On 9 November 2020, Federal Law No. 368-FZ was adopted. The Law introduces amendments to the Controlled Foreign Company (CFC) legislation, in particular allowing individuals to pay RUB 5 000 000 per year for all their CFCs, while not calculating profits and taxes for each of them (hereinafter – “the Special Regime”), as well as introducing new requirements and tightened sanctions.
The CFC Special Regime
This regime allows the owners of CFCs (individuals) to pay personal income tax from the fixed profit of the CFC. This means that the base for calculating and paying tax is already predetermined for a taxpayer. The fixed profit for the tax period of 2020 is set at RUB 38 460 000, meanwhile the fixed profit for the tax period of 2021 and subsequent years is RUB 34 000 000.
Thus, regardless of the number of CFCs owned by a taxpayer, the country of their registration, the level of profit received and the type of activity, the total amount of personal income tax in relation to CFCs for those who will switch to the Special Regime will amount to RUB 5 000 000 a year.
How to switch to the Special Regime?
The right to implement the Special Regime is assigned exclusively to the controlling persons of a CFC, therefore legal entities are not entitled to the Regime.
In order to apply the Special Regime, individuals must submit a transition notification to the tax authorities. For those, who decide to switch to the Regime in 2020 (which recognizes the CFC's profit earned in the 2019 financial year), the deadline for filing the notification of transition is February 1st, 2021. When switching to the Special Regime for 2021 and subsequent periods, the notification must be submitted by 31 December of the reporting year.
The Law established minimum terms for applying the Regime - 3 years for those who star to apply it in 2020 or 2021 and 5 years for those who make the transition in 2022 and later.
Importantly, the fixed profit of CFC is applied to the individual who switched to the Special Regime, and not the CFC. Thus, if the CFC has several controlling persons, the transition to the Special Regime will allow paying tax in the amount of RUB 5 000,000 per year to the shareholder who has switched to this regime. The second shareholder, if he/she decides not to use the Regime (or if represented by a legal entity), will pay tax calculated according to the general rule in proportion to the share of the CFC's profit.
Under the Special Regime, controlling persons are released from the obligation to provide financial statements of the CFC (even in the case of the tax authority’s request). The exemption is especially relevant, given that from 2021 and onwards, it will be obligatory to submit documents confirming the amount of profit / loss of a CFC, regardless of whether the income in the form of the CFC's profit is recorded in the tax base of the controlling entity or not (i.e. even though the CFC is unprofitable, its year profit is less than RUB 10 000 000 or if it applies the exemptions established by Article 25.13-1 of the Tax Code of the Russian Federation).
However, notification of participation in foreign companies / establishment of foreign structures, as well as notifications for all CFCs, will still be required. Nevertheless, the administrative burden in relation to CFCs will decrease and controlling persons will be able to decrease costs of preparing reports and conducting audits, especially if the country of CFC registration does not impose such obligations on them. Meanwhile, if the CFC incurs losses during the period of application of the Regime, it will need documents to offset them, therefore, one should assess the necessity of keeping record for each specific case.
Please note that from 2021 on, the deadline for submitting notifications on CFCs by individuals will change and will match the one for personal income tax declaration, therefore, a notification on CFC must be submitted by April 30 of the year following the reporting year.
Unlike the standard regime, the new one does not allow to implement mechanisms of avoiding double taxation: (1) there is no possibility of offsetting taxes on CFC profits paid in the Russian Federation or abroad against a flat personal income tax of RUB 5 000 000; (2) it will not be possible to reduce the amount of dividends for the attributed profit under the Special Regime, on which the tax was previously paid. Since the income limit of RUB 5 000 000 rubles, which is taxed at the rate of 13%, will be exceeded for an individual, with a progressive scale of taxation, tax on dividends received in 2021 and later will have to be paid at 15% rate.
During application of the Special Regime, it is impossible to account the losses of the CFC. However, the losses can be used after exiting the Regime.
As mentioned above, starting from 2021, individuals who have not switched to the Special Regime will have to submit the documents confirming the company's profit / loss for all CFCs, regardless of the amount of profit (including unprofitable ones), to the tax authorities. The documents must be translated into Russian and submitted together with the CFC notification.
Legal entities recognized as controlling persons of a CFC must submit such documents together with a profit tax return (if the CFC applies the exemptions established by Article 25.13-1 of the Tax Code of the Russian Federation, these documents are required for the exemptions to be confirmed and must be submitted together with the CFC notification).
Failure to provide documents results in a significant increase in fines:
- Failure to submit documents confirming the financial results of the CFC will result in a fine increased from RUB 100 000 to RUB 500 000;
- Late submission of a CFC notification will also lead to a fine increased from RUB 100 000 to RUB 500 000.
In addition, the Law introduces Article 24.14-1 to the Tax Code. It provides the tax authorities with the right to request a number of documents related to the activities of the company; however, those who apply the Special Regime may be asked to provide the documents only for the periods, when it was not used (three previous years are reviewed). Failure to provide the documents on time (within 30 days from the issue date of receipt for the request from the tax authorities) will lead to a fine of RUB 1 000 000 rubles.
How can we help?
Despite the number of hidden hazards, application of the Special Regime may be beneficial in a number of cases (for example, in case a CFC makes substantial profits, does not plan to pay dividends for several years; when an individual has several CFCs generating profits, or does not intend to disclose data on the financial statements of their foreign companies). To make a decision in favor of the Special Regime, we recommend, among other things, determining the amount of the tax burden for the controlling person when receiving dividends from the CFC and the amount of the CFC's tax in the country of its location.
We will help to:
- Analyse the consequences of transitioning to the Special CFC Tax Regime, predict the tax burden, and prepare relevant documents;
- Analyse the consequences arising from the application of the standard CFC regime, select possible options for exemptions from the payment of CFC profits tax and help prepare documents confirming the exemption;
- Suggest options for restructuring ownership using foreign companies;
- Prepare all reporting documents in accordance with the CFC legislation.
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