Pitfalls of foreign business in Russia ©Economy and Life

Despite all difficulties, Russia is still of considerable interest to foreign investors. However, doing business in our country has certain features and sometimes is associated with serious risks. How can a foreigner start to conquer the Russian market with correct position in law, and what pitfalls can he face here?

Choosing honest counterparties

But on Aristotle’s view, the lives of individual human beings are invariably linked together in a social context. In the Peri PoliV he speculated about the origins of the state, described and assessed the relative merits of various types of government, and listed the obligations of the individual citizen.

First of all, a foreign investor needs to keep in mind that Russia with the first President of the Russian Federation Boris Yeltsin and Russia with the current Head of state Vladimir Putin are completely different countries in their legal nature. Today, Russians already know what private property is, and the state understands the importance of transparent business relationships and is doing everything possible for companies to work “in white” and to pay all the required taxes.

At the same time, it is necessary to realize that certain risks still exist. First of all, they are connected with the fact that there are still entrepreneurs in the country who are eager to earn more money at any way, including those who do not pay taxes. This is perhaps the main danger for a foreign businessman. The question is: what the matter to a foreign investor to business practices of some unscrupulous Russian entrepreneurs? The thing is that the modern business community in Russia is still not used to pay absolutely all taxes. And the Russian tax authorities, in turn, do not have a formal purpose of applying additional charges to such companies, which  ignore the obligation to pay taxes, but the task of actually filling the state budget, that is, actually getting tax debts from companies which are able to pay.

Thus, the first conclusion that can be made: a foreign investor needs to work only with those Russian conscientious counterparties who pay taxes honestly.

At the same time, however, a foreign businessman needs to take into account one more thing: nowhere in the Russian legislation is the concept of a “bona fide counterparty” fixed, it is simply blurred in numerous court practice. In this regard, a foreign investor needs to develop, independently or with the help of professional consultants, the method of checking counterparties in order to avoid problems in the future, including relations with Russian tax and law authorities.

What purpose will pursue such a test?

1. Creation of conditions for the rejection of all possible claims of tax and law enforcement authorities related to the exclusion from the structure of income tax expenses and the failure to deduct the amount of value added tax (hereinafter referred to as VAT) paid to a dishonest supplier.

2. Preparation of an evidence base in the event of a possible tax dispute in order to confirm the reality of the relationship with the “problem” counterparties.

3. Prevention of possible negative civil legal consequences associated with the supply of goods (completing of works, provision of services) from an unreliable counterparty.

By the way, it is also advisable at the same time to develop and implement a receivables management method in the company. Unfortunately, in Russia, the promise to pay on time, given by the counterparty,  in fact may turn into costly lawsuits, and due to the increasing incidence of bankruptcy of legal entities, the foreign partner can get nothing from the counterparty to whom he delivered the goods (done the work, rendered the service), and the goods will not be returned. And this is a direct loss.

Beneficiaries under threat

Nowadays, the country has set the vector of tax liability not for nominal directors and owners of companies, but for specific ultimate beneficiaries, that is, individuals who actually manage the business and make strategically important decisions for it.

So, in the Russian criminal legislation there is a rule that eliminates the criminal liability of nominal persons if the latter indicate specific beneficiaries, that is, true business owners. Russian bankruptcy laws are also changing towards prioritizing the satisfaction of tax authorities and the application of subsidiary liability to companies’ beneficiaries. What is it done for? The answer is simple: the state understands that only a specific person (the beneficiary) will look for money to pay off the debt to the state to be not imprisoned, only such a person can have enough property to meet the demands of the fiscal authorities.

By the way, especially for cases when even the beneficiary is unable to pay the state, Federal Law dated December 29, 2014 No. 476-FL “On Amendments to the Federal Law“ On Insolvency (Bankruptcy) ”and certain legislative acts of the Russian Federation in terms of regulation the rehabilitation procedures applied in relation to a citizen-debtor ”were amended in the Federal Law of October 26, 2002 No. 127-FL“ On Insolvency (Bankruptcy) ”, allowing the bankruptcy procedure to be applied to individuals.

At the same time, it is worth paying attention to the fact that the bankruptcy mechanisms are nowadays used not only by fiscal authorities, but also by unscrupulous counterparties, who consider bankruptcy to be a tool for capturing the business they like. A foreign businessman being far from Russian realities has to understand that if he does not have a majority creditor in bankruptcy, then in 90% of cases he will lose his business in our country forever. And if the bankruptcy also affected his company, to which all assets (fixed assets) were brought, then it would be almost impossible to “pull out” them in the absence of peculiar control over the bankruptcy procedure.

“Surprise” from the bank and tax authorities

It should be borne in mind the significant risks associated with the changes in the Federal Law dated August 07, 2001 No. 115-FL “On Counteracting Legalization (Laundering) of Proceeds from Crime and Financing of Terrorism” (hereinafter referred to as Law No. 115). -FL), which allowed credit organizations to suspend operations on accounts and even block the latter. In practice, it looks like this.

For example, a company needs to make a payment in favor of a foreign person, including, possibly, transferring dividends to it. However, as soon as the relevant payment order is “suspended” in banking, the bank’s security service almost in 90% of cases immediately blocks account transactions. In the future, the client of the bank will have to prove that the payment is made lawfully and the transfer of money abroad does not have the goal of legalizing (laundering) the proceeds from crime. Moreover, many “top” banks have already introduced the Traffic Light counterparty system for Russian companies, so now these “surprises” associated with the blocking of accounts under the Law No. 115-FL can be unexpectedly obtained when calculating the Russian counterparty, if the latter is on the “black list” of the bank due to suspicious transactions falling within the norms of the Law No. 115-FL.

Tax authorities are not lagging behind banks. This fall, they began to practice a new approach, which consists in deciding on the blocking of accounts, as well as any registration actions with a legal entity on the basis of the inconsistency of the legal entity’s address. If the legal address specified by the company in the Unified State Register of Legal Entities (hereinafter – USRLE) is not confirmed, the fiscal authority makes an entry in the Unified State Register of Invalidity of the address of its location. That is, if a legal entity is only registered at one or another address, but in reality it is not there, such an entry in the Unified State Register of Legal Entities will certainly appear – with all the ensuing consequences. This makes it very difficult to work with contractors, because for this reason the company becomes unreliable for them.

Protecting comprehensively

What is the result? Is it better for a foreigner not to work in Russia at all? Of course, not. The Russian economy is developing at a very good pace, and today there are all the prerequisites that a foreign businessman, who has invested his knowledge and skills in business, as well as experience gained in economically more developed countries, can occupy a decent niche in the relevant business sector in Russia. It is necessary to know the local risks and to take the necessary steps in advance so that these risks never appear in practice.

How to avoid the risks described above? Our answer is simple: building a business in Russia, you should act strictly within the law, competently building a legal structure with the assistance of experienced consultants and applying only those tax optimization mechanisms that are allowed by Russian law.

And it is also very important “not to put all eggs in one basket”, clearly separating financial and economic activities from the property complex in order to protect the latter.

Why do this? We will explain.

The tax debts collection from the company in the absence of cash and liquid assets is the basis for bringing an interdependent person to liability (paragraphs 8, 9 sub. 2 paragraph 2 of article 45 of the Tax Code of the Russian Federation; hereinafter – the Tax Code of the Russian Federation).

The tax authorities insist on interdependence if they find that the company has transferred its activities to a controlled legal entity. They investigate the relationship between the founders and employees of companies and, on this basis, determine organizations as dependent persons

Most courts currently collect tax arrears from a formally independent legal entity.

Courts consider persons dependent for the purposes of sub. 2p. 2 Art. 45 of the Tax Code of the Russian Federation and satisfy claims for the recovery of tax arrears of VAT, fines, fine on income tax due to non-fulfillment of obligations to pay the assessed amounts of tax by the taxpayer, in respect of which the tax audit was conducted.

 Thus, when building the legal structures of a group of companies, it is necessary to take into account their interconnection.

Unfortunately, there are no clear criteria for establishing the interconnection of companies with each other in Russian legislation – all signs are formed exclusively by judicial practice.

At the same time, some “distinctive features” can still be distinguished: general staff, one location address, one IP address, regular mutual loans between companies to eliminate cash gaps, etc.

“Not to get burned” in this case a foreign businessman can only with the help of professional consultants. Starting building your business in Russia without their help actually turns out to be much more expensive than with it, because, as you know, an incorrectly made first move can decide the outcome of the entire chess game as a whole. Thus, only the development of the most efficient format of the legal structure of business and ownership of assets will allow the owner to control the business processes in the Russian jurisdiction without the risk of losing assets and in the most comfortable tax system, that is, to use the most effective tax planning structure.

Only a correctly built business structure, starting from the choice of the form of a legal entity (whether it is a joint-stock company or a limited liability company), at the initial stage allows to create a system for investing and reinvesting a business.

At the same time, it is not enough to form the proper legal structure of the business – it is also necessary to build management control, develop and integrate the right personnel motivation system into business processes. This is also an important task. And for its solution a foreign investor in Russia will certainly need consultants.

Please contact the BRB Ramo Group experts to discuss this topic or any other development issue for your business.


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