New items have been added to the existing conditions for performing transactions involving hostile non-residents disposing of shares of and membership interests in Russian Joint Stock and Limited Liability Companies
Pepeliaev Group advises that the Government Commission on Monitoring Foreign Investment in Russia (the “Government Commission”) has supplemented the list of conditions for carrying out (performing) transactions (operations) with a view to disposing of securities including shares of and membership interests (contributions) in the issued capital of Russian business entities in which “hostile” non-residents (persons under their control) participate.
We remind you that the extract from Minutes No. 118/1 dated 22 December 2022 of the Government Commission’s meeting, which was previously published, contained a number of conditions[1]. When deciding on whether to permit transactions (operations) where “hostile” non-residents aim to dispose of shares of and membership interests in the issued capital of Russian business entities, the regulator paid attention to compliance with these conditions, including whether there was an independent appraisal of the market value of assets, whether a discount was provided of at least 50% of the market value of corresponding assets, etc.
The extract from Minutes No. 143/4 dated 2 March 2023 of the Government Commission’s meeting[2] (the “Extract from the Minutes”), which was published on the Ministry of Finance’s website on 27 March 2023, supplements the terms and conditions of Minutes No. 118/1 of the Government Commission’s meeting with the following:
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the obligation to contribute voluntarily to the federal budget at least 10% of the halved market value of the relevant assets as indicated in the asset valuation report;
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he obligation to make a voluntary contribution to the federal budget equalling at least 10% of the market value of the relevant assets specified in the asset valuation report, if the assets are sold with a discount exceeding 90% of their market value specified in the asset valuation report.
Comment
The wording is exquisite in its own way — the “obligation (!) to make a voluntary (!!) contribution to the federal budget” — but unfortunately leaves questions that are already arising in practice when transactions involving the disposal of assets are approved and performed.
1) Who is this obligation vested in, the seller or the buyer? Following economic logic, the obligation must presumably be vested in the seller, and the buyer must bear a separate obligation to withhold the relevant amount from the funds owed to the seller and pay it to the state budget (in the same way that a buyer acts as a tax agent for profit tax purposes when it pays to a foreign seller the price of the Russian property being acquired – article 309(1)(6) of the Russian Tax Code). Yet, if the discount comes to more than 90% of the market value of the assets (clause 2 of the Extract from the Minutes) this option is impossible, as the price will be lower than the amount to be voluntarily paid to the state budget.
If it is required to transfer to the state budget 10% of the halved market value of the assets (clause 1 of the Extract from the Minutes), then it may be assumed that both options are possible at the choice of the parties (or the Government Commission?), i.e. the obligation may be imposed on either the seller or the buyer as the parties may decide.
2) Connected with the first question is the next tax issue: may the buyer reduce the taxable profit by deducting expenses in the amount of the funds transferred to the state budget?
If these funds are transferred out of what belongs to the seller, then, for the buyer, this is just a part of the price of the assets and, consequently, together with the entire price it forms part of the expenses for profit tax purposes under the same procedure as the value of the asset (for instance, the expenses on purchasing membership interests in a limited liability company or shares are generally deducted at the time when they are subsequently disposed of – see article 268 and 280 of the Tax Code).
However, if the price of the transaction is determined without taking account of the “voluntary” contribution, and the buyer makes this contribution out of its own capital, the inspectorate may point out that the transfer is made on a non-repayment basis and therefore the buyer may not deduct this contribution as expenses (article 270(16) of the Russian Tax Code). At the same time, we believe this approach to be incorrect. It may be reasonably argued that these expenses are a compulsory requirement for obtaining the government’s approval for a transaction involving the acquisition of assets, and, therefore, the expenses are economically justified and must be deducted from the taxable profit of the buyer. A detailed justification of this position requires that the terms of a specific transaction be analysed.
3) Technical problems are also possible if the buyer is a foreign company from a “friendly” jurisdiction. Settlements may then be performed between foreign banks and the very procedure of a voluntary contribution to the Russian state budget (whichever party to the transaction makes it) may give rise to questions.
Please be reminded that the Russian President’s Decrees No. 618[3] dated 8 September 2022 and No. 81 dated 1 March 2022[4] (the “Decrees”) have introduced restrictions on carrying out transactions (operations) that result in ownership title to securities arising, and transactions (operations) which directly and/or indirectly entail the establishment, modification or termination of rights of ownership, the use and/or disposal of membership interests, as well as other rights which allow for conditions to be determined subject to which Russian LLCs should manage and/or pursue their entrepreneurial activities if these transactions are entered into involving ‘hostile’ non-residents[5] (with certain exceptions). Such transactions can be carried out only if permission to that effect has been obtained from the Government Commission.
What to think about and what to do
The Extract from the Minutes is not direct permission to make transactions (operations) that meet the conditions set forth in it. Even if a transaction (operation) is in full compliance with such conditions, it remains necessary to obtain the permissions specified in the relevant Decrees of the Russian President for such transactions (operations) to be carried out.
On the other hand, we believe that the non-compliance of a transaction (operation) with the conditions set out in the Extract from the Minutes is highly likely to be the basis for a refusal to issue the necessary permission. On this basis, we recommend adhering to the criteria established by the Government Commission when working out the terms of transactions (operations) for the disposal of shares of or membership interests in Russian JSCs and LLCs by ‘hostile’ non-residents or persons under their control.
Help from your adviser
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Within its range of services, Pepeliaev Group provides legal support for various aspects of companies’ operations connected with corporate legislation, in particular, with the support of transactions involving membership interests in LLCs and shares of JSCs, including advising on the tax implications of such transactions.
[1] We have written previously about these minutes of the Government Commission’s meeting: link.
[2] To access the Extract from the Minutes, please go to: link.
[3] The Russian President’s Decree No. 618 “On the special procedure for specific types of transactions (operations) to be carried out (performed) between certain parties” dated 8 September 2022. To access the electronic version, please go to: link.
[4] The Russian President’s Decree No. 81 “On additional temporary measures of an economic nature to secure financial stability of the Russian Federation” dated 1 March 2022. To access the electronic version, please go to: link.
[5] The list of “hostile states” is set out in Directive No. 430-r of the Russian Government dated 5 March 2022.