9if by a local normative act and (or) by a collective agreement it is envisaged that per diem should be paid during such business trip, these sums, nevertheless, cannot be charged to costs for the purpose of taxation of profit.
On the contrary, if an employee is sent to a one-day business trip abroad, then in accordance with Item 20 of the Statute per diem will be paid, but in the amount of 50% of the norm established for this type of expenses as determined by a collective agreement or by a local normative act.
In accordance with Item 5 of the new Statute, if an employee sent on a business has to work on days off or non-working days (public holidays), he or she is reimbursed in accordance with RF labor legislation, and in particular the rules stipulated in Article 153 of the RF Labor Code, whereby an employer is obliged to pay remuneration for the work on such days in the amount of no less than a double rate of tariff (or salary), or (if so desired by the employee) at a single rate but with granting an extra day off at another time.
In accordance with Item 26 of the new Statute, an employee, on returning from a business trip, must submit within 3 workdays the following documents:
- the advance accounting report on the expenses incurred in connection with the business trip and to settle them against the advance money paid to him or her before the departure on the business trip. The following documents are attached to the advance accounting report: the properly formalized business trip certificate; the document confirming lodging expenses and travel costs (including the insurance contribution to cover mandatory passenger insurance, the cost of issuing travel documents and of the bed-sheet package on the train); and other expenses associated with the business trip;
- a written report on the work performed during the business trip, in coordination with the hear of the employer's structural subdivision.
Annex 2. Legal backing behind the attractiveness of the tax system of Cyprus for Russian taxpayers
An important method of planning and minimizing taxation consists in organizing foreign economic activity is such a way so as to make use of subjects residing in countries with beneficial taxation. This section presents an overview of the principal methods of minimizing taxation applied by Russian entrepreneurs when operating in Cyprus. In this connection, the majority of tax planning methods are based not so much on the norms stipulated in the 1998 agreement between the Russian Federation and Cyprus to avoid double taxation (which in its content does not differ from similar agreements concluded by the Russian Federation with other countries) than on the beneficial provisions of Cyprus domestic legislation. At the same time, in this section it is pointed out that the inclusion of certain additional norms into Russian tax legislation could make it possible to reduce the size of tax losses and capital outflow from Russia to Cyprus without infringing on the rights of taxpayers.
1. Privilege-granting provisions of the domestic legislation of the Republic of Cyprus
An agreement for the avoidance of double taxation between the Russian Federation and
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Cyprus was signed in December 1998 (and has been applied since 1 January 2001). This Agreement replaced the previously concluded 1982 Agreement between the USSR and Cyprus.
It should be noted that the Russian Federation - just as almost every other country -bases its international agreements for the avoidance of double taxation on the 1963 Model Convention With Respect to Taxes On Income and On Capital of the Organization for Economic Co-operation and Development (OECD) 19
The agreement signed by Russia and Cyprus in 1998 contains norms which are compatible with the requirements and recommendations of the OECD, as well as with domestic legislations of the two countries. This Agreement has been subject to much criticism. Moreover, it was proposed that it should be denounced. Such proposals were put forth in connection with the "beneficial investment climate" created in Cyprus for Russian entrepreneurs. The majority of those who have criticized the agreement share the opinion that the provisions stipulated in its norms offer to Russian companies numerous ways to minimize their taxation - or provide them with opportunities for applying various schemes for tax avoidance. However, from early 2002 onwards this Agreement between Russia and Cyprus began to be viewed differently. This happened because in 2001 Cyprus had come to occupy the topmost
position among the countries providing the national economy of the Russian Federation with
20
foreign investments . Besides, in 2004 Cyprus joined the European Union, and so its tax legislation was brought in conformity with the EC and OECD requirements, and it was officially deprived of the status of an offshore zone (the main alteration was that the rate of profit tax in Cyprus was increased from 4.25 to 10% both for resident and non-resident companies).
However, it is necessary to distinguish between the beneficial investment climate existing in Cyprus due to its domestic legislation and the beneficial investment climate created by the provision of the 1998 Agreement concluded between Russia and Cyprus with respect to the avoidance of double taxation of taxes on income and on capital. Besides, in Russia's domestic legislation there also exist certain gaps - and in particular, in tax legislation - which are also conducive to tax evasion in Russia by means of capital transfers abroad on perfectly legal grounds.
The domestic legislation provisions of Cyprus on the basis of which Russian companies enjoy the opportunities for minimizing taxation in order to increase their own profit, to keep their savings and to export their capital are as follows:
18 "The Agreement for the avoidance of double taxation with respect to taxes on income and on capital", concluded between the RF Government and the Government of the Republic of Cyprus of 5 December 1998. Published source: Legislative Assembly of the RF. 13 September 1999 No 37, Article 4447; Bulletin of International Agreements. 1999. No 12. The Agreement was ratified by Federal Law of 17 July 1999, No 167 - FZ.
19 http://www.oecd.org/dataoecd/50/49/35363840.pdf (1963 Model Convention With Respect to Taxes On Income and On Capital of the Organization for Economic Co-operation and Development (OECD), as of July 2005); http://www.oecd.org/dataoecd/48/60/40489100.pdf (the 2008 Update to the 1963 Model Tax Convention of the OECD).
20 Nikolaev D. V. O pol 'ze i vrede nalogovogo soglasheniia Rossii s Kiprom [ On the benefit and harm of the tax agreement between Russia and Cyprus] //Vash nalogovyi advokat [Your tax lawyer]. No 1.Q I 2003.
1) the beneficial taxation regime for companies - residents of Cyprus: the rate of tax on corporate profit is only 10% (in Russia - 20%);
2) tax-free transfer of the profit received by a company (a resident of Cyprus) to its shareholders abroad who are not residents of Cyprus. This is due to the fact that the affiliated companies - residents of Cyprus, when they are created by a Russian parent company and pay their received profit ion the form of dividends to the shareholders of that Russian parent company - resident of the Russian Federation - do not pay tax on dividends in Cyprus at the rate of 10% (withholding tax - 0%);
3) the profit received from the sale by a company - resident of Cyprus of its shares in Cyprus is exempt from the payment of tax. Similarly, the profit received from the sale of other securities is not levied by taxes - both in respect of juridical and physical persons;
4) the profit received by a parent Cyprus company from its permanent affiliated company situated outside of the territory of Cyprus is fully exempt from the tax on profit in Cyprus. However, the dividends received by residents of Cyprus from their non-resident affiliated companies are levied by the defense tax at the rate of 15%. But the dividends received by a resident company from a non-resident company are exempt from this tax if the participation of the resident company in the charter capital of the non-resident company amounts to more than 1%. This exemption means, in fact, that the dividends transferred by an affiliated company (a resident of Russia) to its parent company (a resident of Cyprus) in the majority of cases are not levied by any taxes;
5) the immovable property tax is levied only on property situated in Cyprus. The size of the annual immovable property tax depends on the value of that immovable property. If the value of immovable property is less than 100 000 Cyprus pounds (approximately USD 223 000), the rate of tax is zero;
6) a Cyprus company is registered by applying the institution of nominal shareholders, that is, such a company is managed by nominal directors who undertake no actions without the orders thereto of the real owner whose name is hidden under the mask of the "nominals" and is unknown to the national tax and supervisory agencies. As demonstrated by practice, Article 26 of the Agreement for the avoidance of double taxation between the Russian Federation and Cyprus, which is designed to regulate the exchange of information between the tax and supervisory agencies of the Contracting States, is not operative. Exchange of information between the empowered bodies of two countries must represent an efficient mechanism for eliminating double taxation between these countries. Regular exchange of information must serve as a mechanism designed to control the outflow of incomes and capital from a country and to ensure timely and in full payment of tax.
However, in actual practice even the most developed countries of the European Union and the USA have begun, relatively recently (since 2001) and with the substantial aid and support provided by the OECD, to work on practical implementation of the norms prescribing it as their duty to exchange information with other countries. This has been necessitated, in particular, by the fact that each country has its own grounds for disclosing information, the types of such information and the mechanism for its relating / receiving as established by the norms of national legislation, etc. The OECD's goal in this connection is to unify all these notions and processes without violating the legislative sovereignty of any of the countries. Article 26 of the Agreement between the Russian Federation and Cyprus is contrary neither to the norms established by the OECD nor to the norms stipulated in the domestic legislation of each of
these two countries, but at the same time it contains no mention of the grounds for disclosing information, or of the grounds for a refusal to disclose information, or of the timelines for disclosing or refusing to disclose information. Thus, Article 26 of the Agreement established no mechanisms for implementing it in actual practice, which makes it significantly more difficult to apply;
7) in 2008, certain groups of companies - residents of Cyprus were freed from the responsibility to submit consolidated financial reports (this amendment increases the attractiveness of Cyprus for registering holdings there: if a core company is registered in Cyprus, then only the reports of that particular company, and not the whole holding, are submitted to the tax agencies);
8) The rate of value added tax in Cyprus is 15% (in Russia - 18%). The reduced VAT rate is 5%;
9) commercial navigation companies flying the flag of Cyprus are exempt from tax on
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profit . Besides, the salary and other payments to the master, commanding officers and other members of the crew of a vessel flying the flag of Cyprus are exempt from taxes and social security deductions. If a vessel or shares owned by a commercial navigation company are sold or transferred, the capital gains tax in the territory of Cyprus is not levied.
The main advantage of registering a company in Cyprus is that a Russian entrepreneur thus obtains a fully controllable foreign Cyprus-based company. Such a possibility to have "one's own" company in Cyprus opens up vast opportunities for carrying on a variety of business transactions - on a foreign or sometimes even on a domestic basis (in Russia). It is essential that from the point of view of law this foreign company controlled by its owner is a fully-fledged juridical person capable of participating, on absolutely lawful terms, in any commercial transactions.
Below we are going to discuss the most commonly applied schemes with the participation of Cyprus companies whose purpose is capital accumulation, planning and legal minimization of taxation.
2. The main legal schemes with the participation of a Cyprus company
It is feasible for Russian entrepreneurs to conduct their businesses through establishing holding companies within the framework of beneficial tax jurisdiction offered by Cyprus. This has become possible both due to the existing domestic tax legislation of Cyprus and to the norms stipulated in the Agreement for the avoidance of double taxation signed between Russia and Cyprus.
A holding company is an entity consisting of two or more juridical persons (participants in a holding company) related in such a way that one of the participants (the core company) is granted the right to govern the activity of the other participants in a given holding company by determining their decision-making process.
The reason for creating a holding company is the need to organize financial flows. Holding company schemes provide solutions to many problems: they unite into a single structure companies engaged in different types of activity; they optimize taxation inside a holding com-
21 In Part 4 of the 1992 Law "On commercial navigation" (with later amendments) a regime is envisaged for the commercial navigation companies Cyprus whereby any profits and dividends arising from the operation of the fleet flying the flag of Cyprus are fully exempt from any taxation. The vessels flying the flag of Cyprus are those that are registered in the a Cyprus register of naval vessels.
pany; and they help to arrange incomes in the form of dividends and to apply the most convenient taxes. Besides, holding company schemes help to minimize taxation of domestic entrepreneurs when they conduct export and import operations, as well as when paying royal-
22
ties . In addition, a Cyprus company participating in a holding company may act as a Russian company's contractor and thus decrease the taxable base for the tax on profits in the Russian Federation, and in the capacity of a naval vessel's owner - to minimize the taxes on servicing naval vessels and the tax on profits. Also, a Cyprus company participating in a holding company may act as a leasing company in order to transfer capital to foreign banks and to decrease the taxable base for the tax on profits in Russia by means of specially concluded contracts, etc..
The legal scheme for optimizing the taxation of dividends
The principal factors determining the choice of Cyprus as a jurisdiction for building under it a holding company scheme designed to minimize the taxation of dividends are as follows:
1) the payments of dividends by affiliated companies - residents of Cyprus transferred to their parent company which is a resident of Russia are not subject to taxation in Cyprus, which means that the incoming dividends due to the shareholders non-resident in Cyprus are fully exempt from any taxes in Cyprus;
2) the shareholders who are not residents of Cyprus are obliged, when receiving dividends in the territory of Russia, to pay tax on profits at the rate of 9%;
3) a Cyprus-based company affiliated to a Russian company may carry on active busi-
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ness transactions in Cyprus while paying the tax on profits in Cyprus at the rate of 9 10% ;
4) from 1 January 2008 onwards, those non-residents who have an intention to establish a company in Cyprus, or to acquire shares in already existing Cyprus companies in or outside of the territory of Cyprus, no longer need to apply for the permission of the Central Bank of Cyprus. As a result of this decision, the only regulating body in the sphere of direct investments made by non-residents is now the Ministry of Finance of Cyprus; thus, the procedure for establishing a company in territory of Cyprus has become considerably simpler.
As noted earlier, the payment of dividends by affiliated companies (residents of Cyprus) to their parent company (a resident of Russia) are not subject to any tax in Cyprus. In accordance with the provisions stipulated in Article 10 of the Agreement between Russia and Cyprus, dividends may be taxed in that other State where those dividends have been received (that is, where the recipient of dividends is situated). At the same time, such dividends may also be taxed in the State where these dividends are actually paid (that is, at the source of payment of dividends), if the persons enjoying the right to receive these dividends is a resident of the State where such dividends are transferred (i. e., Cyprus). In this case the tax on dividends should not exceed 5 and 10% (depending on the amount of investment in capital - no less than 100,000 USD and less than 100,000 USD respectively).
22 The term "royalty" (as applied to intellectual property) is not determined by Russian laws, although they do sometimes make use of this term. In the 1963 Model Tax Convention of the OECD (in Article 12): "royalty" is understood as payments of any kind received as a consideration for the use of, or the right to use, any elements of intellectual property.
23 http://www.worldwide-tax.com/cyprus/cyprus_tax.asp. The Income Tax Law, 2002. 582
From 1 January 2008, amendments were introduced into the Tax Code of the Russian Federation which envisage, in respect of the taxation of dividends received both from Russian and foreign juridical persons, that the rate of tax on profit of 9 and 0% respectively should be applied. The rate of 0% may be applied only in cases when dividends are transferred from a state which is not included in the list (approved by the RF Ministry of Finance) of states and territories that grant beneficial taxation regimes (where the rate of tax on profits is below 16%), and on condition that as of the day on which the decision as to the payment of dividends was made the recipient organization had been the owner, uninterruptedly, for no less than 365 days of a no less than 50% stake (or share) in the charter (or joint-stock) capital (or fund) of the organization - the payer of dividends, and on condition that the value of the acquisition and (or ) transfer into ownership of the stake (or share) in the charter (or joint-stock) capital (or fund) of the latter organization is more than 500 million rubles.
As Cyprus, where the rate of tax on profit is only 10%, is included in this "blacklist" of the Ministry of Finance, the rate of tax on profit for a Russian organization receiving dividends from a Cyprus company will be 9%, instead of the beneficial 0%, irrespective of the period of ownership, the size of share and the amount of contribution in the charter capital.
However, it can hardly be expected that the introduction of these amendments will result in the RF tax system's increased competitive potential on the international scale. In particular, one cannot agree that these amendments will create additional incentives for establishing affiliated and holding companies in the Russian Federation or in other countries with standard taxation systems instead of in Cyprus, because the conditions stipulated in Part 3 of Article 384 of the RF TC concerning the period of ownership and the size of shares (365 days and 50% respectively) - and moreover, those concerning the amount of the charter capital of an affiliated company (500 million rubles) - are too difficult for most of the rank-and-file Russian companies to comply with.
By way of arbitrary example, one can compare the financial results of two Russian companies. Let us ssume that the first company has an affiliate in Germany. In addition, all the conditions established by Part 3 of Article 384 of the RF TC are complied with, that is, the Russian parent company holds a 50% stake in that affiliated company for a period longer than 365 days. The charter capital of the affiliated company is 501 million rubles If this affiliated
24
company pays tax on 100 euro of its profit at a rate of 15% , the net sum of dividends received will be 85 euro. In accordance with the terms of the Agreement for the avoidance of
25
double taxation between Russia and Germany 25, in the instance of the payment of dividends in Germany the sum of 85 euro will be taxed at a rate of 5%, levied on the amount actually transferred. Consequently, the amount received in Russia will be 80.75 euro. Due to the new exemption, this sum will not be levied by tax in Russia (the rate of tax on profit - 0%).
Now assume that another Russian company has an affiliate in Cyprus. In this connection, neither the size of stakes, nor the period of ownership, nor the size of the charter capital of that affiliated company are of any importance, because Cyprus belongs to the RF Ministry of Finance's "blacklist". If 100 euro of profit received by the affiliated company is levied by the Cyprus tax on profit at the rate of 10%, the sum of dividends will be 90 euro. In accor-
24 The rate of profits tax in Germany in 2008 (http://www.worldwide-tax.com/germany/germany_tax.asp).
25 Agreement as of 29 May 1996 between the Russian Federation and the Federal Republic of Germany for the avoidance of double taxation with respect to taxes on incomes and on property // Sobranie zakonodatel'stva RF [Collection of RF Legislation]. 23 February 1998. No 8. P. 913.
dance with the Cyprus laws, no additional taxes are levied in connection with the payment of dividends, and so the amount received in Russia will be 90 euro. Since the RF Ministry of Finance does not deem Cyprus to be a state that grants a beneficial taxation regime, the Russian organization will pay tax on profits on this sum at the rate of 9%, after which it will have net profit of 81.9 euro. Thus, in case of an affiliated company registered in Cyprus, the amount of tax loss will be 1.15 euro less.
Thus, in spite of everything said, it is still feasible for companies - residents of the RF to create their affiliates in Cyprus, because the dividends paid by an affiliated company in Cyprus to its Russian parent company are not taxed in the instance of payment of dividends (in contrast to what happens in other countries with standard taxation systems) - no matter what the size of shares, the period of ownership, or the amount of the charter capital of the affiliated company might be. Consequently, the main incentives for the placement, by Russian entrepreneurs, of their capital in Cyprus are the beneficial provisions stipulated in the Cyprus laws, and not the standard provisions incorporated into the Agreement between Russia and Cyprus.
The legal schemes for the payment of royalties
In order to minimize taxation, the holder of the right for an object of intellectual property can be a company registered under a low-taxing jurisdiction. In this connection, a licensing or sub-licensing agreement is concluded with a Russian organization (depending on the length of the chain of participants). Under this scheme, royalties26 are consistently transferred
27
from the final licensee in Russia to the licensor (the owner of a patent, copyright, etc.) situated abroad.
In international practice it is quite common to use Cyprus companies for the transfer to
them of the ownership right to intellectual property (copyrights, patents, trademarks, etc.). The
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reason is that intellectual property , by definition, can easily be transferred to a Cyprus company because it is non-material and does not require that any additional expenses be incurred in its transfer - in addition to the conclusion of a relevant licensing agreement. If different types of intellectual property are involved, this means that their owner will receive certain amounts of royalties from third parties. The receipt of royalties specifically in the territory of Cyprus is associated with the lowest tax losses. This has to do both with domestic legislation of Cyprus and with the provisions of the Agreement for the avoidance of double taxation between Russia and Cyprus. Below we discuss different variants of schemes for the payment of royalties, which differ by their subjects - the owners of intellectual property.
26 "Royalties" means compensation received as a consideration for the use of a patent, copyright, natural resources, or other types of property, paid in the form of interest on the value of sold products and servioces for the production of which patents, copyright, etc. have been used.
27 Licensee is the person obtaining from the owner of an invention, a patent, industrial or commercial know-how, etc. (the licensor) a license for the right to use it.
28 See the Convention Establishing the World Intellectual Property Organization adopted at Stockholm on 14 July 1967); Article 1225 of the RF CC // Civil Code of the Russian Federation (Part Four) of 18.12.2006, No 230-FZ. A Collection of RF Legislation. 25.12.2006. No 52 (P. 1). Article 5496.
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1. The owner of intellectual property is a company which is not a resident of Cyprus . This company does not pay taxes on its incomes received outside Cyprus; however, it is not subject to the tax agreements concluded by Cyprus, because it is not a resident of that state. Thus, in the event of the payment of royalties from the Russian Federation, they will be levied by the Russian tax on profits at their source at a rate of 20%. No tax arises in Cyprus. No tax at the source arises during the subsequent distribution of the profit of the Cyprus company or the payment of dividends, either (0%).
2. The owner of intellectual property is a company which is a resident of Cyprus. When a Russian company pays royalties to the Cyprus company, the latter pays, in Cyprus, the tax on the received profit in the amount of 10% (because, being a resident of Cyprus, it is subject to that country's domestic tax legislation). In this connection, the Russian company pays no taxes, because no tax at the source is levied in the instance of payment of royalties from Rus-
30
sia (see Item 1 of Article 12 of the Agreement between the Russian Federation and Cyprus30). As in the case of the previous scheme, no tax at the source arises during the distribution of the Cyprus company's profit or the payment of dividends (0%).
3. The owner of intellectual property is a foreign company (a resident of any tax-free offshore jurisdiction). This company (registered in the territory of countries like Panama, etc.), being the owner of intellectual property, transfers under a concluded licensing agreement the right to issue sub-licenses for the use of a given patent (or trademark, or copyright) to a company which is a resident of Cyprus. Later on, the Cyprus company signs a licensing agree-
31
ment with a Russian company. Due to the fact that the country of registration is a tax-free jurisdiction, and Russia has no agreements for the avoidance of double taxation with that state, whereas Cyprus, on the contrary, does have such agreement both with Russia and with the tax-free state, the low rate of the tax on profits in Cyprus (10%) and the beneficial provisions stipulated in the agreements make it possible to use Cyprus-based companies as transit components in the schemes designed to minimize the tax load associated with royalties.
By Article 12 of the Agreement between Russia and Cyprus for the avoidance of double taxation with respect to taxes on income and on capital, a zero rate of tax on profit at the source is established for outgoing royalties. In order to be able to take advantage of this exemption, a Cyprus-based company must be a resident of Cyprus. Thus, in our case no tax on profit at the source arises when royalties are paid from Russia to Cyprus. Then, the Cyprus company, as the licensee, must transfer the sum of royalties as determined in the licensing agreement to the offshore company (licensor). Tax at the source is levied on the outgoing roy-
29 A non-resident is a company which has a registered office in a given country and is managed by local directors but is owned by non-residents of the country of registration. Such companies have no right to conduct their activity inside the country of registration. Such companies are fully exempt from the payment of all taxes in the country of registration and have no right to make use of any norms of the domestic legislation of the country of registration or of any international agreements concluded by that country with other countries.
30 Royalties arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State (Item 1 of Article 12 of the Agreement between the Government of the Russian Federation and the Government of the Republic of Cyprus for the avoidance of double taxation with respect to taxes on income and on capital) of 5 December 1998).
31 With the written consent of the licensor (the owner of an intellectual right) the licensee (the user of an intellectual right under a licensing agreement concluded with the licensor) may, under the agreement, grant the right to use the result of intellectual activity or the means of individualization to another (third) party. (Article 1238 of the RF CC).
alties at the rate of 10% only if the services being rendered are actually used in the territory of Cyprus (for example, the rate of the tax on profit with regard to film-lending services is 3%). The tax on profit in Cyprus is paid be resident companies on the difference between the amount of royalties received (from a Russian company) and paid (by an offshore company) at the rate of 10%. In this connection, the tax on profit is not levied on outgoing royalties in Cyprus (0%). In its turn, there is no duty to pay tax on profits on the sum of royalties received in the tax-free jurisdiction, either.
Thus, the creation of companies - owners of intellectual property and recipients of royalties in Cyprus and in other offshore zones respectively represents a tax planning method which is commonly applied by Russian entrepreneurs. This can be explained by the low rates of the tax on royalties withheld in Cyprus and by the provisions stipulated in the Agreement for the avoidance of double taxation between Russia and Cyprus, which are designed to regulate the process of the taxation of royalties.
The legal schemes applied in the export / import of goods (or services)
In international trade, it is indeed possible to conclude the import / export transactions with companies registered in Cyprus in order to minimize the level of taxation with regard to tax on profits. In this connection, within the framework of such import / export transactions between Russian and Cyprus companies the method of transferring profit is envisaged which involves the generation of the main income from the transaction not under the jurisdiction with a high taxation level (in Russia) but in the zone of beneficial taxation (in Cyprus). To achieve this end, it is enough to include an intermediary company situated in the zone of beneficial taxation in the chain of operations carried on between the companies situated in the jurisdiction with a high taxation level.
However, when applying the schemes for the import / export of goods (or services) described below, it is necessary to take into account national legislation on transfer pricing and the insufficient capitalization rules.
Transfer pricing means the setting and applying of prices the size of which is determined by the parties to a given transaction not by a market method - that is, not for commercial purposes, but only in order to reduce their tax load. Russian tax legislation, in Articles 20 and 40 of the RF TC, stipulates the main norms designed to prevent transfer pricing. By Article 20 of the RF TC it is determined which persons are recognized as mutually dependent for the purpose of taxation (these are, in particular, parent, affiliated and dependent entities). Article 40 of the RF TC established directly the limited list of cases when tax agencies have the right to check the correspondence of a contract price to the market one (these are: transactions between mutually dependent persons; barter and foreign trade transactions; and all those transactions in which the deviation from the market price or from the prices applied by the taxpayer during a short period of time is more than the permitted 20%).
Thus, tax agencies, in accordance with Articles 20 and 40 of the RF TC, are granted the right to check the justification for the price indicated in a contract concluded between mutually dependent persons in an event of foreign trade transactions. Besides, tax agencies can check all the transactions where the deviation from the market price or the prices applied by the taxpayer during a short period of time is more than the permitted 20%.
Russian tax legislation envisages certain sanctions for violation of the insufficient capitalization rules. One of the main indicia of insufficient capitalization is the high share of bor-
rowed funds against that of joint-stock capital. Such a high share of debt in an organization's total capital can be an indication that a given group of companies is making efforts in order to obtain tax benefits. All other conditions being equal, a group incorporating a parent company may, with regard to the corporation as a whole, pay a lower amount of tax if the profit of the affiliated company is transferred to the parent one in the form of interest on a loan, and not as dividends on shares: the sums of interest on a loan decrease the taxable income of the affiliated company, while dividends are paid from the sum of profit after tax.
The special norms designed to limit opportunities for misdeeds by means of applying insufficient capitalization are stipulated in Article 269 of the RF TC, which establishes the conditions whereby a Russian organization's debt to its foreign creditor is to be deemed to be
32
controlled . Article 269 of the RF TC restricts the sum of interest to be deducted from the amount of tax on profit if a loan is obtained from a foreign mutually dependent person, and the value of the capitalization coefficient falls within certain limits; that is, the size of debt obligations which are not redeemed by the borrower cannot exceed by more than three times (for banks and organizations engaged in leasing operations - by more than 12.5 times) the size of its own capital.
The consequence of such debt having been recognized as controlled by tax agencies is that, for the purpose of taxation, the positive difference between interest charged and marginal interest on dividends is treated as the obligation to pay tax on dividends at the rate of 15% from the relevant sum of recognized dividends.
The legal scheme for the import of goods with the participation of a Cyprus company as an intermediary
A Russian company buys goods from a foreign company. A Cyprus company acts as an intermediary, thus making it possible for the Russian company to alter the price of the goods. In this connection, it becomes possible to deliberately increase the prices entered into the contract in order to diminish the profit of the Russian company, and as a result - to decrease the sum of tax on profit.
Suppose the Russian company buys goods from a foreign one at the price of 120 rubles per unit, which are then sold in the territory of Russia at 140 rubles per unit. The company's profit amounts to 20 rubles, from which it will have to pay tax on profit at the rate of 20% in the amount of 4 rubles. However, if it establishes an additional company in Cyprus, the Russian company will then be able to carry out this transaction through its Cyprus affiliate. The Cyprus company thus buys goods from the foreign company at 120 rubles per unit, then sells
32 Debt liabilities of Russian organizations in respect of foreign creditors may be recognized by tax agencies to be controlled if interest is paid by these Russian debtors:
1) against a debt liability in respect of a foreign organization which directly or indirectly has under its ownership more than 20 per cent of the authorized (pooled) capital (fund) of this debtor;
2) against a debt liability in respect of a Russian organization recognized in accordance with legislation of the Russian Federation to be the affiliated person of a foreign organization which directly or indirectly has under its ownership more than 20 per cent of the authorized (pooled) capital (fund) of the Russian organization - the borrower;
3) against a debt liability in respect of a company for which a foreign organization, which directly or indirectly has under its ownership more than 20 per cent of the authorized (pooled) capital (fund) of the borrower, or which is its affiliated person, acts as surety, guarantor, or in any other ways is responsible for the execution of the aforesaid debt liability (Article 269 of the RF CC).
them to the Russian company at 135 rubles per unit. The latter sells them in the territory of Russia at 140 rubles per unit goods. The profit of the Russian company will be 5 rubles, and the amount of tax on profit - 1 ruble. The profit of the Cyprus company amounts to 15 rubles, from which it will have to pay tax on profit at the rate of 10% in the amount of 1 ruble 50 kopecks. Thus, the Russian company will save 2 rubles on the payment of tax on profit in the territory of Russia (in this case, the Russian entrepreneur pays almost 40% less of taxes than when the transaction is carried out directly, without an intermediary - a Cyprus company).
The legal scheme for the import of goods with the participation of a Cyprus company as an intermediary and by applying the mechanism of credit against goods
It is possible to implement a scheme for the import of goods by applying the provisions stipulated in Article 11 ("Interest") of the Agreement for the avoidance of double taxation between Russia and Cyprus. For example, a Russian entrepreneur creates a company in Cyprus which, in its turn, creates its affiliated company in Russia. The Cyprus company buys goods from a foreign company (say, a resident of Germany), and then grants to the Russian company
33
(its affiliate) credit against goods 33 in the form of purchased goods. The interest paid by the Russian company on that credit against goods diminishes its taxable profit. The monies transferred from the Russian company to the Cyprus one as interest on the credit against goods are then accumulated, and tax on profit is levied in Cyprus at the minimum rate of 10%. For the Russian company to be able later to make use of these transferred monies, the Cyprus company grants to it a loan in the amount of the aforesaid monies, or - as a parent company - invests these monies in the fixed assets of its affiliated Russian company. Thus, all other conditions being equal, an affiliated company in Russia, whose ratio of borrowed and its own funds is high, pays a lower tax on profits than a company whose ratio of the same indices is low.
If this scheme is applied by a Russian entrepreneur, then there arises the risk of being brought to responsibility for violation of tax legislation in the part relating to the compliance with the insufficient capitalization rules (thin capitalization) described earlier.
The legal scheme for the import of goods with the participation of an intermediary (a Cyprus company) and by applying the mechanism of a leasing agreement
The application of a leasing scheme makes it possible for a Russian company to purchase goods on behalf of a Cyprus company, while at the same time diminishing the taxable base for the tax on profits for that Russian company by exporting capital to Cyprus.
Under a leasing agreement the lessor is obliged to acquire into ownership the property specified by the lessee from a certain seller and then to grant to the lessee that property, on a commercial basis, for disposal and use for entrepreneurial activity. The implementation of the scheme based on a leasing agreement, in accordance with which a Cyprus company becomes
33 Goods credit is a borrowing obligation which provides for the duty of one party (the creditor) to grant to the other party (the borrower) things determined by generic indicia, while the borrower pays to the creditor specially determined and regularly payable interest. The transfer of the right of ownership of the goods under a goods credit contract takes place at the moment of its actual transfer of the goods from the creditor to the borrower (Article 822 of the RF CC). 588
the lessor, and a Russian company - the lessee, makes it possible for the Russian company to lawfully diminish its payments of tax on profit.
Suppose that it is necessary for a Russian entrepreneur to purchase certain equipment from a foreign company (a resident of Germany). So, the former establishes an additional company in Cyprus, which purchases the necessary equipment; then, the Russian company concludes a leasing agreement, that is, the Russian company leases the equipment from the Cyprus company. The profit generated as a result of the activity of the Russian company is transferred to Cyprus in the form of leasing payments, which under this agreement are paid by the Russian company to the one in Cyprus, where these payments, in their turn, are levied by tax on profits at the rate of 10%. At the same time, the leasing payment decreases the Russian company's taxable base for tax on profit.
With regard to the use of this scheme, it is necessary to address the issue of property depreciation in accordance with a leasing agreement. The depreciation deductions are made by that party to the leasing agreement on whose balance sheet the subject of leasing in kept. In this connection, the subject of leasing transferred to the lessee under a leasing agreement is entered in the balance sheet of either the lessor or the lessee, in accordance with their mutual agreement. Since depreciation decreases the taxable base for tax on profits, it is the Russian company (the lessee) who benefits from keeping the subject of leasing on its balance sheet because it thus can make the deductions in order to minimize the payments of tax on profits (because in Russia the rate of tax on profits is 20%, and in Cyprus - only 10%).
The legal scheme for the export of goods
For the purpose of minimizing the sum of payments of tax on profit, it is convenient for Russian companies to use a Cyprus company as an intermediary when selling their goods / services to a foreign partner.
Let us assume that a Russian company exports goods to a foreign company (for example, a resident of Germany) at a price of 120 rubles per unit. The profit then received by the Russian company amounts to 20 rubles per unit. There arises the duty to pay tax on profit, the rate of which in Russia is 20%; so, the Russian company will pay 4 rubles
Now let us consider the scheme envisaging the participation of a Cyprus company. The owners of the Russian company, which must sell its goods / services to a foreign company, create their company in Cyprus and conclude with it an export contract, but the price entered into it is 101 rubles per unit instead of 120 rubles. The profit of the Russian company is thus decreased to 1 ruble, and tax profit (at the rate of 20%) - to 0.20 rubles The Cyprus company, in its turn, sells goods to the foreign company at the old price - 120 rubles per unit. The profit of the Cyprus company amounts to 19 rubles From this sum the Cyprus company is going to pay in Cyprus the amount of tax on profit at a rate of 10% - 1 ruble 90 kopecks. The total sum of Russian (0.20 rubles) and Cyprus (1 ruble 90 kopecks) tax on profit will thus amount to 2 rubles 10 kopecks. The amount saved by the Russian entrepreneur as a result of using a Cyprus company as an intermediary in this scheme will be 1 ruble 90 kopecks (a domestic entrepreneur pays 30% less in tax).
When such schemes are applied in carrying on the import / export of goods, there is a risk of the taxpayer being brought to responsibility for violating the provisions of Russian tax legislation on transfer pricing described above.
In this case, Russian entrepreneurs minimize the profit of a Russian company and the sum of tax on profit by means of concluding the import / export transactions with a Cyprus company, thus concentrating the bulk of their monies in Cyprus, where a Cyprus company pays the minimum tax on profit at a rate of 10%.
As noted earlier, the RF Tax Code presently contains only two articles designed to prevent the use of transfer prices - Articles 20 and 40 RF, in accordance with which tax agencies have the right to check the justification for using certain prices in contracts, and in an event when the price indicated in a contract does not correspond to the level of market prices - to charge additional tax on profit and to oblige the taxpayer to pay penalties and fines.
All the aforesaid conditions, under which the price indicated in a contract can be checked by tax agencies in order to verify whether or not it corresponds to the market price, are fully applicable to the tax planning schemes with the participation of a Cyprus company in the import / export of goods (or services). In order to avoid sanctions imposed by tax agencies, it is necessary for the Cyprus and Russian companies not to be mutually dependent from a formal point of view (the Russian company cannot be the founder of the Cyprus one, while the founders of the Russian company cannot at the same time be the founders of the Cyprus company, etc.)34. Besides, the price indicated in a contract cannot be more than 20% higher (or lower) than the level of market prices for similar (or identical) goods / services, i. e., the raising (or lowering) of price must be simultaneously feasible from the point of view of economics and take into account the potential risk of sanctions to be imposed by tax agencies in connection with violation of the provisions of Russian legislation concerning transfer pricing.
The legal schemes for self-financing of holding companies
In international practice it is quite common for Cyprus companies to participate in the process of financing an international group of companies (or a holding company) in order to minimize the taxable base for tax on profits of a company situated in a country with a standard system of taxation.
The essence of such a scheme is that a Cyprus company issues a credit35 or loan36 to its partners situated in the territory of Russia and having the status of Russia's residents. Under such a scheme, the credit can be repaid to the Cyprus company together with the interest agreed upon, while the monies received by the Russian company in the form of a loan from the Cyprus company will be partly spent on the repayment of the loan and the payment if in-
34 Natural persons and (or) organizations, the relations between which may exert influence the conditions or the economic results of their activity or activity of the persons represented by them, shall be deemed for the purposes of taxation to be inter-dependent persons, namely 1) one organization directly and (or) indirectly participates in another organization, and the total participatory share of such participation comprises more than 20%; 2) one natural person is subordinated to another natural person with regard to official position; 3) persons are in accordance with family legislation of the Russian Federation in marriage relations, relations of kinship or affinity, adoptive or adopted, and also trustee and ward (Article 20 of the RF TC).
35 Under a credit contract a bank or other credit organization (creditor) is obliged to grant monetary means (credit) to the borrower in the amount and on the conditions provided for by the contract, and the borrower shall be obliged to return the monetary amount received and to pay interest on it (Article 819 of the RF CC).
36 Under a contract of loan one party (the lender) is obliged to transfer or transfers a thing for temporary uncom-pensated use to the other party (the recipient), and the last is obliged to return this thing in the same state in which it was received, taking into account normal wear and tear, or in a state stipulated by the contract (Article 689 of the RF CC).
terest on it. The purpose of this scheme is to reduce the Russian company's taxable base for tax on profit (it has costs because it has to repay credit) and to concentrate profit with the Cyprus company (which receives monies in repayment of the credit with the agreed amount of interest, while paying profit tax on half of its received interest at the rate of 10%). As has been noted earlier, this method of financing can be preferable to direct contributions to charter capital, because the payment of interest reduces the taxable base for tax on profit in Russia. When paying interest to a Cyprus company, a Russian company pays no profit tax in the territory of Russia. In accordance with the provisions of Article 11 of the Agreement between Russia and Cyprus, profit tax on only half of the amount of charged interest is paid by the re-
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cipient of interest, in this case - by the Cyprus company . This happens so because, in accordance with the domestic legislation of the Republic of Cyprus, a company resident in Cyprus is exempt from the payment of profit tax on 50% of the monies received by it. Physical per-
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sons in Cyprus are fully exempt from the payment of profit tax on their received interest .
Consequently, this scheme makes it possible, with minimum tax expenses, first to export, and then to return monies to Russia: the interest paid by a Russian company to a Cyprus company under a credit agreement reduced the sum of taxation in Russia and is subject to minimum taxation in Cyprus.
When implementing this scheme, it is necessary to remember the insufficient (thin) capitalization rules. As the creditor in this scheme is a resident of a foreign state (Cyprus), no taxation of interest in the country of source (i. e., in Russia) is envisaged by the Agreement for the avoidance of double taxation (Article 11 of the Agreement for the avoidance of double taxation). At the same time, the recipient of interest in Cyprus pays profit tax only from 50% of the received amount of interest at the rate of 10%. Thus, as a result of this scheme, the tax base is reduced in the country of source ( in Russia).
Special norm designed to limit opportunities for misdeeds based on thin capitalization are stipulated in Article 269 of the RF TC. As a result of the application of this norm by tax agencies, the amount of interest paid in excess of the marginal level is treated in tax records as the payment of dividends by a Russian affiliate to its parent company (in Cyprus), and so it is taxed in Russia accordingly - at a rate of 15%.
The legal schemes for decreasing the taxable base for tax on profits of a Russian company based on rendering fictitious services
This scheme results in minimization of tax on profits through increasing a company's costs. A Cyprus company created by Russian entrepreneurs may render to a Russian company legal, informational, auditing or other services which are essentially fictitious - that is, nonexistent. The monies paid to the Cyprus company are thus accumulated on its account, the Cyprus company, in its turn, paying profit tax on them at a minimum rate - 10%. In this connection, the sums spent by the Russian company decrease its taxable base for tax on profit in accordance with Articles 251 - 254 of the RF TC.
37 Interest arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State (Item 1 of Article 11 of the Agreement between the Government of the Russian Federation and the Government of the Republic of Cyprus for the avoidance of double taxation with respect to taxes on income and on capital) of 5 December 1998.
38 The Income Tax Law of 2002 (as amended, 2004) (Cyprus) art.8 (19).
The legal scheme for exporting the capital of a Russian company to Cyprus by using promissory notes
A promissory note is a security that confirms the obligation of the issuer of the promissory note to pay a certain sum to the bearer of the promissory note. The application of a scheme based on investment promissory notes with the participation of a Cyprus company makes it possible to export a certain sum of money belonging to a resident of Russia to Cyprus, thereby decreasing the Russian company's tax base for tax on profits in the territory of Russia and decreasing the tax expenses relating to tax on profits for the Cyprus company. Besides, Russian currency and customs legislation imposes no restrictions on the removal, by residents or non-residents of the Russian Federation, of any promissory notes out of its territory. The use of a promissory note as a means for exporting capital to Cyprus allows the participants in such a transaction not to pay customs duties when carrying promissory notes through the border of the RF (Article 35 of Federal Law of 21 May 1993, No 5003-1, "On customs tariffs"), and not to request the permission for capital export from the RF Central Bank.
The scheme may be arranged in the following way: a Russian company issues a discounted promissory note with face value of 100 rubles The sum of the actual placement of the promissory note is 80 rubles, i. e. the amount of discount on it is 20 rubles
It is necessary to note that a discounted promissory note may also be interest bearing, thus implying the obligation of the promissory note's issuer to pay to its bearer, on it being presented for payment, not only the sum of the promissory note's face value, but also interest on that sum. The bearer of the promissory note thus becomes the previously registered Cyprus company which had acquired it from the Russian company for 80 rubles. When carrying on operations with its own promissory notes, their bearer (the Russian company) incurs certain expenses which, in accordance with Chapter. 25 of the RF TC, are recognized as non-realization costs: the cost of the making (or acquisition of) promissory note forms and their servicing (Subitem 3 of Item 1 of Article 265 of the RF TC), as well as expenses in the form of interest charged on a promissory note (Subitem 2 of Item 1 of Article 265 of the RF TC). The discount on a promissory note, as stipulated in the provisions of the RF Tax Code, is treated as interest. So, the issuer of a promissory note thus bears expenses in the form of interest (or discount) on the promissory note, which are distributed evenly over the period of circulation of the promissory note and are included in the tax base either on a quarterly (or a monthly) basis depending on the duration of a reporting period, or as of the date of the redemption of the debt obligation (Item 8 of Article 272 of the RF TC).
From 2005 onwards, the sum of discount on a promissory note can be charged to non-realization costs only by the organization who issues the promissory note. This means that the next owner of the promissory note who acquires it from the issuer with the intention to subsequently resell it to a third party with a new discount will have no such right.
After purchasing the promissory note, the Cyprus company presents it for payment to the Russian company and receives income in the form of discount on a promissory note and/or interest charged on the promissory note (if the promissory note is discounted and/or interest bearing), which happens in the territory of Cyprus. Of course, income in the form of interest on securities, according to the provisions of Article 11 of the Agreement for the avoidance of double taxation between Russia and Cyprus, is subject to tax on profit in the territory of Cy-
prus at a rate of 10%, which halves the expenses of the participants in such a transaction (in
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Russia, the rate of the tax on profits is 20%).
It is also possible to implement an investment scheme with promissory notes, with the participation of a Russian bank. A Russian company purchases from a Russian bank a discounted (and/or interest bearing) promissory note. In order to decrease its payments of the tax on profits when receiving income on a promissory note, the Russian company sells the promissory note to a Cyprus company at the same price which was paid when purchasing it from the bank. In this case no VAT is paid, because this transaction generates no added value. It is not profitable for the Russian company to sell the promissory note with a new discount in order to decrease its taxable base for tax on profits, because due to the provisions of the RF Tax Code only the issuer of a promissory note (a bank) enjoys the right to charge the sum of discount to non-realization costs. For the Russian company this discount represents a loss. Then the Cyprus company, who is the bearer of the promissory note, presents it for payment to the Russian bank and thus receives income, which is levied by the tax on profits in the territory of Cyprus at a rate of 10%.
Thus, the investment scheme based on the use of promissory notes with the participation of a Cyprus company allows Russian entrepreneurs to export their capital in an amount equal to the discount and/or interest on a promissory note, thus decreasing their tax payments. The purpose of such a scheme is to export capital from Russia and then to invest it40. In this connection, when using the schemes based on promissory notes it is necessary to remember the norms of Russian tax legislation designed to prevent the failure of taxpayers to fulfill the duty to pay taxes in the territory of Russia - that is, the norms concerning the thin capitalization rules and transfer pricing.
The legal schemes for non-payment of tax on the profit received from alienation of Russian immovable property
In the event of sale of immovable property (a house, a building, etc.), the profit received from this operation in Russia is levied by the tax on profit at the rate of 20%. If it is sold by a foreign company without a permanent representation office in Russia, the profit thus received is subject to tax on profit at the source of payment, without any possibility of decreasing the tax rate in accordance with the terms of international tax agreements.
However, it is much more feasible for Russian entrepreneurs, in order to minimize taxation, to realize immovable property by selling shares or stakes in the company owning that
39 Article 284 of the RF TC.
40 In confirmation of the actual existence and importance of such investment scheme based on the use of promissory notes, we can point to Letter of the RF Central Bank of 4 July 2008, No 80-T, which specifically addresses this problem. In particular, it is pointed out that the initial holders of promissory notes within a short period of time after their acquisition transfer these notes to other Russian juridical persons. However, these promissory notes are then presented for payment to Russian credit institutions by non-residents of Russia, who in many instances are registered in offshore zones are clients, in particular, of banks of Latvia and Cyprus. The growing scale of such operations has made it possible to assume that their true purposes may be not only tax avoidance (and so Cyprus or Latvia are chosen), but also the avoidance of customs control and customs duties, withdrawal of money from the Russian Federation outside of the framework of currency control, and money laundering. In this connection, as a measure of supervision, the RF CB recommends in this letter that Russian credit organizations, when identifying the presence of such operations, to submit the relevant information on them to the authorized body - the Federal Financial Monitoring Service.
immovable property, after registering that company in Cyprus. This is due to the fact that at present, in accordance with Article 13 of the Agreement for the avoidance of double taxation between Russia and Cyprus, the incomes from alienation of any property (including shares), except immovables, are subject to taxation only in that State where the person alienating the property is a resident. Shares - even if they are set in a company's balance sheet against immovable property - are movables, and so the income from their realization must be taxed only in that state where the person alienating such shares is registered as a resident.
Thus, the following scheme, which involves the construction and subsequent sale of Russian immovable property, becomes possible. Russian entrepreneurs register a company in Cyprus with a minimum charter capital; the founders can be either those entrepreneurs, or any other Cyprus company, which was previously registered there. Then the Cyprus company establishes in the territory of Russia a construction company, which takes a credit or loan in the amount necessary for erecting a building in the territory of Russia, while enjoying the status of a RF resident. As a result, the Cyprus company becomes the owner of the building erected in the territory of Russia, because the Cyprus company owns shares in the Russian company which has erected it. After completing the construction of the building, the Cyprus company advertises it for sale in the territory of Russia at a market price, which is higher that the construction price The Cyprus company sells the building by means of selling shares in the Russian company, in whose balance sheet these shares are set against the newly constructed immovable property, to the Russian company at a price corresponding to the real value of that building, and that company then begins to exploit the building. As a result, the Russian company (the seller) becomes the owner of Russian immovable property through purchasing shares belonging to the Cyprus company. Thus, the transaction of sale of the shares is effectuated in Cyprus, because the seller is the Cyprus company in the capacity of the owner of shares in the Russian company, in whose balance sheet these shares are set against that immovable property situated in Russia. In this connection, no duty to pay the capital gains tax in Cyprus arises as a result of such a transaction
Consequently, in Cyprus there exist conditions that make it much more feasible to place capital there and carry out through companies registered in Cyprus the transactions of alienating Russian immovable property, which involve construction and subsequent sale of Russian immovable property.
The legal scheme applied for minimizing the taxation of ship-owning (commercial navigation) activity
Cyprus is one of the main centers for foreign ship-owning companies to carry on their ship-owning activity, commercial navigation and the rendering of sea carriage services.
The established form of a ship-owning company registered in Cyprus is a private limited liability company engaged in ship-owning activity and commercial navigation. Such a company, which owns or charters vessels flying the flag of Cyprus and operates in international waters is fully exempt from all taxes and duties, including the duty to pay profit tax, the tax on the payment of dividends and the tax on remuneration of personnel. Exceptions are represented by the annual duty, registration fees, and the duty on re-registration of a vessel. Besides, no tax is levied on incomes from capital gains in the event of a sale or resale of a vessel, or of a division of a commercial navigation company.
The responsibility of a ship-owning company to keep accounting records, draw up annual reports and submit audit reports arises only in cases when at least one of its shareholders is a juridical person.
Thus, it is feasible for those Russian entrepreneurs whose main source of profit is precisely their ship-owning activity to register their companies in the territory of Cyprus.
3. Proposals concerning the introduction into Russian legislation of some amendments designed to prevent the non-payment of tax on profit in the territory of Russia and to ensure control over capital outflow to Cyprus
The introduction of certain new norms into Russian legislation may decrease the attractiveness of capital export to Cyprus for Russian companies. It would be feasible to augment the system of national legislation by the norms concerning controlled foreign companies.
Controlled foreign companies (CFC) are those companies which are situated, as a rule, in beneficial tax jurisdictions, and certain shares in which are held by domestic companies. The general rules concerning CFCs envisage that if the holders of shares (the parent company) are situated in the country where such norms concerning CFCs are in force, a certain part of undistributed profits of their foreign affiliated company must be included into the parent company's taxable income. The main idea behind this procedure is that part of the income received by a foreign affiliated company is to be actually treated as shareholders' (or parent company's) profit that has been exported beyond the borders of the tax jurisdiction of the parent company's country as a result of inter- company deals.
When the draft wording of Chapter 25 of the RF TC was being prepared, it was envisaged that proper regulation should be introduced, but the final and currently effective version of that chapter have never contained and does not contain now any of the necessary norms41.
Let us consider a case when a parent company is registered in Russia, while its affiliated company is registered in Cyprus, and both companies are independent juridical persons. Under existing legislation, the Russian parent company reports only its incomes received independently, as well as the incomes received in the form of dividends and other incomes (interest, royalties, etc.) received from its foreign affiliate. The affiliated company's undistributed profit is not included in the Russian parent company's taxable income, including in the income from sale of its shares in the affiliated company (profit from sale of shares not being subject to taxation in Cyprus). Consequently, the introduction into Russian legislation of the norm concerning CFCs would have made it possible, in the case described above, to record the profit received by the affiliated company in the tax declaration submitted by the parent core company in the RF - on condition that there is indeed a well-functioning mechanism for exchanging information between the competent authorities of the Republic of Cyprus and Russia.
Certain changes can also be introduced into the Agreement for the avoidance of double taxation between Russia and Cyprus, which would reduce the scope of capital outflow from Russia. Thus, Article 26 of the Agreement, which addresses the issue of information exchange between the competent authorities of Russia and Cyprus, could provide an effective mecha-
41 Kornienko N. Yu. Nekotorye aspekty podkhodov k probleme bor'by s nedobrosovestnoi nalogovoi konkurentsiei v kontekste begstva kapitalov [Some aspects of the approaches to the problem of struggle against dishonest competition in the context of capital flight] // Rossiiskaia ekonomika v 2006: tendentsii i perspektivy [Russian economy: Trends and Perspectives]. M.: IET, 2007.
nism for regulating the financial flows in both directions between Russia and Cyprus, as it has been proven by the OECD experience. However, this Article, which on the face of it does not contradict the OECD norms or the norms stipulated in the domestic legislations of both countries, contains neither the grounds for information disclosure nor the grounds for a refusal to disclose information nor the timelines for the disclosure or the refusal to disclose information by any of the two countries. Thus, Article 26 of the Agreement provides no mechanisms for implementing it in actual practice, which considerably hinders its application.
