Foreign Direct Investment.
a. General Discussion.
Special regulation of rights, obligations and guarantees for foreign investors in Russia is implemented through a number of federal and local laws and other legal instruments. The Federal Law On Foreign Investments in the Russian Federation of 9 July 1999 No. 160-FZ (as amended) and bilateral investment treaties of the RF are among the most important acts.
Foreign investments are defined by the law as the contribution of the foreign capital, i.e. money or other assets, owned by the foreign investor to the business on the territory of the RF. Rights for exploration of natural resources and other rights under contracts are recognized as investments as well. A special term “foreign direct investment” is used to describe the portfolio investment representing not less than 10 per cent of equity interest in the company, investment of capital assets to the branch of a foreign legal entity established on the territory of the RF, leasing of the equipment (of certain type and value) carried out by the foreign legal entity on the territory of the RF.
The law operates with categories of investment projects and priority investment projects. Priority investment projects enjoy preferential treatment, including tax benefits. To qualify as priority investment project the investment must meet certain requirements as regards the amount and procedure of approval. The list of the priority investment projects is enacted by the RF Government.
Investment of foreign capital in the banks and other credit organizations, insurance organizations and non-commercial organizations such as charities, scientific and religious organizations is subject to the specific regulation under the corresponding Russian laws such as the Federal Laws On Insurance, On Securities, On Protection of Investors Rights and Lawful Interests on the Securities Market, On Communal Associations, On Banks and Banking Activity, etc.
b. Regulations and Restrictions.
The law on foreign investments guarantees national treatment of foreign investments, with certain exceptions. Special restrictions affecting foreign investors may be introduced only by federal laws where it is necessary to protect the fundamentals of the constitutional system, public moral, health, rights and lawful interests of the other persons, to safeguard the defense and national security of the state.
The law provides a system of guarantees for direct foreign investments in Russia. These guarantees shall not apply to foreign capital deposited with (invested in) banks or other credit institutions or insurance companies, as well as to foreign capital investment in not-for-profit entities with a socially beneficial objective in the sphere of education, charity, science or religion. These forms of investment are governed, respectively, by Russian laws on banks and banking activity, Russian insurance laws and Russian laws on non-profit organizations. The system of guarantees includes: fair, efficient and adequate compensation of in case of investment nationalization or requisition; grandfathering clause for priority investment projects in which foreign investment share exceeds 25 per cent (unfavorable subsequent amendments to tax legislation do not apply to existing priority investment projects for the period of return of initial investments but not more than 7 years); repatriation of income and proceeds from the investment; repatriation of assets and information previously imported to the RF as the investment.
Special provision of the law recognizes the validity of assignment of rights and obligations from a foreign investor to another entity. It is a standard clause required by many international financial institutions to underwrite international investment projects.
Foreign investors may incorporate domestic commercial organizations in any form provided by national legislation. Foreign entities are also authorized to open branch offices (structural units of a foreign legal entity not possessing legal personality), the procedure of registration and the legal status of such branch offices are governed by the Law On Foreign Investments.
It is specifically emphasized by the law On Foreign Investments that foreign investors must abide the anti-monopoly legislation of the RF and not to engage in unfair competition and restrictive business practices. In particular, the following business practices are considered illegal: launching domestic production of goods in a short supply and subsequent termination of this manufacturing in order to promote sales of the same product of foreign origin on Russian market; entering into price-fixing agreement or market-sharing arrangement in respect of certain product or in respect of participation in tenders (auctions, competitions).
Major construction projects of national importance involving foreign investments are subject to the state expert examination (The Resolution of the Ministry of Construction of the RF of 16 February 1999 N 18-18). Major construction or renovation projects implemented by companies with foreign investments which may negatively impact the environment are subject to the ecological audit (the RF Federal law On Ecological Expert Examination of 23 November 1995 No. 174-FZ).
c. Taxation of Foreign Direct Investment.
General tax rules are applicable to taxation of foreign direct investments. These rules are provided for by the RF Tax Code, other federal and local laws and by-law acts of Russian federal finance and tax authorities. The exhaustive list of the federal, regional and local taxes currently in effect is set forth in the Chapter 2 Section 1 Part 1 of the Tax Code of the Russian Federation and Articles 18-21 of the Federal Law On Fundamentals of Tax System in the RF of 27 December 1991 No. 2118-1. Value added tax, excise taxes, profits and income taxes, as well as customs duties are the most significant and sensitive taxes. Payroll taxes and payments such as social security, pension fund, employment fund and state medical insurance contributions, which are borne in Russia by the employer, represent another substantial fiscal cost of doing business.
As a general rule, income gained by foreign companies in Russia, including but not limited to income from lease or sub-lease of real property located in the territory of the RF, from leasing of movables in Russia, from distribution of property of Russian legal entities in case of their dissolution or liquidation, from loans of Russian companies, from exploiting of intellectual property rights in Russia, etc. are subject to income tax at the rate of 20 per cent (with the exception to income gained from sale of real property located in Russia which is taxable in accordance with special rules). Withholding tax at the rate of 15 per cent applies to dividends, interest and other income on investments. Double tax treaties may provide for other rates of withholding tax.
Real estate and other fixed assets of foreign entities are also subject to tax on assets located on the RF at the rate not higher than 2,2 per cent.
Foreign investments enjoy certain tax exemptions. Capital goods (technological equipment) imported by foreign investors into the RF as a capital contribution to businesses with foreign investments are exempt from the customs duties and VAT, provided they are not subject to excise taxes (Art. 37 of the law on Customs Tariff of 21 May 1993 No. 5003-1, Art. 150 of the RF Customs Code). There are strings attached to such exemption: in case the title to such goods is subsequently transferred to the other entities, the customs duties and VAT shall be paid in full. However, these goods may be leased out without compromising the exemption (Letter of the State Customs Committee of 25 January 1999 No. 01-33/1827).
Cumulative value of imported goods should not exceed the nominal amount of the contribution stated in the constituent documents of a Russian company with foreign investments. Goods imported by the investors or operators under production sharing agreements (PSA) are exempt from Value Added Tax and excise taxes insofar as they are required for carrying out of works under the PSA. Production of businesses with foreign investments manufactured under PSA may be exempted from export customs duties under the terms of the PSA concluded with the RF Government or other authorized body.