It has always been difficult to develop a long-term tax structure for an IT company, but in the past couple of years things have become even more complicated. Russia has started to revise its international agreements and domestic tax regulations. The rules of the game are changing for large and medium-sized companies in the IT sector.
Many Russian IT businesses were incorporated under the laws of such “prestigious” jurisdictions as Lichtenstein, Switzerland, Malta, the Netherlands, as well as less prestigious ones as Panama, Belize, the British Virgin Islands and some others. The companies located their controlled entities there and optimized taxes on their operations in general.
The Federal Tax Service and the Finance Ministry have lists that include some 100 countries and areas that can be considered offshore countries and low-tax jurisdictions. The second category has always seemed less attractive. First, the taxes, however low, still must be paid there, and second, these countries actively cooperate with the Russian state agencies (in addition to the automated information exchange with most offshore countries).
From Cyprus to Belarus
So it is hardly surprising that over the past three years, from 2018 through 2020, according to a survey by the Kartoteka database, the number of companies affiliated with Russian organizations has reduced significantly, first of all in the popular Republic of Cyprus. This country tops the list of low-tax zones for Russian firms, but only 125 companies were registered there last year, which is three times less than in 2018. Only 22 Russia-related organizations were registered in Seychelles in 2020, 13 times less than in 2018. Belarus, previously unexplored in this regard, is currently the fifth most popular jurisdiction with a soft tax regime. According to Kartoteka, 96 companies were registered there by Russian legal entities in 2020, which is three times more than in 2018. However, this mostly refers to representative offices other than money laundering.
The benefits of offshore companies are not as interesting anymore as they used to be. The Federal Tax Service’s updated list of states (territories) with which it has automated exchange of financial information now includes more than 90 countries. In other words, Russian tax agencies will promptly receive all information about the assets of non-residents in offshore and other areas. Let alone the fact that Russian entrepreneurs that use “simplified” taxation have been feeling increased pressure in the past several months.
Moreover, being under pressure from the Russian authorities, popular jurisdictions are forced to revise or denounce double taxation treaties. For instance, Cyprus, forced by the Finance Ministry, has agreed to increase the tax rate on dividends and interest to 15%. In the Netherlands, those who use this jurisdiction will be subject to double taxation starting January 1, 2022. That is, if dividends paid to a Russian resident were subject to an 8% tax in the Netherlands, and were tax exempt in Russia, next year, the resident will have to pay both the Netherlands’ tax and all Russian income taxes.
The Netherlands scheme was only recently considered to be convenient and time-tested: many Russian companies created holdings and then debited money to an account in a typical offshore related to this country by the colonial history. Naturally, there have been cases when the court found that the Dutch company did not have any actual operations and took away the dividend preference, thus creating reasons to demand additional taxes from such holdings. Not only IT companies but such major businesses as Lukoil, X5 Retail Group and others have been in litigation with the Russian Federal Tax Service in the recent years. This mechanism is no longer reliable. Therefore, most offshore companies have to be ready for unpleasant surprises from the Russian government.
Is imitating real activity efficient?
It would seem there is a simple solution to the problem: carrying out real activities in low-tax jurisdiction, or at least imitating it. In the latter case, question arises as to how much the ‘setup’ may cost. For instance, a company that solely performs money transfers cannot be considered “real”. This would require an office located at the registration address with paid rent as well as personnel, preferably those with proper skills needed to conclude transactions, maintain paperwork, be present in the office, and order office accessories. In case of a software development IT company, it is highly desirable that at least part of its activity should take place at the location.
These initial calculations show that benefits of utilizing such a scheme are close to zero. In early 2021, we were approached by representatives of a well-known IT company who requested to wind down their offshore activities. This is totally understandable: in 2018, this company had to instantaneously spend over 20% of its revenues to set up actual operations in the Netherlands, and at the beginning of this year, they became aware that at least 10% of their business’s turnover would have to be paid to maintain their activities. With the double taxation in effect, the project that aimed to cut costs has proven inefficient, to say the least.
Today, only such giants as Google or Facebook can afford to run their business without any particular problems in zones with eased exchange rate regime. For many years, they have employed the so-called Dutch sandwich technique, which involves the use of a combination of two Irish companies and a Dutch one. Under the scheme, an offshore Irish company grants the licensing rights to a Dutch company, which then transfers sublicense rights to a second Irish company registered in a tax haven. The latter company is the one that conducts operational activities, with fees for rights and dividends kept offshore while the said company shows a minimum amount of profits taxed at a low rate. So far, this smooth technique has worked flawlessly and has been only slightly upgraded each year. The companies are not Russia-based, after all.
Just like other states, our country introduces a growing number of additional measures aimed to counter capital withdrawal and increase local tax collection. The term ‘Google tax,’ which has become quite common in Russia, means that any foreign company that sells its digital products in the Russia’s territory must register as a VAT payer and pay the amount of VAT to the Russian budget. Currently, some 200 international companies have been registered as ‘Google tax’ payers.
Yet, this is a rather light option compared to the concept of digital tax which is either being introduced or considered in more than 120 countries. Its fundamental novelty is dismantling the paradigm that implies that taxes are paid in the location where a company is registered. For the IT industry — and in certain countries for others as well — this scheme is planned to be replaced with a new one, which would require businesses to pay taxes where their profits are gained and consumers are located.
For instance, sales of Kaspersky Lab licenses in China will be subject to further VAT and income tax, while goods sold by AliExpress will also be subject to VAT and income tax to benefit Russia’s budget. This all renders offshore schemes simply useless.
This approach is being actively considered by the Organization for Economic Cooperation and Development (OECD). With discussions underway since 2016 as part of the G20 activities and over 120 countries having joined the efforts in the crisis-ridden 2020, we can expect certain decisions to be made soon.
By Yevgeny Tsaryov, Managing Director, RTM Group