Interest deduction
The general rules of the Russian Tax Code (item 1 of art. 269 of the Russian Tax Code) presume a full deduction for interest on loans except for loan agreements concluded between related parties (controlled loans). The basic criteria of control (among others) being the holding of more than 25% of the shares of a counterparty. A controlled loan is a loan provided by a foreign lender, which holds more than 25% of the shares of a Russian borrower.
When a foreign controlling shareholder (which holds >25% shares) provides financing to a subsidiary, two basic options are available: an injection into equity (assets) or a loan.
From a shareholder point of view, the loan could be more beneficial as is illustrated in the following example (which assumes that ultimately all income of the period will be distributed to the shareholder as interest and/or dividend).
Item number
|
Index
|
Loan
|
Injection into equity (assets)
|
|
|
RR
|
RR
|
1
|
Loan provided (interest at 5% p.a.)
|
100,000,000
|
|
2 |
Funds provided by injection into equity (assets)
|
|
100,000,000
|
|
|
|
|
3 |
Corporate profits tax base of the period before interest and tax
|
10,000,000
|
10,000,000
|
4
|
Interest deductible (item1*5%)
|
(5,000,000)
|
|
|
|
|
|
5 |
Corporate profits tax base of the period (item3- item4)
|
5,000,000
|
10,000,000
|
6
|
Corporate profits tax at 20% rate (item 5*20%)
|
(1,000,000)
|
(2,000,000)
|
7
|
Net income of the period (item5- item6)
|
4,000,000
|
8,000,000
|
8
|
Withholding corporate profits tax (WHT) on dividends at 15% rate* (item 7*15%)
|
(600,000)
|
(1,200,000)
|
9
|
Net dividends of the period (item7- item8)
|
3,400,000
|
6,800,000
|
|
|
|
|
10
|
Total income of the shareholder** (-item4+ item9)
|
8,400,000 (5,000,000 of interest+3,400,000 of dividends)
|
6,800,000
|
11
|
Total corporate income tax in Russia (item6+ item8)
|
(1,600,000)
|
(3,200,000)
|
*assuming standard rate for dividends payable to foreign shareholder
**assuming exception of interest from taxation at source according to standard Double tax treaty and ignoring tax implications of country of residency of the shareholder
Withholding of corporate profits tax at source with 20% rate from the interest (assuming absence of a Double tax treaty with country of the shareholder residency) can decrease the difference between those two options, however a loan would continue to be more beneficial than the injection.
If, in the above example, the shareholder had charged a 10% interest rate for the loan, the result would be more effective:
|
Loan
|
Injection into equity (assets)
|
Total income of the shareholder**
|
10,000,000 (100m*10%)
|
6,800,000
|
Total corporate income tax
|
(0)
|
(3,200,000)
|
Therefore, it can be seen that a shareholder can potentially “manipulate” the tax burden by providing financing to a subsidiary with an excessively high loan interest rate and/or by providing a loan instead of equity injection (for financing of long term projects), aiming at getting increased income from, with decreased taxation in, the country of residency of the subsidiary (in Russia).
To address those two possibilities, the Russian Tax Code has the following rules in respect of controlled loans (article 269 of RTC), received from a foreign related party:
- Interest deduction - Interest rates are limited for corporate profits tax deduction purposes in that the interest is recognised as deductible provided that the interest rate of the loan is less than the statutory limit;
- Thin capitalisation rules – Interest deduction is limited to the extent that the cumulative controlled debt exceeds net assets by more than three times. Interest on the excess debt is non-deductible and is treated as a dividend subject to withholding tax. The proportion is calculated at the end of each reporting and tax period.
Interest deduction limit
The threshold interest rates for profits tax purposes for controlled loans (provided in TAX RATES AND ALLOWANCES in the exam):
Loan currency
|
Lower limit
|
Upper limit
|
RR
|
75% of CB key rate*
|
125% of CB key rate*
|
GBP
|
SONIA + 4%
|
SONIA + 7%
|
EUR
|
_STR + 4%
|
_STR + 7%
|
Other currencies
|
SOFR + 4%
|
SOFR + 7%
|
Application of these limits can be illustrated by the following example.
EXAMPLE 1
OOO Apple, incorporated in Greece, holds a 60% equity stake in OOO Pear, a Russian taxpayer of corporate profits tax, for which OOO Pear applies the accrual method.
At 1 October 2022 OOO Apple provided a loan of 1,000,000 Euro repayable in 5 years at 10% per annum to OOO Pear. The quarter interest is payable on the fourth working day of the next quarter.
The net assets of OOO Pear multiplied by three exceeds the value of the loan amount plus interest at the end of the period.
_STR at the end of 2022 is 0.5%.
Exchange rates RR/Euro
31.10.2022
|
90
|
30.11.2022
|
91
|
31.12.2022
|
92
|
Required:
Calculate deductible and non-deductible interest on the loan for corporate profits tax purposes for 2022.
Answer:
The loan is controlled (the Greek company holds 60% which is more than 25%).
Net assets of OOO Pear*3 > the loan amount + interest (according to question data), so the thin capitalisation rules should not be applied.
The exchange rate is given on the last day of each month of the quarter – the date of recognition of the interest expense for corporate profits tax purposes.
Actual interest
October: 1,000,000 Euro*10%*90 RR/Euro*(31 days -1)/ 365 = 739,726 RR
November: 1,000,000 Euro*10%*91 RR/Euro*30 days/ 365 = 747,945 RR
December: 1,000,000 Euro*10%*92 RR/Euro*31 days/ 365 = 781,370 RR
Total actual interest: 2,269,041 RR
_STR 0.5% +7% limit = 7.5% - deductibility threshold.
Deductible interest
October: 1,000,000 Euro*7.5%*90 RR/Euro*(31 days -1)/ 365 = 554,795 RR
November: 1,000,000 Euro*7.5%*91 RR/Euro*30 days/ 365 = 560,959 RR
December: 1,000,000 Euro*7.5%*92 RR/Euro*31 days/ 365 = 586,027 RR
Total deductible interest: 1,701,781 RR
Total non-deductible interest = Total actual interest - Total deductible interest = 2,269,041 RR - 1,701,781 RR = 567,260 RR
Thin capitalisation rules
The Russian Tax Code (article 269) assumes deductible interest attributable to loan only where the loan amount is less than the net assets multiplied by three.
Net assets = Assets – (Total Liabilities - Tax liabilities*)