Since 2022, various restrictions imposed by the US, EU, UK, Japan and several other jurisdictions on a wide range of investment activities in Russia have led many Western manufacturers to withdraw from the Russian market, either by selling their businesses to local entities or by placing them in “dormant” mode. This has impacted most sectors of the Russian economy, including automotive, where foreign producers have historically played a key role.

In response, some Chinese carmakers have seized the opportunity by both significantly increasing their exports to Russia and establishing partnerships with Russian companies (thus gradually filling the gap in vacated production sites). However, only a few seem prepared to invest in local production, particularly in R&D. At best, this localisation effort is limited to SKD (semi-knocked down) assembly.

Naturally, this situation has raised concerns for the Russian government, which is actively seeking to boost domestic manufacturing. One recent measure has been a significant increase in the so-called “utilisation fee”, payable by all vehicle manufacturers and importers. This fee, however, is fully compensated by the government to local producers, giving them an advantage over importers.

Under these circumstances, Asian car manufacturers may find new potential for localisation, possibly even unlocking new market opportunities for themselves in the Russian automotive sector.

Localisation

One of the most successful examples of Russia’s localisation policy is its promotion of domestic production in the automotive industry. Since the early 2000s, Russia has offered reduced customs tariffs for automotive products imported into the country, provided the importer transfers some of its production to Russia.

However, following Russia’s accession to the WTO in 2012, this incentive system lost its initial impact, as customs barriers for all importers were expected to be gradually eliminated.

The current approach to import substitution is based on the Industrial Policy Law, which came into effect in 2015. This law replaced previous principles of public procurement (i.e. procurement by the state or state-owned companies). Whereas foreign and domestic goods once competed on equal terms, the advantage now goes to domestic goods.

For instance, state and municipal authorities are now prohibited from purchasing foreign automotive products and vehicles such as cars, buses and trucks. Additionally, state-owned companies must meet minimum mandatory quotas for goods of Russian or Eurasian Economic Union (EEU) origin in their procurement. For vehicles, the quota currently ranges from 60% to 90%, depending on the vehicle type.

Given the public sector’s significant share in the Russian economy, these changes present a substantial challenge for companies focusing on the Russian market. To freely participate in public procurement tenders and avoid discrimination in general tenders, companies must classify their products as “domestic”.

Whether a product qualifies as Russian is generally determined by the customs laws and regulations of the EEU. A product receives a certificate of Russian origin if it is fully manufactured or sufficiently processed in Russia, such sufficiency being determined on a case-by-case basis depending on a particular product.

In automotive manufacturing, one way to “bypass” these general requirements to confirm the origin of goods is through the signing of a special investment contract (SPIC).

The SPIC

The concept of the SPIC was introduced by the Industrial Policy Law in 2015. Under these contracts, the Russian government guarantees long-term benefits and incentives to investors who commit to implementing industrial investment projects.

What primarily distinguishes the SPIC from other contractual arrangements formalising public-private partnerships is that the state does not contribute budgetary funds or state-owned property to the project. Instead, the cost of these incentives is anticipated to be offset by the projected positive economic effects for the state, including new infrastructure, technologies, innovation, jobs and tax revenues generated by new businesses.

The main tax benefits for investors under a SPIC include:

1. A corporate profit tax rate of 0% on the portion payable to the federal budget, with a possible reduction of the regional component to as low as 0% (allowing the overall tax rate to be reduced from 20% to 0%;
2. Exemptions from property, land and transport taxes; and
3. Accelerated depreciation.

SPIC investors may also qualify for state subsidies (e.g. for R&D expenditure, industrial infrastructure development, or reimbursement of the utilisation fee) and long-term financing from designated state funds. However, the total amount of financial support from the state under a SPIC cannot exceed 50% of the total investment amount.

At the regional or local levels, investors may benefit from additional incentives such as reduced land lease rates and preferential access to public utilities.

Another significant incentive under a SPIC is the investor’s right to a simplified procedure for confirming localisation levels, allowing them to obtain “Made in Russia” status for their products. As noted earlier, this status facilitates access to public tenders. The specific SPIC can stipulate the level of localisation required for the investor to qualify for “Made in Russia” status.

Additionally, the SPIC may allow for a “transitional period” (e.g. three years from the start of production), during which the investor’s products are still considered “Made in Russia”, regardless of whether the required localisation level has been achieved.

Russian law also allows for a stability clause (the so-called “grandfather clause”) to be included in the SPIC. This clause generally prohibits the increase of certain federal tax rates (except for VAT, excise tax and social security contributions) or the application of new prohibitions or restrictions until the investor has recouped its initial investment.

Thus, the main advantage of a SPIC is its ability to provide a comprehensive package of necessary incentives to the investor. However, it should be noted that customs incentives cannot be granted under a SPIC.

Construction and infrastructure

Beyond localisation requirements, it is crucial for an investor to consider the construction and infrastructure specifics related to implementing an investment project, as these factors may significantly impact costs or timelines.

In the automotive sector, common options such as greenfield, brownfield, leasing and the so-called “contractual scheme” ‒ where the investor partners with a Russian company that organises local manufacturing using the investor’s imported components, and under the investor’s control according to the manufacturing contract ‒ are generally available.

However, given the current circumstances with some production sites underutilised, brownfield, leasing or contractual schemes may prove more efficient than developing a greenfield project.

The investor’s first task is to determine the region where they will implement the project. Several regions in Russia including Kaliningrad, Kaluga, Saint Petersburg, Samara, Republic of Tatarstan and the Far East have established automotive industries. Each of these regions offers dedicated industrial sites (parks or clusters) with sufficient infrastructure and access to qualified manpower.

Once a region has been preliminarily selected, it is recommended to engage with the relevant regional or, if necessary, federal authorities to gain insights into existing capacities, available state support measures, and broader investment opportunities.

As a subsequent step, the investor may enter into an investment agreement (such as a SPIC) to clearly outline the mutual obligations of both the investor and public authorities before, during and after the project’s implementation.

Conclusion

For a business, the decision to localise production in Russia entails a readiness to manage production risks in the country. This includes establishing and operating a local production unit within a market environment that may be unfamiliar and subject to frequent change. In return, localisation in Russia offers direct access to the local market. By transferring production closer to the sales market, a business will achieve both lower logistics costs and a stronger local presence.

Localisation is undoubtedly key to gaining a competitive edge over other foreign competitors lacking a local presence in Russia. By localising production, a business secures long-term access to the market. Over time, it may even consider expanding into neighbouring sales markets within the EEU (Armenia, Belarus, Kazakhstan and Kyrgyzstan).

The publication is also available in Japanese, Korean and Chinese languages.

Initially published in Asia Business Law Journal.