Changes in Regulation on Undercapitalization: Are All Ambiguities Cleared Up?

The latest changes in the Russian regulation on undercapitalization1 (namely, Article 269. 2-4 of the Tax Code of the Russian Federation) were introduced by Federal Law No.25-FZ of 15 February 2016 on “Amendment of Article 269 of Part 2 of the Tax Code of the RF as Regards Definition of Controlled Indebtedness” (hereinafter FL 25-FZ).

Federal Law 25-FZ as amended eliminated most ambiguities related to application of the Russian regulation on undercapitalization and generalized trends prevailing in judicial and administrative practice as of the date of approval of the law.

At the same time, the language of the law has some ambiguities which may result in real difficulties for taxpayers and disagreements between them and tax authorities.

For example, in FL 25-FZ there is ambiguity as regards identification of the fact which company is “an interrelated foreign entity specified in Article 269.2.1 of the Tax Code of the Russian Federation (FL 25-FZ as amended), that is, which company of the group/holding is a foreign company the debt to which is recognized as a controlled one in accordance with the logic of Article 269 of the RF Tax Code (FL 25-FZ as amended); a company in respect of which all controlled debts are to be totaled; a company whose share of participation in a Russian borrower-entity is to be accounted for in calculating of a capitalization ratio.

In addition to the above, some issues related primarily to correlation of the article in question with other articles of the RF Tax Code, other norms of the Russian legislation and international agreements which the Russian Federation is a party to, rather than the language of Article 269 of the RF Tax Code, remain unsolved. Such issues include the procedure for taxation at source of interests classified as dividends; correlation of the Russian regulation on undercapitalization with norms of double-taxation treaties; taxation of interests classified as dividends with Russian lenders and other.

As seen from practice, plenty of controversial issues arise only at the stage of preparation of tax reporting by taxpayers in accordance with a new legislation. For example, despite a lengthy period of approval of FL 25-FZ and with the text of the draft law being available to the public the issue related to the special status of the Vneshekonombank2 started to be publicly debated only closer to H2 2016.3

As most provisions of FL 25-FZ become effective from 1 January 2017 questions regarding the new legislation on undercapitalization are expected to arise late in 2016 - early in 2017 or even later.

Natalia Kostrykina, Researcher

1 Rules preventing transfer from the Russian Federation of dividends disguised as interest payments.
2 A special status of the Vneshekonombank bans application of FL 25-FZ provisions on recognition as an uncontrolled one of an outstanding debt of a Russian entity-taxpayer to the Vneshekonombank.
3 See, for example, letter No. 03-03-06/1/29269 and Letter No. 03-03-06/3/29266 of 23 May 2016 of the RF Ministry of Finance.