To apply the new tax regime, an individual should file a special notification with the Russian tax authorities by December 31. The regime will be applicable as of January 1 of the year when the notification is filed. For 2020, the filing deadline for the notification has been set as February 1, 2021. Taxpayers may be interested in the new regime if their CFC profits consistently exceed the imputed fixed amount. But they should also be aware that this new regime could be only temporary, as it may contradict the current OECD initiatives on a “new global minimum tax regime” and top-up taxation in source countries (see details in this Baker McKenzie report). If the new tax regime results in low tax revenues, it may prove to be short-lived.
In more detail
- Upon switching to the new regime, individuals will not be required: (i) to file CFC financial statements, (ii) to determine the CFC's profits using adjustments set forth in the Russian Tax Code, and/or (iii) to pay individual income tax on the CFC's profits. The Russian tax authorities will not be able to request the CFC's financial statements for the period when the new regime is applied.
- The new regime will be beneficial if the total profits of all of the controlling individual’s CFCs are expected to consistently exceed the imputed fixed amount. The individual shall apply the new regime for at least 5 years (at least 3 years if the new regime is applied as of 2020 or 2021). Thus, the imputed tax costs will be RUB 25 million (or RUB 15 million for 3 years) even if a CFC suffers losses or its annual profits are under RUB 10 million.
- In contrast to the general CFC profits tax regime, which exempts from taxation the dividends subsequently distributed by the CFC, individuals will pay both the tax on the fixed amount and 13% individual income tax on the dividends received. Therefore, the new regime may be beneficial if no substantial distribution of CFC profits is planned.
- The bill does not guarantee the continuity of the new tax regime. A possible increase in the fixed amount is already factored in. In this case, individuals will have the right to switch back to the ordinary regime without penalties.
- The new regime does not eliminate the obligation to file notifications on the CFCs. Individuals will have to file such notifications by April 30 together with their 3-NDFL tax returns. The fine for failure to file a CFC notification has been increased to up to RUB 500,000; the fine for non-provision of the information required for calculation of tax on the CFC profits – up to RUB 1,000,000.
We recommend persons controlling CFCs to consider the following actions to assess whether the flat tax on the fixed CFC profits may be more efficient:
- Determine whether the new regime will be beneficial with respect to particular CFCs, taking into account the expected profits over a three-to-five-year period and the decrease in the costs associated with tax administration (preparation of the financial statements, income declaration, calculation of the tax amount and its payment, assessment of tax credits, etc.);
- Apply a comprehensive approach to determining the tax burden under the new regime, considering the subsequent taxation on CFC profits distribution, increases in withholding tax rates under double tax treaties with Russia, and taxes in foreign jurisdictions which may not be credited under the new regime, and factoring in substance requirements and related costs in other countries;
- Estimate the potential risks of top-up taxation of the CFC’s income in other source states, taking into account current trends in international taxation that may outweigh the benefits of the new regime.
We would be glad to assist you (i) with the overall assessment of all pros and cons of switching over to the new regime, taking into account Russian and foreign tax legislation, as well as (ii) with the preparation of a complete set of required documents and notifications.