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Rebooting regulation CFC – what to prepare regulatory entities?

On 9 November 2020, the Russian President signed Federal act No. 368-FZ «On amendments to parts one and two of the Tax Code of the Russian Federation» («368-FZ»), which makes significant changes to the regulation of controlled foreign companies («CFC») in Russia.

1. Payment of fixed personal income tax CFC profits

In his video message dated June 23, 2020, the President of the Russian Federation proposed «to grant the right to pay a fixed tax amount – 5 million rubles a year-without additional reporting».

Pursuant to this proposal, 368-FZ establishes an alternative regime for paying personal income tax with a fixed, rather than actual, profit of the CFC. Russian tax residents will be able to switch to the alternative regime voluntarily by submitting a corresponding notification to the tax authorities.

1.1. The order and application of alternative mode

The transition to an alternative mode of payment of fixed income tax CFC is possible only for individuals.

A taxpayer who has switched to an alternative regime will not be required to confirm the amount of the CFC's actual profit for the tax periods during which such an alternative regime is applied. Instead, a fixed amount of CFC profit is set in the amount of:

  • 38.46 million rubles – for the tax period of 2020;
  • 34 million rubles – for subsequent tax periods starting from 2021.

Thus, the amount of annual tax, which will be calculated at the personal income tax rate applicable to the above-mentioned fixed amount of CFC profit, will be about 5 million rubles. This tax must be paid by the controlling person to the budget regardless of the amount of actual profit (loss) CFC in the reporting period and regardless of whether there are conditions for exemption of CFC profits from taxation.

The fixed amount of profit established by the act does not depend on the number of CFC's in respect of which the taxpayer is the controlling person. For example, one taxpayer may be the controlling person of just one CFC, and another may be the controlling person of several dozen CFC, but for both taxpayers, the amount of fixed profit and, consequently, the amount of tax payable will be the same.

1.2. Deadlines for notifying tax authorities of the transition to an alternative regime

The controlling person has the right to notify the tax authorities of the transition to the payment of personal income tax from the fixed profit of the CFC by December 31 of the year that is the tax period from which the taxpayer plans to apply the alternative regime. For example, if a taxpayer plans to apply the personal income tax regime with a fixed CFC profit starting from the tax period of 2021, they must notify the tax authority of their decision by December 31, 2021.

For controlling persons who plan to apply the alternative regime starting from the tax period of 2020, a different notification period is set for tax authorities – February 1, 2021.

1.3. Minimum terms for applying the alternative regime

After switching to the personal income tax regime with a fixed profit CFC, the taxpayer will be required to apply the alternative regime within the time limits established by the act:

  • at least 3 tax periods, starting from the tax period in which the taxpayer notified the tax authorities of its transition to the alternative regime, if the transition took place in 2020 or 2021;
  • at least 5 tax periods starting from the tax period in which the taxpayer notified the tax authorities of its transition to an alternative regime, in all other cases.

If the taxpayer has ceased to be a controlling person in respect of all CFC's within the specified time frame (for example, all its CFC's were liquidated or sold to a third party), then the obligation to pay personal income tax on fixed profits does not arise in respect of those tax periods in which the taxpayer was no longer a controlling person of all CFC's.

1.4. Restrictions when applying the alternative mode

The use of an alternative regime for paying personal income tax with a fixed CFC profit for taxpayers will be associated with a number of restrictions on the elimination of double taxation.

First, under the General regime for paying personal income tax from the actual profit of a CFC, there is a provision that provides for the exemption of dividends received by the taxpayer as a result of the distribution of CFC profits from taxation if personal income tax has already been paid from the income in the form of CFC profits for the corresponding period.

This exemption will not be applied to the alternative mode of payment of fixed personal income tax on the CFC's profits. Thus, a situation may arise when the taxpayer first pay the income tax with a fixed amount of CFC's profit, and subsequently, upon distribution of dividends from the amount of actual CFC profits for the relevant period, will also have to pay personal income tax. In this sense, the application of the personal income tax regime with a fixed profit of a CFC is appropriate if the taxpayer does not plan to receive dividends from the CFC during the periods of application of such an alternative regime.

Second, under the General regime for paying personal income tax on the actual profit of a CFC, there is a rule that the amount of personal income tax calculated in relation to the CFC's profit is reduced by the amount of tax calculated in relation to this profit in another state (for example, by the amount of foreign tax at the source of income payment).

Under the alternative regime for paying personal income tax from a fixed profit, the CFC will not reduce the amount of personal income tax calculated from a fixed profit by the amount of tax paid by a controlling person in a foreign country from the income received by them.

1.5. The subsequent abandonment of the use of alternative modes

The controlling person has the right to refuse to apply the personal income tax regime with a fixed profit CFC by notifying the tax authorities if one of the following conditions is met:

  • Option 1

The notification of refusal is submitted no earlier than the expiration of the minimum time limit for applying the alternative CFC regime established by the act (see paragraph 1.3 of the information letter).

In this case, the notification must be submitted by December 31 of the year that is the tax period starting from which the taxpayer plans to refuse to apply the alternative regime; or

  • Option 2

The notification of refusal was submitted before the expiration of the minimum period for applying the alternative CFC regime established by the act (see paragraph 1.3 of the information letter), but changes were made to the legislation that lead to an increase in the amount of fixed income tax.

In this case, the notification must be submitted by 31 December of the year preceding the year from which the relevant changes are applied, resulting in an increase in the amount of fixed income tax.

However, if the taxpayer subsequently decides to switch to the fixed income tax regime again (including during 2020 or 2021), the period for applying the alternative regime will be at least 5 tax periods starting from the tax period in which the taxpayer notified the tax authorities of its re-transition.

2. Terms and procedure for submitting CFC notifications and supporting documents to the tax authorities

2.1. Individuals

Starting from 2021, notifications about CFC are submitted by individual taxpayers no later than April 30 of the year following the tax period in which the controlling person recognizes income in the form of CFC profit or based on the results of which the CFC loss is determined.

For example, a CFC notification for the 2020 tax period will need to be submitted to the tax authorities no later than April 30, 2021.

The obligation to submit CFC notifications remains for all taxpayers, regardless of whether they apply the General regime for paying tax on the CFC's actual profits or the new alternative regime for paying tax on the CFC's fixed profits.

It is now mandatory to submit documents confirming the amount of profit (loss) together with the CFC notification) CFC (financial statements, auditor's report). The occurrence of the obligation to submit these documents does not depend on the existence of the obligation to account for income in the form of CFC profit in the personal income tax base. Supporting documents are provided to the tax authorities even in cases where the CFC's loss was determined at the end of the financial year or the CFC's profit did not exceed the threshold value (10 million rubles currently).

At the same time, the requirement to submit supporting documents does not apply to those tax periods during which the taxpayer applied an alternative regime for paying tax on fixed profits of the CFC. However, if a loss was actually incurred during the periods when the alternative CFC regime was applied, the taxpayer will be able to take this loss into account when determining the CFC's profit starting from the tax period in which it refuses to apply the alternative regime, but such loss must be documented in accordance with the requirements of the CFC legislation.

2.2. Organizations

The deadline for submitting CFC notifications for taxpayers-organizations remained the same – no later than March 20 of the year following the tax period in which the controlling person recognizes income in the form of CFC profit or based on the results of which the CFC loss is determined.

Documents confirming the amount of profit (loss) CFC (financial statements, auditor's report) are submitted to the tax authorities together with the income tax Declaration. The occurrence of the obligation to submit these documents does not depend on the existence of the obligation to account for income in the form of CFC profit in the personal income tax base. Supporting documents are provided to the tax authorities even in cases where the CFC's loss was determined at the end of the financial year or the CFC's profit did not exceed the threshold value (10 million rubles currently).

2.3. Fines

Increased the amount of liability for failure to submit a CFC notification within the established period and for submitting a CFC notification containing false information. Now the Commission of such an offense entails a fine from the controlling person in the amount of 500 thousand rubles for each CFC (100 thousand rubles for each CFC previously).

In turn, failure to submit documents confirming the amount of profit (loss) The CFC (financial statements, audit report) within the time limits established by the act or the submission of such documents with deliberately false information entails the collection of a fine from the controlling person in the amount of 500 thousand rubles.

3. Requesting documents in respect of CFC from taxpayers-controlling persons

368-FZ establishes a special procedure for requesting documents from taxpayers – controlling persons in respect of CFC controlled by them.

If the taxpayer has not submitted documents confirming the amount of the CFC's profit (loss) or documents confirming compliance with the conditions for exemption of the CFC's profit from taxation, the tax authority has the right to request the relevant documents related to the tax periods preceding the year of filing the claim, but not more than three calendar years in advance.

For example, in 2021, the tax authority will have the right to request supporting documents for the tax periods of 2018, 2019 and 2020 (usually, in such cases, we are talking about the financial statements of the CFC for the reporting periods 2017, 2018 and 2019).

The documents must be submitted by the taxpayer to the tax authority within 1 month from the date of receipt of the claim, with a translation into Russian in the part necessary to confirm the amount of profit (loss) CFC or compliance with the conditions for exemption of CFC profits from taxation.

At the same time, supporting documents cannot be requested from an individual taxpayer if they relate to tax periods during which such taxpayer applied an alternative regime for paying tax on fixed profits of a CFC.

Failure to submit the requested documents within the prescribed period or submission of such documents with deliberately false information entails a fine from the controlling person in the amount of 1 million rubles.

4. Changing the conditions for tax exemption of active CFC profits

The current regulation exempts CFC profits from taxation if a number of conditions are met, including if, for example, the CFC is an active foreign company, an active foreign holding company, or an active foreign sub-holding company.

368-FZ changed the criteria for classifying CFC as active foreign holding and sub-holding companies. Upon request, we will be ready to provide you with detailed information.

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If you have any questions or need additional information or comments on the new CFC regulation in the Russian Federation, please contact us:

  • Konstantin Ziyatdinov, head of the international projects Department
    kz@hlbprime.com
  • Ksenia Komkova, senior associate
    k.komkova@hlbprime.com
  • Olga Nosova, senior associate
    o.nosova@hlbprime.com