'Russian offshore companies': companies to be allowed to register in Kaliningrad and Primorye
What are the benefits for the Russian economy?
The State Duma immediately in the second and third readings adopted a law on the rules for Russian companies to obtain the status of residents of special administrative regions (SAR) in Kaliningrad and Primorsky Krai — the so-called “Russian offshore”. The document provides for changes in the taxation of international holding companies in the SAR. It should be noted that these regions have had the status for already several years, but residence has so far been available only to foreign legal entities that have changed their registration to Russian and acquired the status of international holding companies under Russian law. Artur Safiulin, a columnist for Realnoe Vremya, economist with many years of banking experience, suggests figuring out what benefits this initiative promises to the Russian economy.
What is the SAR?
In fact, these are territories with preferential tax treatment for investors. The history of the project began in 2018 with the organisation of such areas on Oktyabrsky Island in Kaliningrad Oblast and on Russky Island in the Primorsky Krai. The goal was to return Russian capital from abroad and protect businesses from sanctions after the Ukrainian events of 2014. Until now, only foreign legal entities could carry out the so-called redomiciliation (home return): they changed their registration to Russian and acquired the status of international holding companies (IHC). Currently, more than 50 residents are registered in them, most of them are in Kaliningrad Oblast.
The main benefits of these territories are zero tax on dividends received with a capital share of 15%, a five percent tax on the transfer of dividends abroad (for PJSCs), 0% on income from the sale of shares in companies, 0% on the income of Russian beneficiaries of resident companies in the form of company profits.
Essence of the proposed changes
It should be noted right away that the amendments to the Tax Code were motivated by the decision of the European Union to include Russia in the gray tax list due to unfair tax competition that arose as a result of the introduction of the SAR regime. To avoid being included in this list, which includes countries such as Costa Rica, Hong Kong, Malaysia, Uruguay, Jamaica, North Macedonia, the government decided to amend the Tax Code. The requirement of the European Union was to allow Russian companies to use this regime under the mandatory condition for them to have real offices when moving.
The amendments themselves provide for a Russian legal entity to receive similar status if the following conditions are met:
- The company was established before January 1, 2018 and the location at the time of filing the application for recognition of the IHC are the two islands mentioned above. In this case, the location provides for the presence of the executive body (director) in these regions.
- The controlling entities of the company became such before January 1, 2017 (this is both individuals and legal entities with a participation share of more than 15%). For legal persons, there is the additional condition: either more than 25% of their shares must be traded on the Russian stock exchange, or at least 50% of the authorised capital must belong to the state (Russia or any other of those who exchange tax information automatically with Russia), if there is permission from this state to transfer the company to the SAR.
- The company has submitted the relevant application and information about the controlling persons to the tax authority.
- The government of the region in which the company was previously located has no objection to re-registration in the SAR at the time of filing the application. Interestingly, the region will have the right to object if the share of income tax receipts from the company exceeds 1% of all receipts of this tax to the budget of the region in at least one of the previous three years.
There are also penalties in the form of the loss of the status of the IHC by Russian companies that moved to the SAR. In particular, they will come in force in the event of a merger with another organisation, if that is not an IHC, or if a new controlling person appears within one year after the change of jurisdiction.
The amendments also provide additional tax benefits for residents of the SAR in the form of reduced income tax rates. For this, companies need to meet the following conditions:
- At least one controlling person must be a resident of Russia.
- The share of the company's expenses in Russia is at least 70%.
- The share of passive income (interest, dividends, royalties from various services) exceeds 90%.
- The company is managed on the territory of the Russian Federation.
- The staff consists of at least 15 people on a permanent basis.
- The company has an office on the territory of the SAR with an area of at least 50 square metres.
- The obligation to make capital investments in the amount of at least 300 million rubles within three years after registration in the SAR.
Benefits and risks for the economy
It should be understood that the demand for the option of moving to the “Russian offshore” will depend on what tax benefits the Ministry of Finance will offer for residents of the SAR. There is no exact information yet. For the application of benefits, there is a limit on the share of passive income in total revenue — more than 90%. In this case, the SAR will not be of interest to the companies that receive such active income as revenue from the sale of goods. At the same time, for companies with passive income, the income tax rate of 5% would be interesting, which is not yet guaranteed by the Ministry of Finance.
Besides, there is a whole layer of claims to this decision, which are expressed by current residents of the SAR. In particular, they believe that the relocation of public companies with registration in other regions will undermine investor confidence and reduce the value of companies.
The argument is the fact that initially the SARs were created to return the capital of foreign companies controlled by the Russians. As a result, residents were given freedom in corporate matters to facilitate moving to Russia. This provided for the preservation of foreign law and well-established rules of corporate governance. In fact, the extension of the SAR regime to Russian companies is not redomiciliation and does not correspond to the original goal of creating a SAR.
The main risk for investors of companies moving to the SAR is that Russian corporate law does not work in the SAR. As a result, we may face a situation where the interests of minority shareholders are infringed. The company may revoke the right of shareholders to demand the repurchase of their shares, cumulative voting, rules for holding shareholder meetings, electing boards of directors, the procedure for calculating and paying dividends, challenging transactions, and so on.
The cancellation of the right to demand the company's repurchase of shares may leave small shareholders with illiquid securities. The cancellation of cumulative voting (in which the number of shareholder votes is multiplied by the number of seats in the board of directors, which increases the chances of minority shareholders to elect their candidates) will make it impossible to elect a representative of minority shareholders to the board of directors.
The company may also deprive shareholders of the pre-emptive right to purchase newly issued shares, allow delisting of the company's shares and becoming non-public by the decision of the CEO, etc. The company may prescribe in the articles of association that transactions with the controlling shareholder no longer fall under the rules on related-party transactions and further it is possible to withdraw assets non-transparently and without approval.
In conclusion, I would like to note that this decision is rather forced in the light of the requirements of the European Union. The pros and cons will become clear after the decision of the Ministry of Finance on tax benefits. In any case, this measure has always concerned large businesses, systemically significant. Small and medium-sized businesses simply do not have requests of this level, so this initiative passes by as information noise and nothing more.
The author's opinion may not coincide with the position of the editorial board of Realnoe Vremya.