The New Russian CFC Rules – A Superyacht Perspective
Quentin Bargate and Adam Ramlugon, Bargate Murray, look at the impact of the new Russian CFC Rules on the superyacht industry.
For some time now, the Russian authorities have expressed concerns over the use of offshore structures by Russian corporations and individuals.
This has culminated in the enactment of the Controlled Foreign Companies (“CFC”) Rules – A regime which provides the authorities with the jurisdiction to tax Russian corporations and individuals on profits held by Russian controlled CFC’s.
Given that many superyachts are beneficially owned by Russian nationals, Quentin Bargate and Adam Ramlugon, Partners in the superyacht specialist law firm Bargate Murray, consider the impact that the CFC Rules may have on the superyacht industry.
Introduction
Back in the day, tax on yachts and the foreign special purpose vehicles (SPV’s) set up to own them was but a minor concern for yacht owners. However, over the last 10 or so years – and particularly since the financial crisis in 2008 – superyacht yacht owners and their advisors have had to take extra care to stay on the right side of the law.
This has meant taking care in structuring the commercial use of yachts within EU waters and now it must also include the long potential reach of fiscal authorities of countries trying to reduce the use of offshore SPV’s to reduce tax.
Superyachts are generally associated with jurisdictions that are viewed as “offshore”. It is a term which, wrongly (we would argue), is used by some to connote secrecy and suggest the owner of the offshore entity has something to hide – why else would they own or flag their yacht through a company based half a world away?
The fact is many offshore jurisdictions offer great expertise as well as low tax rates.
The Cayman Islands, for example, is a “red ensign” (British) flag, on the Paris MoU “White List” of top quality flag states and an understandably popular choice both to flag superyachts and to set up the SPVs to own them. Other good quality offshore jurisdictions include Malta, Bahamas, Isle of Man, and many others.
While using an offshore jurisdiction both to flag your yacht and as a corporate base for the SPV that owns it makes perfect sense to yacht and maritime lawyers like us, if the ultimate beneficial owner is Russian tax resident, he or she will be subject to the new CFC (Controlled foreign Company) Rules and therefore potentially liable to tax in Russia on any undistributed profits retained by that company, together with additional reporting requirements.
One of the criteria used to determine whether a company is a CFC is whether it is incorporated in a jurisdiction which is “blacklisted” by Russia because, for example, it does not exchange information with the Russian Federal Tax Service. Cayman is one such blacklisted country. There is a long list of many others, and the list may of course be added to in the future.
Accordingly, any yacht that is owned by a Cayman company, or any other entity that meets the definition of a “controlled foreign company”, will fall within the ambit of the new Russian CFC regime.
Background
On 18 March 2014, the Russian Ministry of Finance published a draft law, the purpose of which was to introduce, for the first time, the concept of controlled foreign companies rules in to Russian law. This move was widely regarded as the most significant reform of the Russian tax legislation of the last decade.
- The draft law went through a number of revisions between March and November 2014, until the lower chamber of the Russian parliament finally passed the law on 18 November 2014, requiring only final sign off from the upper chamber. This sign off was received and the law was approved by President Vladimir Putin on 24 November 2014.
- The rules, often described as “anti-offshore rules” are aimed at preventing tax avoidance by Russian tax residents through the use of tax havens and low-tax jurisdictions. The key developments in the law include the introduction of:
a. A beneficial ownership concept for the purposes of applying double tax treaty (DTT) benefits;
b. A tax on “indirect” sales of immovable property in Russia;
c. A tax residency concept for legal entities, based on place of management; and,
d. A controlled foreign companies* regime (the CFC Rules).
Potential Sanctions
Under the CFC rules, a Russian tax resident with a sufficiently large interest in a CFC (as defined) will, at the time of writing, be subject to tax of between 13% and 20% in Russia on the CFC’s undistributed profits. This is in addition to any tax payable in the jurisdiction in which the CFC is incorporated.
Moreover, there are notification obligations. Any Russian tax resident that fails to disclose their interest in a CFC (regardless of whether it does or does not have any undistributed profits) could find themselves facing a penalty of up to RUB 100,000.
What does this mean for superyacht owners?
Having written the above, in the context of superyacht ownership, even where the yacht is chartered commercially, the penalties carried by the CFC Rules are likely to be a paper tiger.
Keep in mind that the rules are directed at taxing “undistributed profits”. As most industry players and superyacht owners will tell you, it is almost unheard of for even a successful commercial charter yacht to turn a profit, owing to the very high costs of ownership – maintenance costs, crew wages, insurance costs, fuel, management charges etc. which generally exceed the income from a few weeks chartering every year**. In the majority of cases, and with the proviso that the CFC does not enjoy retained profits resulting from other commercial activity, our understanding is therefore that there should not be much in the way of undistributed profits to be affected by the Rules.
The one caveat here is that a CFC with no undistributed profits does not escape the notification obligations we have already mentioned. At the time of writing, it is too early to tell whether there may be any negative stigma associated with a Russian individual’s ownership or participation in a CFC. This is a matter to be kept under review as the law is applied.
A final aside. One should not rule out the development of structures that might fully comply with the CFC rules but legitimately avoid (not evade) their impact, including the reporting obligations. Watch this space.
*Controlled foreign companies, as defined under the CFC Rules, has a wide meaning which includes corporations, partnerships, trusts and other forms of collective investment vehicle.
**There is the old joke, “how do you make a small fortune?” Answer: “start with a large one and buy a yacht”.
Originally published by Bargate Murray
Quentin Bargate
Senior Partner Head of Superyacht and Aviation Group Bargate Murray
E: [email protected] T: +44 (0)2073751393
Adam Ramlugon
Partner Superyacht and Aviation Group Bargate Murray
E: [email protected] T: +44 (0)2073751393
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