Interest deduction and dividends treatment for corporate profits tax purposes are regularly examined in the TX (RUS) exam, although such questions are generally not answered as well as would be expected. This article will cover these topics within items C2bi, C2biii and C3bxii of the Syllabus and Study Guide.
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).
| Loan | Injection into equity (assets) | |
| RR | RR | |
| Loan provided (interest at 5% pa) | 100,000,000 | |
| Funds provided by injection into equity (assets) | 100,000,000 | |
| Corporate profits tax base of the period before interest and tax | 10,000,000 | 10,000,000 |
| Interest deductible | (5,000,000) | |
| Corporate profits tax base of the period | 5,000,000 | 10,000,000 |
| Corporate profits tax at 20% rate | (1,000,000) | (2,000,000) |
| Net income of the period | 4,000,000 | 8,000,000 |
| Withholding corporate profits tax on dividends at 15% rate* | (600,000) | (1,200,000) |
| Net dividends of the period | 3,400,000 | 6,800,000 |
| Total income of the shareholder** | 8,400,000 (5,000,000 of interest+3,400,000 of dividends) | 6,800,000 |
| Total corporate income tax in Russia | (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.
If, in the above example, the shareholder had charged a 10% interest rate for the loan, the result would be the following:
|
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, aiming at getting increased income from, with decreased taxation in, the country of residency of the subsidiary.
To address those two possibilities, the Russian Tax Code has the following rules in respect of controlled loans, received from a foreign related party:
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 |
GBP LIBOR + 4% |
GBP LIBOR + 7% |
EUR |
EURIBOR + 4% |
EURIBOR + 7% |
USD |
USD LIBOR + 4% |
USD LIBOR + 7% |
CHF |
CHF LIBOR + 2% |
CHF LIBOR + 5% |
Other currencies |
USD LIBOR + 4% |
USD LIBOR + 7% |
Application of these limits can be illustrated by the following example.
EXAMPLE 1
OOO Apple, based 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 of 2021 OOO Apple provided a loan of 1,000,000 Euro repayable in five years at 10% per annum to OOO Pear. The interest is payable by the fourth working day of the next month.
The net assets of OOO Pear multiplied by three exceeds the value of the loan amount plus interest at the end of the period.
EURIBOR at the end of quarter (Q4) 2021 is 0.5%.
Exchange rates RR/Euro
31.10.2021 |
90 |
30.11.2021 |
91 |
31.12.2021 |
92 |
Required:
Calculate deductible and non-deductible interest on the loan for Q4 2021 for corporate profits tax purposes.
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, 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
EURIBOR 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
The Russian Tax Code 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*)
* Tax liabilities do not include social insurance contributions.
The rule prescribes that if controlled liabilities (loan amount plus unpaid interest) is more than the net assets multiplied by three at the end of the period, the threshold of deductible interest should be calculated using the coefficient of capitalisation.
The capitalisation coefficient = controlled liabilities (loan amount + unpaid interest)/(net assets *3*percentage of shareholding of the lender)
EXAMPLE 2
Modifying some of the data in example 1, to illustrate how thin capitalisation rules work in practice.
OOO Pear has the following data at the end of Q4 2021:
Assets |
150,000,000 |
Total liabilities |
125,000,000 (including the loan and interest) |
Tax liabilities (included above) |
2,000,000 |
Other numbers are as per example 1.
Required:
Calculate deductible and non-deductible interest for Q4 2021 in respect of the loan.
Answer:
Net assets = 150,000,000-(125,000,000-2,000,000) = 27,000,000 RR
Loan amount at the end of Q4 2021 = 1,000,000 Euro*92 RR/Euro = 92,000,000 RR
Total actual interest from example 1: 2,269,041 RR
Loan amount 92,000,000 + 2,269,041 (interest) > net assets*3 (27,000,000*3 = 81,000,000 RR)
So the thin capitalisation rules should be applied.
Coefficient of capitalisation = (Controlled loan + interest)/(3*Net assets*percentage of shareholding of the lender) = (92,000,000 + 2,269,041)/(3*27,000,000*60%) = 1.94
Amount of deductible interest threshold under thin capitalisation rules = 2,269,041 / 1.94 = 1,169,609 RR
Deemed dividends = 2,269,041 - 1,169,609 = 1,099,432 RR
Withholding Corporate Profits Tax from deemed dividends = 1,099,432 *15%=164,915 RR
Deductible Interest = Total actual interest - Total non-deductible interest due to excess of interest rate above the statutory limit - Deemed dividends = 2,269,041 - 567,260 – 1,099,432 = 602,349 RR
Or
Deductible Interest = Upper threshold of deductible interest - Total non-deductible interest due to excess of interest rate above the statutory limit = 1,169,609 - 567,260
= 602,349 RR
There will be no exact correlation between deductible interest and net assets multiplied by three and the interest rate (within the limits) because the Tax Codes applies the capitalisation coefficient to actual interest, not to interest attributable to the interest rate within statutory limits. This discourages taxpayers from concluding controlled loan agreements where the amount exceeds net assets multiplied by three.
A subsidiary which pays dividends should act as a tax agent and withhold corporate profits tax (hereinafter referred to as tax on dividends or withholding tax) at the time of the dividend payment. Dividends are taxed with the following rates:
Tax on dividends for residents (which continuously holds not less than 50% of shares for more than 365 calendar days at the time of dividend distribution*): 0%
Tax on dividends for residents: 13%
Tax on dividends for foreign companies: 15%
* Distribution of dividends means the making of an official decision by shareholders to allocate a particular share of retained earnings (which can include earnings of previous and/or current year/period) to dividends and setting a particular date or period for payment.
EXAMPLE 3
OOO Violet has the following shareholders on 31 June 2021, when dividends were paid:
OOO Yellow, a Russian company (holds shares for two years): 55%
OOO Red, a Russian company: 15%
Orange BV, a Netherlands company: 30%
OOO Violet has a corporate profits tax base of 25,000,000 RUR in 2020.
Shareholders decided to distribute 100% of retained earnings for 2020.
Required:
Calculate tax on dividends (withholding profits tax) and the net amount of dividends paid on 31 June 2021.
Answer:
| Corporate profits tax base | ||
| Profits tax at 20% rate | ||
| Retained earnings for 2020 |
OOO Yellow, the Russian company (has held 55% of the shares for two years)
| Gross dividends attributable to OOO Yellow | ||
| Withholding tax at 0% (holds not less than 50% for more than 365 days) | ||
| Net Dividends to be paid to the shareholder |
OOO Red, the Russian company, holds 15% of the shares
| Gross dividends attributable to OOO Red | ||
| Withholding tax at 13% (holds less than 50%) | ||
| Net Dividends to be paid to the shareholder |
Orange BV, the Netherlands company, holds 30% of the shares
| Gross dividends attributable to Orange B.V. | ||
| Withholding tax at 15% (foreign company) | ||
| Net Dividends to be paid to the shareholder | ||
| Total amount of withholding tax |
If a Russian taxpayer pays dividends to a Russian legal entity or a Russian resident and at the same time receives dividends from a Russian taxpayer, special formulae should be applied in respect of taxation of those distributable dividends at source. Generally, incoming dividends should be deducted from distributable dividends, because incoming dividends were already taxed at source. And the same income after tax, distributable within Russia, should not be taxed twice.
So the following formulae to calculate corporate profits tax at source should be applied:
T = P * R * (D1 - D2), where:
T – Corporate Profits Tax that should be withheld from dividends payable to a Russian legal entity or a Russian resident;
P – share of dividends distributable to the shareholder (a Russian legal entity or a Russian resident);
R – applicable tax rate;
D1 – total amount of dividends distributable to all shareholders;
D2 – total amount of dividends, received by the Russian taxpayer, acting as a tax agent (except for received dividends, taxed at source at 0% withholding tax rate).
EXAMPLE 4
Adding some data to the previous example to illustrate how the rule for transit dividends within Russia works in practice.
OOO Violet received dividends from the following Russian subsidiaries in February 2021:
OOO Black, where 100% shares are held by OOO Violet for five years – 5,000,000 RR
OOO White, where 20% shares are held by OOO Violet for six months – 7,000,000 RR
Required:
Calculate the tax on dividends (withholding profits tax) and net amount of dividends paid on 31 June 2021.
OOO Yellow, the Russian company (holds 55% shares for two years)
| Gross dividends attributable to OOO Yellow | ||
| Withholding tax at 0% (holds not less than 50% for more than 365 days) | ||
| Dividends to be paid to the shareholder |
OOO Red, the Russian company, holds 15% shares
| Gross dividends attributable to OOO Red | ||
| Withholding tax at 13% (holds less than 50%) | ||
| Dividends to be paid to the shareholder |
* Dividends from OOO Black should not be included as they were taxed at 0% withholding tax rate at source because of holding not less than 50% (100% shares) for more than 365 days (five years).
For Orange BV, the Netherlands company, the taxation will not change as the rule is not applicable to foreign companies.
| Gross dividends attributable to Orange B.V. | ||
| Withholding tax at 15% (foreign company) | ||
| Dividends to be paid to the shareholder | ||
| Total amount of withholding tax |
Written by a member of the TX (RUS) examining team