INVESTMENT CLIMATE

How the Life of the Rich Changes

The year turned out to be difficult. It is generally accepted that in difficult times the poor are poorer, and the rich grow rich. The leaders of the American Forbes list stormed new peaks all year; in Russia the movement was multidirectional, yet the dramatic diminution of the reach citizens’ wealth did not happen. Apparently, for this reason, so many events occurred last year in the field of private capital management, affecting the wealthy part of our population.

Credit: depositphotos.com
Credit: depositphotos.com

Introduction of a progressive personal income tax rate

Despite the fact that the possibility of introducing progressive rates has been discussed for a long time – the left political agenda is popular in our country – the news was still unexpected. Since 2019, I have heard more and more questions from customers: when “they” raise the rate.

The professional community could not comment on the rumors, the bill was developed without wide public discussion. In fairness, it is worth noting, that even in an increased form, the income tax rate in Russia is still one of the lowest in the world. We do not record that due to an increase in the rate, any of our customers began thinking about changing Russian residency, as everyone who wanted to move to low-tax jurisdictions, have done this for a long time, although I admit that in some cases this could be the very last straw.

Obviously rate increases will not become the argument for the return either, although some of the individual measures described below may attract wealthy people who have left the country back to Russia. The next logical step to expect is introduction of other – more flexible – criteria for recognition of tax residency of Russia. Now a simple system of calculating days is used, while in most developed countries it is already the concept of a center of vital interests which has been in use for a long time: that is, taxes must be paid in that country with which you and your family have the closest connection. Such an approach can be indigenous in changing the approach of wealthy Russians to choosing a place of residence and force some of them to return to Russia, and others — to break all ties with the country. It is advisable that residency abroad or in Russia in current realities was associated with the presence and real life interests of the beneficiary: that is, according to the general rule, the beneficiary should be followed by his family, and his business, and his bank accounts, and possibly by his family office.

Fixed income tax on foreign companies

Proposal to introduce a fixed tax for controlled foreign companies (CFC) sounded unexpected for many experts – obviously, the tax service is considering the proposal like a certain carrot against the background of a stick — that is, the increase of the personal income tax rate. The idea is very simple – instead of a complex calculation of the income of foreign companies you just have to pay 5 million rubles annually.

Lump sum tax in Russia? Sounds interesting, everyone was waiting for details. When we got acquainted with the text of the law, the situation has become clear: in fact, we are not talking about a fixed tax, but about fixed fee for deferral of tax payment, since when distributing money from CFC to the level of the beneficiary, personal income tax will need to be paid. Until February 1 of this year, there is still time to submit a notice and use the new regime already for the 2019 financial year of the CFC – in fact, there is a rare opportunity to reduce the amount payable for the previous tax period.

We recommend considering a new mode in in the following cases: when significant profit is generated at the CFC level and there are no plans for its distribution, when in the future the beneficiary considers the possibility of moving to low-tax jurisdiction, when there are many foreign companies in the structure and their administration takes a lot of resources, when for one reason or another disclosure of financial statements to the tax service is undesirable. Perhaps this is the only positive news for 2020 for owners of large capital. To determine the feasibility use should carefully analyze each situation with the tax consultant.

Amendment of tax agreements with Cyprus, Luxembourg, Malta and the Netherlands

By the end of the year, it became clear that from 2021, taxation of cash flows with important non-offshore investors – Cyprus, Malta, Luxembourg and the Netherlands – will be changed. On the one hand, ) I want to react emotionally to modification of double taxation agreements (DTA) and say that Russia is only deepening isolation from the outside world. On the other hand, it is worth recognizing that DTA with these countries no longer encouraged real trade and did not stimulate investment from these countries, but helped Russian entrepreneurs to optimize the tax burden. Apparently, real foreign investors will suffer the worst – their interests are not protected now in any way. What’s next? Obviously, the same fate awaits all the agreements of Russia with any more or less significant trade volume.

All these new facts push entrepreneurs either to avoid using foreign structures in principle, or to use more complex business ownership and financing tools that are not covered by the new rules. Such options exist, but an entrance ticket for the use of the foreign structure will become significantly higher than it was before. As a result, we forecast, as the trend to receive its development in 2021, the creation of foreign companies with priority goals being not for business ownership in Russia, but for ownership of family liquid capital. In other words, family-owned purse companies will be more often created abroad that will be replenished with money from their shareholders, formally unrelated to Russian business families. At the same time, Russian business may be directly owned by Russian holding companies. This is a very correct approach – we always recommend sharing the ownership of the family business and the family business finance.

Interest on deposits

For a long time, interest on deposits in Russian banks was actually exempt from taxation, since this year the situation has changed. Since the tax will be withheld and I am sure that many citizens will not know that they began to pay more.

Such a benefit is rare abroad, most often income from deposits is subject to taxation. As a result, income taxation in Russian and foreign banks evened out; for wealthy citizens, most of whom have accounts on both sides of the border, this is an additional argument, unfortunately, not in favor of our banking system. In current market realities where rates are at unprecedented low levels, an alternative to deposits may be to place capital on the securities market based on Russian or foreign brokers or banks. Deposit and securities income are now the same, you still have to find a good manager whom you can trust for this job.

Increased demand for migration services and inheritance

Due to closed borders and covid panic, the professional community expected in 2020 that hereditary planning services and migration services should be in high demand.

According to the results of the year I can confirm: the number of requests for these services has actually increased. Customers made sure that the world is not as global as it seemed earlier, for movement without restrictions is impossible without residence permit or citizenship of another country, in addition to Russia. Meanwhile, in 2020 Cyprus closed its citizenship program for investments popular among Russians, so in Europe, in fact, only the Maltese program and a number of opportunities with residence permit remained. In 2021 we expect the closure of any citizenship programmes for investment in developed countries; probably, options will remain only with Caribbean countries, so anyone who has not yet thought about it earlier, is strongly recommended in 2021 to take up migration planning.

Among the options that exist today, I recommend to consider Malta, Montenegro, Portugal, Grenada and Saint Kitts and Nevis, in the case of citizenship. What about the USA? We recommend obtaining citizenship of this country only in cases where the family really plans to move there. The final choice must always be made based on life plans and goals. If you need a passport only for traveling without a visa, for these purposes relatively low-cost Caribbean programmes would suffice. When the family really plans to move, you need to be guided by the family’s preferences about where to live more comfortably. Our customers consider Portugal, Spain, Italy, Austria, Monaco, Dubai, Cyprus, Malta and a number of other countries as countries suitable for receiving residence permit.

As for hereditary planning, in 2020 everyone discussed several high-profile cases: among them the conflict of the heirs of Dmitry Bosov and the death of the head of Samsung Lee Kun-hee, when inheritance tax amounted to half of the property received. Both situations could be avoided with competent timely planning and creation of structure for capital transmission within the family. We worked on two large-scale hereditary projects in 2020; we are sure that one of the triggers of these tasks was pandemic, although clients did not explicitly confirm this. Unfortunately, the new Russian tools for hereditary planning, namely, hereditary funds, did not yet become popular, so consultants still use wills in Russia and abroad and complex foreign instruments such as trusts and foundations. In this area no novelties should be expected in 2021 – it is unlikely that the Russian jurisdiction will offer something to wealthy citizens for succession planning.

Our recommendation for 2021 is to audit the current structure and simulate stress -test: what will happen to family assets if the controlling shareholder dies? Usually such an exercise shows all the weaknesses of the ownership structure of family capital and identifies risks. Next, you need to draw up a roadmap for risk reduction, usually one of the solutions will be the establishment of a new family structure in the form of a fund or trust, there are no more effective solutions for large capital. We recommend to discuss the roadmap with the family so that its provisions do not become subsequently a surprise to successors.

In practice, the road map phase takes from two weeks to six months; this is the longest stage of hereditary planning. After the roadmap is agreed you need to start implementing its provisions, usually it is a composition of several instruments: will, establishment of a fund or trust, lifetime donation, change in corporate governance in the current structure. Very often, when revising a structure, non-inheritance risks, such as tax or corporate risks, are identified which also can be minimized along with reorganization initiated for other reasons.

By Nikolai Vargasov, head of Legal and Tax Department, UFG Wealth Management

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