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Ekaterina Smolovaya
Capital Legal Services, St Petersburg
esmolovaya@cls.ru

 

2020 was the year of many dramatic events; as usual, changes in tax laws were among them. This article reviews the most important changes that impact the taxation of individuals, and identifies the main points that should be considered when planning your future activities. These include:

1. Individual approach: on 1 February, the Russian Federal Tax Service established a new inspectorate to administer taxpayers with an annual income of over RUB 500m.

2. Higher rates: on 1 January, a higher personal income tax rate was introduced with respect to annual personal income exceeding RUB 5m (from 13 per cent to 15 per cent).

3. Personal income tax on deposit interest: on 1 January, income from deposits exceeding the non-taxable interest amount became subject to personal income tax. The non-taxable amount is calculated as RUB 1m multiplied by the key rate of the Bank of Russia as of 1 January (in 2021, the amount of non-taxable interest will be RUB 42,500). For the first time, depositors will have to pay this tax for 2021 only in 2022.

4. Fixed rate for controlled foreign companies: there is a new option to apply a fixed personal income tax rate to profit from a controlled foreign company (CFC). We will review the main provisions and assess the prospects of applying this regime.

5. Cancellation of tax incentives for accrued interest: beginning in 2021, accrued interest on all bonds is subject to personal income tax at the 13 per cent rate for tax residents of the Russian Federation. All previous incentives for bondholders are cancelled, but there are alternative options.

6. New opportunities for selling shares in foreign companies: an incentive allowing tax exemptions on share sale gains can be applied to shares in foreign companies.

The individual approach

The Russian Federal Tax Service announced that, starting 1 February 2021, it is establishing a new specialised tax inspectorate for major individual taxpayers in the structure of tax authorities (Interregional Inspectorate No10 of the Russian Federal Tax Service for major taxpayers).

The inspectorate is designed to administer individual taxpayers with major income (over RUB 500m), taking into account such additional criteria as CFCs, foreign transactions, accounts abroad and taxable investment transactions.

The need for the new inspectorate in the Federal Tax Service is justified by the fact that administrating individuals with a large income requires special competence due to the complexity of financial transactions and application of international tax treaties.

At the same time, the specialised inspectorate is expected to provide a better analysis of the tax obligations of such individuals, as well as ensuring better compliance with the requirements of tax laws.

It remains unclear which criteria are to be used for assigning particular individuals to this inspectorate and whether such assignment somehow depends on the taxpayers’ will or requires them to take additional actions. Hopefully, this initiative will allow taxpayers to expect that tax authorities will have a more competent understanding of the specifics of transactions and will help simplify the process of interaction with tax authorities, rather than the opposite.

Higher rates

The conventional wisdom says that ‘lowering’ is bad for health. Lawmakers proceeded from the same postulate when introducing a higher personal income tax rate, starting from 1 January 2021, in relation to annual income of individuals of over RUB 5m (going from 13 per cent to 15 per cent).

This procedure is to be applied to the so-called ‘main tax base’, which includes a wide range of income (eg, individual wages, dividends, accrued interest on bonds, foreign income, income from securities – including from their sale – income from business operations, etc), except for income attributed to a separate tax base.

The tax rate remains the same for income of individuals (tax residents of the Russian Federation) from the sale of their property or shares in it, for income received as a gift, for taxable income received by individuals as insurance or pension payments, and for income for which a different rate is provided (eg, 35 per cent or 9 per cent).

In order to apply the 15 per cent rate to the relevant income, an ‘aggregate tax base’ must be calculated for determining whether the threshold of RUB 5m has been exceeded. If, for example, annual income is RUB 6m, then the personal income tax will be charged at the 13 per cent rate on RUB 5m (RUB 650,000), and at the 15 per cent rate on the remaining million (RUB 150,000).

Payment procedure

If separate amounts of income paid by (one or more) tax agents do not exceed RUB 5m, at the end of the year the tax authority will calculate the aggregate amount subject to personal income tax exceeding RUB 5m and will send a notice to the taxpayer.

If an individual declares income on their own, they shall determine the amount of tax payable without taking into account income received from tax agents, but taking into account the amount exceeding the threshold of RUB 5m. The tax authority will summarise the information received from the taxpayer and tax agents, and will send the relevant notice to the taxpayer.

The introduction of the progressive personal income tax rate is expected to add RUB 60bn to the state budget annually. The authorities have promised to take advantage of such additional amounts for medical treatment of children with ‘rare, so-called orphan diseases’.

Personal income tax on deposit interest

From 1 January, income from deposits held in banks on the territory of the Russian Federation became subject to personal income tax at a 13 per cent rate, regardless of residency (instead of 35 per cent for residents and 30 per cent for non-residents). However, the tax base is to be calculated differently.

The taxable income will be determined as the difference between the amount of income in the form of interest received by the taxpayer during the tax period on all Russian deposits (account balances) and the threshold calculated as RUB 1m, multiplied by the key interest rate of the Central Bank of Russia in effect on the first day of the tax period.

Therefore, it will be calculated as follows:

• calculating and summarising all interest on deposits (aggregate interest income);

• (aggregate interest income) minus (RUB 1m × Central Bank key interest rate); and

• multiplying the result by 0.13.

Theoretically, taking into account the effective key rate of 4.25 per cent (as of December 2020), any interest income (including in different banks) exceeding RUB 42,500 will be taxed at a 13 per cent rate.

However, such changes do not apply to ruble deposits with an annual interest rate of 1 per cent or less or to escrow accounts.

Prior to the changes, there was a general rule that only interest exceeding the amount of interest at the key rate of the Central Bank of Russia by 5 per cent was subject to taxation.

Despite such changes taking effect from 2021, taxation under the new rules will take place only in 2022.

Under the new rules, banks are obliged to notify the tax authority at the place of their registration about the interest paid to individuals during the reporting period no later than 1 February of the year following the reporting period – ie, starting in 2022.

All information received by the tax authority will be summarised for calculating tax and sending the relevant notice to the taxpayer. The specified tax must be paid by the individual by 1 December of the year following the year when they received income in the form of interest.

Fixed rate for controlled foreign companies – is it worth the trouble?

The new regime provides that the aggregate amount of CFC profit is fixed at RUB 38.4m for 2020, and at RUB 34m for subsequent tax periods. Therefore, this allows the controlling person to pay about RUB 5m annually (ie, personal imputed income tax) for all CFCs in aggregate, with no obligation to calculate the amount of the imputed income and tax for each of the companies. This procedure can be applied from 2020.

The procedure is voluntary and serves as an alternative to the current procedure. However, in the event of switching to it, the taxpayer will be obliged to apply this regime for a particular period: for at least three years if switching in 2020 or 2021; and for at least five years if switching in 2022 or later.

Advantages

• It fixes the amount of personal income tax in respect of all CFCs, and there is no obligation to pay personal income tax from the CFCs’ actual profit;

• There is no obligation to submit financial statements and an auditor's report, and no risk of liability for failure to provide these documents;

• There is a significant reduction in the administrative burden and costs on preparing CFC reports; and

• There is the possibility to account for CFCs’ losses before switching to this regime and after its termination.

Disadvantages

• Distributed dividends do not allow the reduction of a CFC’s profit, upon which personal income tax would be calculated;

• The CFC’s fixed profit does not reduce the amount of the distributed dividends subject to personal income tax for the relevant periods when this regime is applied;

• Personal income tax on the CFC’s fixed profit cannot be reduced by the amount of other CFC taxes, including withholding taxes;

• In the event one CFC is controlled by several individuals, each of them will be obliged to pay tax on the fixed profit.

Cancellation of tax incentives for accrued interest

From 1 January 2021 incentives are cancelled with respect to accrued interest taxation of several types of bonds. Previously, the following categories of income were exempt from taxation:

• Income from state treasury obligations, bonds and other securities of the former USSR, member states of the Union State, constituent entities of the Russian Federation, as well as bonds and securities issued by decision of representative bodies of local governments;

• income from circulating bonds of Russian companies that have been issued since 1 January 2017 and denominated in rubles, if the accrued interest does not exceed the refinancing rate increased by five percentage points (and only the amount exceeding the threshold was subject to personal income tax at the 35 per cent rate); and

• income in the form of a discount received upon redemption of circulating bonds of Russian companies, denominated in rubles and issued after 1 January 2017.

Starting this year, these incentives are no longer in effect. The rate is now 13 per cent for tax residents of the Russian Federation and 30 per cent for non-residents. However, it does not matter when the shares were purchased (ie, before or after 2021). What matters is the income being paid after 1 January 2021.

Even though these changes have an adverse effect, one should keep in mind the tax incentives for investors that remain in effect and can be used as an alternative.

• Incentives for individual investment account (IIA) holders:

– Type B deductions (for income) allow the exemption of income from tax as to transactions with securities and derivatives (including accrued interest and discount);

– Type A deductions (for contributions) allows the deduction of personal income tax of up to RUB 52,000 annually; together with the purchase on an IIA of such conservative instruments as federal loan bonds (OFZ), it also allows aggregate income exceeding the bank deposit yield; and

– Deductions for long-term holding of certain types of securities (over three years), which allows the exemption of the received profit from tax.

• Loss carry forward, allowing the deduction of losses incurred with respect to securities and derivatives from future profits.

• Exemption from tax on income from the sale of shares in Russian companies owned for over five years (from 2021, this exemption also applies to shares in foreign companies).

Finally, good news for holders of foreign shares

Income from the sale of shares in Russian companies after five years of continuous ownership is exempt from tax. Thanks to the new rules, this exemption now applies to foreign shares.

To use this option, the following conditions must be met:

• a person must own shares for at least five years;

• real estate located on the territory of the Russian Federation can comprise no more than 50 per cent of the assets of the relevant foreign company; and

• the permanent registered address of such a company must not be on the territory of a state included in the 'List of Offshore Zones' of the Russian Ministry of Finance.

It seems that these new rules are among the few innovations that can be assessed as positive and providing additional options for taxpayers. Thus, this option might be useful for owners of CFCs, individuals who received the relevant shares free of charge (for example, from an employer) more than five years ago, and others.

 

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