU VAT principles.
Pursuant to Law No. 1992-1 On Value Added Tax of 6 December 1991 and Instruction No. 39 of the State Tax Service On the Procedure for Calculating and Paying of Value Added Tax of 11 October 1995, VAT is to be paid to the budget of the Russian Federation by Russian entities, including those with foreign investments and foreign legal entities, including permanent establishments of FLEs, engaged in production and other commercial activities in Russia.
Russian VAT legislation provides that turnovers from the sale of goods, works and services in Russia, and goods imported to Russia should be included in the taxable base for VAT purposes. Taxable turnover also includes turnover from barter transactions, turnover from goods (works, services) donated gratis to other legal entities and employees and also the amounts of advances (with certain exceptions) and other prepayments in respect of future supplies of goods or the rendering of works (services).
Pursuant to Article 7 of Russian VAT Law, goods (works, services) should be sold at prices increased by the amount of VAT.
Rates of VAT are fixed in the following range:
Exempt, e.g. insurance, reinsurance, banking operations.
Zero-rated, e.g. exported goods, technological equipment imported, certain charter capital contributions.
10% for food products (except for those liable to excise duties) and commodities for children in accordance with the list endorsed by the Government of the Russian Federation, 10% for grain, raw sugar, fish meal, fish and sea products sold for further processing, fodder production and production of pharmaceuticals;
20% for all other goods (works, services) not specifically mentioned in the lists for other rates.
The amount of VAT, to be paid to the budget, is determined as the difference between the amount of VAT received from the customers from the sale of goods (works, services) (output VAT), and VAT amounts actually paid to suppliers for goods (works, services), whose cost is charged to costs of production (input VAT).
Input VAT paid on the acquisition and import of fixed and intangible assets is offsetable at the moment when these fixed and intangible assets are booked in the accounts of the taxpayer (purchaser/acquirer).
Credit for input VAT paid on certain deductible expenses is not available e.g. VAT on expenses related to the acquisition of an enterprise's cars. Input VAT related to expenses that are not deductible is not available as an input credit i.e. is not offsetable.
Please note that pursuant to Article 19 of Instruction No. 39, invoices should state VAT in a separate line. Otherwise, a credit for input VAT will not be granted.
If VAT is not indicated as a separate entry on invoices, in order to calculate the VAT due to the budget, the tax authorities assess a rate of 20% on the gross amount. However, if this is treated as an advance i.e., that final settlement has not been completed, an imputed rate of 20% may be applied to the sales price i.e. 16.67%;
--------- = 16,67%.
Generally speaking, VAT returns are required to be filed and remittances made no later than the 20th day of the month following the taxable period in question. Small businesses are required to make quarterly returns and payments, while enterprises with larger turnovers are required to make more frequent payments. Russian VAT legislation provides that the following average monthly VAT payments are to be used to determine the deadlines for filing VAT returns and VAT remittance:
up to 3 000 roubles (approx. US$110) - quarterly returns and payments
from 3 000 roubles to 10 000 roubles (approx. US$110-400 - monthly returns and payments)
over 10 000 roubles (over approx. US$400 - monthly returns and installments on the 15th and 25th and the 5th of the following month)
Responsibility for the timely submission of VAT returns and remittances lies entirely with the taxpayer.
VAT on Services Rendered by Foreign Legal Entities not Registered as Tax Payers Pursuant to Russian VAT Law, services rendered on the territory of Russian Federation are subject to 20 % VAT. For crossborder transactions, in Russian legislation there is provision for determination of the place of supply of such a service that is, in general, similar to the EC 6th Directive.
The "place of supply" legislation provides that "consultation, legal, accounting, engineering, advertising, information-processing, and other similar services" are deemed supplied at the place of economic activity of the buyer of the service, where the buyer is located in one state and the seller in another state. Consequently, in the case of the rebilling arrangement, the services will be considered supplied in the place of economic activity of the buyer, in this case, in Russia, with the result that the service is subject to Russian VAT.
Article 7.5 of the VAT Law provides that in the case of the sale of goods (works, services) in Russia by foreign enterprises which have not been registered with the tax authorities, VAT shall be withheld by the payer from the amounts transferred to the FLE in respect of such goods (works, services).
Thus, if FLEs - beneficiaries are not registered with the tax authorities in Russia, the Russian VAT registered payer will need to withhold VAT, at an imputed rate of 20% (i.e. 16.67%), from payments made to such foreign legal entities - beneficiaries and remit it to the budget. Credit can then be taken by the payer in respect of the VAT withheld once the VAT is stated separately on the invoice.