On 15 February 2016, the Russian President signed Federal Law No. 25-FZ (the “Law”) introducing a series of amendments which substantially revise Russian thin capitalisation rules. The Law modifies the scope of controlled transactions, by notably extending it to those involving sister companies within a group, and exempting certain loans from the application of these rules.
These amendments are aimed at combating tax avoidance (resulting for instance, from back-to-back loan financing) and supporting the financing of Russian businesses. In light of these amendments, foreign lenders and Russian borrowers should carefully review their existing financing structures with a view to optimising tax efficiency.
New scope of application of thin capitalisation rules
The Law introduces a new definition of “controlled debt” which includes:
- any loan that is provided by a foreign entity or individual that has a direct or indirect shareholding of at least 25% (currently 20%) in the Russian borrower (a “Foreign Shareholder”);
- any loan that is provided by any party (Russian or foreign) that is related to a Foreign Shareholder (a “Related Party”). This criterion “formally” extends thin capitalisation limitations to loans granted by sister companies, in line with established court practice; or
- any loan that is guaranteed (or otherwise secured) by a Foreign Shareholder or a Related Party.
Exemptions from thin capitalisation rules
The Law introduces a number of important exemptions which have been widely debated in the past few years due to their conflicting interpretation by the Russian tax administration and competent courts. The exemptions introduced cover circumstances in which:
- a loan is provided by a Russian Related Party and the lender has no comparable debt (in terms of both the amount and the period) to a Foreign Shareholder (e.g. back-to-back loans);
- a loan is provided by an independent bank (Russian or foreign) and secured by a Foreign Shareholder (or its Related Party) but the outstanding loan is ultimately not discharged by the guarantor; and
- debt obligations arise in connection with placement of Eurobonds in a foreign SPV that is resident, for tax purposes, in a country that has a treaty with Russia on the avoidance of double taxation.
Interestingly, the Law leaves some room for manoeuvre by the Russian courts, allowing them to deem any loan as controlled if the ultimate purpose of payments under the corresponding debt obligation is to transfer funds to a Foreign Shareholder or a Related Party.
Impact on business
In light of the changes brought about by the Law, it is highly recommended that any international group with a Russian subsidiary:
- reviews from a tax optimisation perspective, the current equity and financing arrangements in their Russian companies, particularly with a view to determining any loans that may benefit from the new exemptions;
- assesses new risks in light of the fact that the thin capitalisation rules now apply to loans granted by foreign sister companies (if not previously done on the basis of court practice);
- checks the comparability of debt obligations from a transfer pricing perspective; and
- identifies the most tax efficient sources of financing for future business activities.
The Law will generally come into force on 1 January 2017. However, rules governing loans granted by independent banks will apply retroactively as from 1 January 2016.