Interests and dividends

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).

*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:

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):

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

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*)

* 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 as actual interest divided by 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 2022 year:

Other numbers are as per example 1.

Required:
Calculate deductible and non-deductible interest for 2022 year 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 2022 = 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 + non-paid 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 to Thin capitalisation rules - 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 rules 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 which amount exceeds net assets multiplied by three.  

Dividends

General rules of taxation at source

A subsidiary which pays dividends should act as a tax agent in respect of those dividends 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 paid to Russian shareholders (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 Russian shareholders**: 13%
• Tax on dividends for foreign shareholders**: 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.

**Provided in TAX RATES AND ALLOWANCES in the exam.

EXAMPLE 3
OOO Violet has the following shareholders on 31 June 2022, 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 on 30 April 2022 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 2022.

Answer:

OOO Yellow, the Russian company (has held 55% of the shares for more than two years)

OOO Red, the Russian company, holds 15% of the shares

Orange BV, the Netherlands company, holds 30% of the shares

Special rule for transit dividends within Russia

If a Russian company pays dividends to a Russian legal entity or a Russian resident (who stays in Russia for more than 183 calendar days within 12 consecutive month) and at the same time receives dividends from a Russian company, 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. And visa-versa dividends, which were never being taxed (or taxed at 0% tax rate), should not be deducted from dividends taxed at 13% rate.

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 2022 for 2021 year:

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 2022.

OOO Yellow, the Russian company (holds 55% shares for two years)

OOO Red, the Russian company, holds 15% shares

* 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.

Written by a member of the TX (RUS) examining team