Category: Russia

On 8 September 2020, Russian and Cypriot authorities signed* a Protocol amending the applicable double taxation treaty (DTT).

The proposed amendments increase the applicable withholding taxation (WHT) rates for outbound interest and dividend payments, as previously reported.

The signed version of the Protocol is not yet available to the public. According to the draft Protocol* published on 4 September 2020, the current WHT rate for dividends has been increased from the currently applicable rate of 5% or 10% to 15%.

Despite this, the 5% WHT rate will still apply when the recipient of the dividends qualifies as a publicly listed company meeting the following criteria:

• at least 15% of the shares of the receiving company are freely traded on a registered stock exchange; and
• the receiving company holds (for not less than 365 days) at least 15% of the shares in the company paying out the dividends.

Apart from that, a reduced WHT rate will apply to dividend payments made to insurance institutions, pension funds or specific state bodies in Russia and Cyprus.

The Protocol also introduces a 15% WHT rate on interest.

A reduced 5% WHT rate will still apply to interest payable to a publicly listed company that meets the criteria listed above for the application of a reduced WHT rate to dividends.

Moreover, after the Protocol comes into force, exemption from WHT will continue to apply to interest payable to banks, insurance institutions, pension funds or specific state bodies in Russia and Cyprus.

The WHT exemption will also apply to the income received from certain types of securities traded on a registered stock exchange, such as:

• government bonds;
• corporate bonds;
• external loan bonds (e.g. Eurobonds).

The Protocol will likely be ratified* before the end of the year so that the new provisions will apply beginning 1 January 2021.

The amendments represent a compromise reached after several rounds of negotiations between Russian and Cypriot authorities, which took place around the time when Russia announced* that it intended to denunciate the applicable DTT.

Similar amendments to applicable DTTs have also been agreed upon with Malta and Luxembourg, and are being negotiated with the Netherlands.

Take action

Since the agreed-upon amendments to the DTT are expected to come into force as early as 2021, affected businesses should review business and corporate structures involving Cypriot entities and make a preliminary assessment of additional tax exposure resulting from the changes introduced.

In a limited number of cases, and to the extent that this also meets the business goals of the considered structure, businesses may consider transforming existing Cypriot entities into publicly-listed companies or applying the “look-through” approach to income distributed via Cypriot entities to other jurisdictions as ways to neutralise the negative tax effect of the changes.

Alternatively, reorganising existing structures could be envisaged, including reviewing whether it is possible to relocate existing Cypriot entities to Russia or other European jurisdictions offering an attractive tax regime for holding structures.

When analysing applicable alternatives, companies should make sure that there are real economic grounds behind the chosen structuring of the corporate presence and that the substance criteria for the incorporation of the holding companies have been satisfied.

Combatting artificial structures created to mainly or solely evade taxes remains one of the key objectives of developing tax legislation and corporate practices in Russia. This is partly illustrated by the ongoing review of DTTs with jurisdictions frequently used for tax-planning purposes.

* In Russian

By Dominique Tissot, Partner, and Maria Kabanova, Senior Associate, CMS Russia

Hogan Lovells has advised Netflix on its partnership with Russia’s National Media Group.

According to Hogan Lovells, “Netflix is expected to become the first global streaming service to offer a fully localized Subscription Video On Demand service in Russia. 144 million Russian residents will soon be able to access localized Netflix’s content with Russian subtitles, dubbing and local films. Russian regulatory framework for SVOD is extremely complex, and Hogan Lovells team has helped Netflix to navigate it successfully to launch the service in compliance with Russian legal requirements. To enter the Russian market Netflix partnered with NMG, a top Russian media holding.”

“This deal is a game changer for Netflix, and has set new standards for foreign streaming services in Russia, itself a growing population,” commented Moscow-based Partner Oxana Balayan, who led the firm’s team on the deal. “This deal is a testimony of Netflix’ pioneering mindset, drive and professionalism.”

In addition to Balayan, Hogan Lovells’ team included Senior Associates Maria Kazakova, Serafima Pankratova, and Julia Gurieva and Associates Ekaterina Nuzhdova and Denis Shakhov, along with other lawyers in both Moscow and London. 

DLA Piper has advised Sberbank Investments on its secured mezzanine loan to Russia’s Nizhny Novgorod Region and Prosveshcheniye Group for the construction of a training and educational center.

Financial aspects of the deal were not disclosed.

According to DLA Piper, “the educational center in Nizhny Novgorod will have a total capacity of 4,550 seats. The financing consists of a loan from Sberbank, the investor’s own money, and the federal budget, which allocated funding for the 800th anniversary of Nizhny Novgorod.”

DLA Piper’s Moscow team consisted of Partner Leo Batalov, Legal Director Ivan Sezin, and Associate Daria Vasilieva.

Debevoise & Plimpton has advised longstanding client PJSC MMC Norilsk Nickel on its USD 500 million Eurobond offering due 2025 with a coupon rate of 2.55% per annum.

According to Debevoise, the 2.55% coupon rate is “the lowest coupon ever achieved by a corporate or sovereign issuer out of Russia and CIS for any USD-denominated Eurobond public placement.”

Nornickel is a diversified mining and metallurgical company and the world’s largest producer of refined nickel and palladium. The company also produces platinum, cobalt, copper, rhodium, gold, silver, iridium, selenium, ruthenium, and tellurium.

The Debevoise team advising Norilsk Nnickel was led by London Partner James Scoville and included Moscow Partner Alan Kartashkin, International Counsel Dmitry Karamyslov, and Associates Evgenii Lebedev and Timur Ochkhaev. Tax advice was provided by Partner Cecile Beurrier, Counsel Huey-Fun Lee, and Associate Patrick Fasoro.

Debevoise has previously advised Norilsk Nickel on a number of similar finance and capital market matters, including on six previous Eurobond offerings totaling USD 5 billion. Most recently, Debevoise advised Norilsk Nickel on in its 2019 USD 750 million Eurobond offering due 2024 (as reported by CEE Legal Matters on November 4, 2019).

Starting from 1 January 2019, Russia has been implementing a programme of “waste reform” to radically change its municipal waste-management system across the country. Many of the scheduled preparation and organisational arrangements have already been implemented or are in the pipeline.

Reform is lagging behind the declared targets, however, especially concerning the creation of necessary infrastructure.

In this situation, it is of paramount importance for Russia to adopt foreign solutions, in particular the European practice of solving such problems. In our opinion, these challenges open great opportunities for potential investors to implement projects in this field.

This article provides a general overview of ongoing Russian municipal waste management reform with more specific topics discussed in future articles. Our aim is to outline the legal and practical framework for players interested in entering the Russian waste market. 

Background

During the almost 20 years that Federal Law No. 89-FZ “On Production and Consumption Waste” dated 24 June 1998* has been in force, landfills have remained the most common means of disposing of solid household municipal waste (“MSW”). The share of disposable (including recyclable) MSW from the total generated MSW, however, was small.

Moreover, the process of collecting, transporting and deploying MSW was poorly organised and insufficiently controlled by the state.

As a result, existing landfills have become critically overfilled, the number of unauthorised dumps has increased, and the overall situation with MSW management has deteriorated, especially in the Moscow Region and other major cities. In fact, the entire country is facing an environmental crisis.

Measures taken

In 2017 and 2018, the federal government adopted a number of organisational and legal measures aimed at resolving the situation.

As a result, at the end of 2017 Federal Law No. 503-FZ “On Amending the Federal Law “On Production and Consumption Waste” and Certain Legislative Acts of the Russian Federation” dated 31 December 2017* was adopted to initiate reform. 

In 2018, pursuant to Executive Order of the Russian President No. 204 “On National Goals and Strategic Objectives of the Russian Federation through to 2024” dated 7 May 2018*, the Presidential Council for Strategic Development and Priority Projects and the Government of the Russian Federation developed an “Environment” national project introducing a federal “Comprehensive MSW Management System” for implementation by the end of 2024.

The main targets of this federal project include:

• an annual increase in the share of processed MSW from 3% (base value as of 1 September 2018) to 60% of the total generated MSW by 2024;
• an annual increase in the share of recycled MSW from 1% (base value as of 1 September 2018) to 36% of the total generated MSW by 2024; and
• the commissioning of 37.1m tons of MSW processing capacity by 2024.

Plans are in place to build 95 waste processing, recycling and neutralisation facilities, 150 MSW sorting facilities and 40 multi-purpose sorting facilities by 2025.

Main directions of the reform

The implementation of the main arrangements for the reform programme started on 1 January 2019 with the objective of arranging the MSW disposal process (including recycling) and separating the collection of waste in order to significantly reduce landfill waste.

To achieve these goals, each region (i.e. constituent entity of the Russian Federation), except for Moscow, St. Petersburg and Sevastopol where “waste reform” was postponed until 1 January 2022, is required to implement the following measures:

• prepare and approve a territorial waste (including MSW) management scheme, including the description of how waste management should be organised and conducted in each relevant constituent entity;
• select a regional operator, which will serve as the company responsible for MSW management process in the relevant region;
• approve regional MSW management tariffs for legal entities and individuals;
• build waste sorting and waste recycling facilities; and
• introduce a separate waste collection or accumulation system.

In connection with the initiation of this reform programme, powers have also been reallocated among regional and municipal authorities. For instance, administration of MSW management has been shifted from the municipal to the regional level. At the same time, municipalities have been authorised to set up and maintain MSW collection (i.e. accumulation) sites, to organise environmental education and form an environmental culture related to MSW management.

By contrast, federal authorities are responsible for prescribing the procedures for developing and approving territorial schemes of waste (including MSW) management, and for approving investment and production programmes in relation to MSW management.

Today, most regions of Russia have already approved their territorial waste management schemes, selected their regional operators and set relevant tariffs. Many regions are gradually introducing the system of separate (i.e. two-container) collection of waste. As a result, the key organisational arrangements are in a high degree of readiness.

The required regulations have been enacted at the federal level, and a federal scheme of waste (including MSW) management has been drafted. The draft is currently being finalised by experts and is being reviewed by regional authorities for approval by the end of this year.

Challenges and prospects

Despite the organisational and legal arrangements already in place, the problem of insufficient funding for the activities of regional operators remains the main obstacle in implementing “waste reform”.

It was initially intended that MSW management services would be paid through the approved tariffs, which will be charged to citizens and legal entities. In practice, the rates of such tariffs have been higher than payers had expected, resulting in regional operators regularly facing the problem of non-payment. During the current pandemic, the situation has only worsened. As a result, the Russian government has been forced to provide financial support to the most affected operators.

The lack of adequate funding also affects the investment part of the reform programme and, above all, projects for the construction of waste sorting and recycling facilities and related infrastructure projects.

In 2019, the Russian Environmental Operator was established as a special public company to coordinate the activities of regional operators and to ensure the implementation of MSW management measures. An important part of the company’s activities is financing investment projects in this area and attracting private investors.

In addition, existing projects are partially financed by federal and regional budgets. For example, seven of the planned thirteen waste recycling plants have already been built in the Moscow Region. A foreign investor in the Kaliningrad Region is implementing another project: a multi-purpose waste sorting plant and a waste landfill. In addition, the planned construction of four waste recycling plants in the Leningrad Region has been announced in connection with the approval of a territorial waste management scheme.

The current pace of construction, however, is not rapid enough to achieve the federal programme’s objectives as mentioned above.

Consequently, this creates an opportunity for potential investors to implement projects in this area, especially in the creation of waste sorting and recycling plants and related infrastructure, and the supply and installation of necessary equipment.

Obviously, an investor’s guaranteed returns remain an important prerequisite for investing in such projects. In this respect, involving a reliable public partner and a financing party in the project is of particular importance. We also believe that a concession agreement or a public private partnership agreement would best serve the interests of investors.

* In Russian

By Thomas Heidemann, Partner, and Dmitry Bogdanov, Senior Associate, CMS Russia

On 31 July 2020, the Russian President signed Federal Law No. 265-FZ* (the “Law”) enacting a tax manoeuvre for the Russian IT industry. How will this manoeuvre affect domestic and foreign market players in this field?

The Law significantly reduces applicable corporate profits tax and social contribution rates for eligible Russian IT companies. This will create a viable tax environment and aims to be competitive with the tax regimes of other jurisdictions historically supporting IT businesses.

Narrowing the scope of the VAT exemption

From 1 January 2021, the disposal of exclusive and non-exclusive rights to computer software and databases will only be exempt from VAT when it relates to software or databases included in the Russian National Software Register (the“Software Register”).

In order to be included in the Software Register, the following four criteria must be met:

• Exclusive worldwide and unlimited rights to the relevant software or database belong to at least one of the following right holders:
  • the Russian Federation; federal subjects of Russia; a Russian municipality;
  • a Russian citizen;
  • a Russian non-commercial organisation where the controlling corporate body is nominated directly or indirectly by one or more of the above right holders, provided that no foreign legal entity or individual can affect its decisions; or
  • a Russian commercial organisation where more than 50% of the share capital or participatory interest is held directly or indirectly by at least one of the right holders specified above.

• The relevant software or database has been lawfully put into circulation in Russia and, in relation to software, copies or the right to use may be freely commercialised throughout the country. 
• The annual payments under any licence agreements or any other agreements for the benefit of foreign parties or any Russian entity controlled by foreign parties does not exceed 30% of the revenues generated by the right holders from its commercialisation.
• No information or data relating to or contained in software or a database is considered a state secret.

The Russian government can set additional criteria for software and databases listed in the Software Register.

Even if a piece of software is in the Software Register, the VAT exemption under the new rules will not apply to operations with IP rights for software used for advertising, counterparty searches, online trade or marketplace purposes (“Advertising and Marketplace Software”).

At the same time, the Law specifically allows for the application of the VAT exemption to software and databases in the Software Register when they are used via remote access and removes the previously applied requirement to put in place a qualifying licence agreement. As a result, the VAT exemption should now be explicitly applicable to SaaS (Software as a Service) products which do not qualify as Advertising and Marketplace Software and are listed in the Software Register. Previously, the application of the VAT exemption to SaaS products was disputable. The Law removes this legal uncertainty. 

Until the Law comes into force on 1 January 2021, the VAT exemption applies to both cross-border and domestic disposals of exclusive and non-exclusive rights to software granted under qualifying licence agreements. This exemption is frequently used both by IT businesses and companies belonging to different sectors of the economy which actively use international software products in their commercial activity, including those acquired as a result of intragroup flows. From 1 January, this VAT exemption will no longer be available to software held by foreign market players and local subsidiaries belonging to or essentially controlled by international groups.

Introduction of new tax incentives for the IT industry

Taxpayers eligible for incentives

Under the Law, new corporate profits tax and social contribution benefits will be granted to Russian IT companies meeting the following criteria:

• A company holds a state accreditation certificate as an IT company.

  A company has the right to obtain this state accreditation provided that it is incorporated in Russia and when, regardless of its legal form and form of ownership, it carries out the following activities in the field of information technology:

  • developing and implementing software and databases on physical media or in electronic form, regardless of the type of contract; and/or
  • providing services (performing works) for the adaptation, modification, installation, testing and/or maintenance of software and databases.

• Revenue from the company’s core IT activity makes up at least 90% of its total income in a single tax reporting period.

  The Law expressly excludes revenues generated by Advertising and Marketplace Software from the eligible IT revenues.

  At the same time, income from SaaS products should qualify as core IT revenue for the purpose of benefits.

• The average number of employees is not less than seven people for a single tax reporting period.

Corporate profits tax implications

As of 1 January 2021, taxpayers meeting the above criteria will benefit from a reduced corporate profits tax rate of 3% instead of the general tax rate of 20%.

At the same time, the Law abolishes the currently applicable right of IT companies to immediately deduct hardware costs instead of gradually recognising such costs through depreciation payments. 

Social contribution rate reduction

As of 1 January 2021, eligible IT companies will enjoy the following reduced rates:

Cumulative social contribution rate (for revenues below the maximum base for social contributions):

• Old rules (applicable in 2020) 30%
• New rules 7.6%

Compulsory pension insurance rate:

• Old rules (applicable in 2020) 22%
• New rules 6%      

Compulsory social insurance rate:

• Old rules (applicable in 2020) 2.9%
• New rules 1.5%

Compulsory medical insurance rate:

• Old rules (applicable in 2020) 5.1%
• New rules 0.1%

Comments

The Law can be seen as having both positive and negative consequences. And the drawbacks could outweigh the Law’s benefits.

Benefits 

The main aim of the Law is to make the Russian market more attractive for software developers, which should result in the growth of the domestic IT sector. To this end, the Law proposes one of the lowest corporate tax rates in the world for this activity.

The significant reduction in social contribution rates should also allow eligible IT companies to increase salaries, which will enhance their local workforce.

In parallel, since the VAT exemption is custom-tailored to apply primarily to local IT companies, this will provide the Russian IT sector with an additional competitive advantage over international market players distributing foreign software in Russia.

Drawbacks

The long-term effect of the IT tax manoeuvre on various sectors of the Russian economy currently remains unclear. 

The Law contains a rather specific definition of eligible IT activities, which excludes certain IT companies, including local IT giants, that generate most of their revenues from advertising, online trade and marketplace activities.

Also, the introduction of an attractive tax regime should normally run in parallel with the creation of a safe and stable legal environment in this sector, which has not, in our view, been provided. The arrival to Russia of more foreign companies that localise their software development would require additional legal adjustments.

Narrowing the scope of the VAT exemption will not necessarily place additional pricing pressure on operations with Russian B2B customers, who should be in a position to neutralise the VAT effect (wholly or partly) by offsetting the corresponding input VAT against local VATable flows. 

However, additional costs associated with the acquisition of foreign software are difficult to avoid for customers who do not enjoy the right to offset VAT, including:

• customers in the B2C sector;
• customers belonging to VAT-exempt sectors of the Russian economy (e.g. banks and financial organisations); and
• local IT companies specialising in software exports. 

Furthermore, introducing VAT on previously exempt flows will give rise to new obligations for foreign providers of electronic services in Russia. More specifically, such e-service providers, which previously filed simplified reporting to Russian tax authorities for VAT-exempt activities, will now need to manage full-fledged local VAT reporting and payment routine, or agree to delegate their obligations to their Russian customers. In addition, the increased VAT burden for the previously exempt flows will automatically increase the penalties for non-compliance with the specific VAT rules for e-service providers.

Finally, the Law does not provide for any transition period, and the new rules will already apply in 2021. This leaves little time to make the required adjustments.

Action required from IT companies

Affected IT market players should assess the influence of the above developments on their Russian business and pricing models, and determine whether they can benefit from the newly introduced incentives if they localise their products in Russia. Should this be impossible or impractical, they should carefully review their contractual arrangements with Russian customers, especially those formalising the provision of e-services to anticipate and cover additional tax obligations in Russia.

* In Russian

By Dominique Tissot, Partner, Anton Bankovskiy, Partner, Maria Kabanova, Senior Associate, Anna Osmakova, Associate, Irina Shurmina, Senior Associate, and Ksenia Danshina, Associate, CMS Russia

Egorov Puginsky Afanasiev & Partners has advised US-based Clemco International, a manufacturer of air-powered abrasive blasting equipment, on IP, corporate, customs, and regulatory matters in Russia.

According to EPAM, the firm advised Clemco International on “potential options to do business in Russia and other related corporate matters, as well as on the certification of products, distributor relations, and protection of trademark rights.”

The Egorov Puginsky Afanasiev & Partners team included Counsels Elena Agaeva and Alexey Karchiomov, Senior Associate Daria Sergeeva, and Associate Yulia Belyakova.

Egorov Puginsky Afanasiev & Partners has provided BNP Paribas Fortis Private Equity Belgium with a red flag analysis of contracts for the provision of freight forwarding and customs representative services and storage.

According to EPAM, “the research was conducted in connection with a potential investment by [BNP Paribas] in the group of commodity trading Russian companies. During the project, the attorneys identified some red flags, in particular, the lack of registration of the contractor – a transport company – which was necessary for customs clearance. The conclusions of the analysis helped to protect [BNP Paribas] from potential contractual risks as well as to develop an effective strategy in accordance with the legislation of the Russian Federation for its future investments.”

The Egorov Puginsky Afanasiev & Partners team included Counsel Alexey Karchiomov, Associate Yulia Beliakova, and Paralegal Arina Nikulushkina.

On 8 July 2020, the Presidium of the Russian Supreme Court approved a Review* on specific issues of judicial practice related to the adoption of measures by the courts to counter illegal financial transactions.

These clarifications by the Supreme Court allow Russian courts to play an active role in identifying and stopping suspicious financial transactions, which participants are trying to legalise through the Russian judicial system.

At the same time, there is a high risk that good-faith plaintiffs who are trying to recover real debts may fall under the scrutiny of judicial authorities. In this case, they will have to bear the additional burden of proof, which could mean justifying their financial ability to transfer money to a defendant. This, in turn, will require additional effort from plaintiffs and will increase the time frame of cases.

Review in a nutshell

The Supreme Court indicated that a court when considering a case has the right to involve state bodies in proceedings if evidence arises of the legalisation of illegally obtained income. In particular, the Supreme Court pointed to the possibility of involving prosecutors, tax and customs authorities, the Bank of Russia and Rosfinmonitoring.

If state authorities were not involved in a case, they have the right to file an application with the court for revising the judicial act on the basis of newly discovered circumstances, if circumstances indicate that the lawsuit’s participants violated anti-money laundering laws.

Using the example of specific cases, the Review also examined situations in which bad-faith individuals and organisations initiated lawsuits in order to legalise illegal financial transactions (i.e. to give a legitimate appearance to the possession, use and disposal of funds or other assets acquired illegally).

In particular, attempts to legalise illegal transactions were identified in disputes involving:

• equipment supply agreements;

• construction contracts;

• agency agreements; 

• promissory notes;

• loan agreements;

• credit agreements;

• sale-purchase agreements; 

• bank guarantees; and 

• compensation claims for unjust enrichment.

When considering these cases, the Supreme Court stated that the courts had noted circumstances where parties to a dispute tried to recover debts based on fictitious obligations and documents. For example, in one case regarding the recovery of a major loan, the court demanded that the plaintiff confirm that it possessed the funds allegedly transferred to the defendant as debt. The plaintiff could not do this, but at the same time the defendant did not deny the transfer of funds.

Tax and financial accounts sent to the courts by state authorities also confirmed the doubts of the courts (e.g. the debts recovered were not reflected in the tax records of the plaintiff).

As a result, the courts decided to dismiss claims, even though the defendants had recognised the fictitious debts.

According to the Supreme Court, if there are reasonable doubts about the legitimacy of a party’s intentions, a court should also not approve a settlement agreement. Neither should it accept a defendant’s acknowledgment of the claim.

Courts should take a similar approach when considering recognition and enforcement of a foreign court judgment or a foreign arbitral award on the issue of a writ of execution for the enforcement of an arbitral award.

During the proceedings, if signs of an economic crime are revealed, the court must report this to law-enforcement agencies.

Comments

The explanations given in the Review impose on the courts a new and not fully standard task to stop attempts to legalise funds through court decisions.

Courts are expected to pay special attention to disputes in which the plaintiff is a foreign company since these cases carry the risk of an outflow of funds from Russia.

Therefore, foreign companies should take additional care when concluding an agreement, and do the following:

• pay special attention to checking the background of counterparties (KYC procedures);

• carefully record all stages of fulfilment of contracts (import of goods to Russia, performance of contract work, transfer of borrowed funds, etc.); and

• be prepared to prove the real creation and existence of a debt in court.

In practice, we have already had to participate in disputes where a court, on its own initiative, involved Rosfinmonitoring in a case. However, carefully selected evidence convinced both the regulator and the court of the legitimacy of the foreign company’s claims.

* In Russian

By Konstantin Baranov, Partner, and Igor Sokolov, Senior Associate, CMS Russia

White & Case has advised Raiffeisenbank on a loan of up to USD 127 million to Rosvodokanal.

Rosvodokanal is a Russian water utilities and water management company. According to White & Case, “Rosvodokanal’s facilities currently provide access to clean water for 5.5 million users and more than 40,000 companies. Rosvodokanal operates a network of water supply and sewerage utilities with a total length of over 16,500 kilometers. The company accounts for more than 20 percent of the market for private operators of water supply and sanitation in Russia.”

White & Case’s Moscow team was headed by Partner Natalia Nikitina, and included Local Partner Ekaterina Logvinov and Associates Rimma Izmaylova, Azamat Gaisenov, Adel Shageev, Maria Kulmukhametova, and Victoria Pimkina.

White & Case declined to provide additional information about the deal.