As with most countries, the laws that direct the collection of tax by the government are in a constant state of flux. The Russian Tax Code is no different and this has significant bearing on Russian outsourcing and the options that exist for Russian software development businesses. This section outlines the government’s various levies on economic transactions including those applying to ISVs and outsourcing vendors.
As a general overview of the current taxes that apply to the Russian software outsourcing companies, this information explains the differing levels of tax liability for those considering engaging a Russian outsourcing provider or establishing a software company in Russia. As defined by the Code, tax on different segments of corporate profit is treated very differently depending on the structure of the organization.
Value Added Tax
VAT only has bearing on software production when it is developed in Russia and used on the domestic market. If an IT company exports its developments, VAT is not imposed. License transfer is not subject to VAT.
VAT exemption is available for numerous industries and extends to traditional banking and insurance services, and the sale of exclusive copyright on software and high-tech contracts.
At first glance, the VAT exemption procedure appears straightforward with the amount of excess VAT paid for a given fiscal period simply being refunded; and further options to either transfer the refund directly a company’s bank account, or used as credit to offset other federal taxes.
In practice, the system is not as clear-cut as it seems and, because refunds are not a priority for the tax authorities, they often take excessive amounts of time to make their decisions. In addition, problems of fraud are widespread when large amounts of VAT are to be refunded. The result is that most Russian software development and IT outsourcing service providers incorporate their expected VAT liabilities into their rate calculations.
Business entities that use the Simplified Taxation System (see below) are exempt from paying VAT.
Corporate Profit Tax
Regional revenue is derived mainly from Corporate Profit Tax (CPT), which is levied at a standard rate of 20 percent on pre-tax profits. Previous limits on the deduction of expenses have been abolished and nearly all business expenses are currently considered fully deductible when related to the daily operations of a business and properly documented by receipts.
The Tax Code defines the exact procedure for the deduction of expenses. What is significant is that this procedure also differs from standard Russian accounting practice, which results in Russian companies being compelled to complete both statutory and fiscal accounting.
A company’s tax on dividend income is set at 9 percent. Under certain terms, dividend income is entitled to exemption when received by companies that maintain a controlling interest in the business. Specifically, when a founding Russian shareholder (which may be either a business entity or an individual, according to Russian Corporate Law) owns at least 50 percent of a Russian company or foreign subsidiary paying dividends for no less than 365 days with an investment exceeding 500 million rubles ($17.07 million), the double taxation of dividends is eliminated. Foreign entities located in tax haven jurisdictions are exempt from this rule and are subject to dividend taxation.
Small businesses with annual sales of less than 60 million rubles ($2.05 million) are entitled to the use of a simplified taxation system for which banks, insurers, foreign companies, and certain other professions and businesses are ineligible. To be eligible, a company must employ less than 100 workers and its assets must not exceed 100 million rubles ($3.4 million). Tax is assessed either on gross receipts at 6 percent, or on profits before income tax at 15 percent. The choice is left to the taxpayer. An eligible business may also decide whether to use the simplified system or not.
If during the course of a year a business becomes ineligible for the simplified system, it continues to operate according to that system through the end of the year. At the end of the tax year, the company must then recalculate its liability according to general taxation rules from the moment it became ineligible to participate in the simplified system.
With tax imposed at 6 percent on gross receipts, this system is generally used by small businesses with negligible profits. IT companies, like most B2B companies, choose to file under the rules of general taxation, because the number of available exemptions is higher.
In the past, payments made by a company on behalf of an employee for medical insurance, pensions and other social insurance contributions were governed by the Unified Social Tax (UST). This flat-rate tax was abolished as of January 1, 2010 and the three non-budgetary payments are now funded separately while remaining mandatory.
The total insurance contribution is currently 34 percent and is the highest single expense for labor-intensive Russian software development businesses. Just as in the US many companies try to reduce this by any means possible, including the use of part-time workers on temporary contracts. In Russia, however, the options for placing the tax burden on the employee, such as the use of independent contractors, are limited. In the past employers have traditionally sought to reduced this burden by offering employees a salary that is a combination of a low contractual salary and payment of an additional sum in cash. While this has the benefit of reducing an employer’s liability, it is also not strictly legal and is gradually being phased out.
Recent important developments
The Russian Ministry of Communications has announced an initiative to accredit IT developers. Accredited IT outsourcing providers are able to reduce their pension and social insurance fund payments from 34 percent to as low as 14 percent. Another significant advantage of the accreditation is that the company may depreciate its computer hardware within 2 years, and in some cases immediately, following the purchase of such equipment.
In order to obtain such benefits a business must meet several criteria. In addition to accreditation, the company must also generate 90 percent of its profit from the sale of software and employ at least 30 workers.
To apply for accreditation, the company must file an application supported by an extract from the Legal Bodies Registrar and copies of the company’s founding documents.
Since the beginning of 2011 hundreds of IT companies have been accredited by the Ministry of Communications. Yandex and Mail.ru are not listed because 90 percent of these IT companies’ profits are derived from advertising sales.
According to recently accredited companies, the examination procedure requires approximately 30 days, with both the request and the result being sent by mail.
Further information is available from the official site of the Mass Communications Ministry at http://minkomsvjaz.ru/news/xPages/entry.10797.html (in Russian).
Personal Income Tax
Personal Income Tax (PIT) is levied at the rate at 13 percent on an individual’s gross income. Income tax is withheld by employers so that individuals are not required to file a tax return. As a result, Russian employees think in terms of, and negotiate contracts, based on net salary—the amount of take-home pay at the end of a pay period—rather than gross income. Individuals may, however, claim a refund based on itemized deductions; the purchase of a home, the cost of education, and medical expenses account for the most significant deductions. Deductions must be properly documented with receipts and are subject to limitations.
For registered entrepreneurs and professionals (lawyers, notaries, etc.), those selling personal assets, and recipients of other income, the filing of an individual tax return is mandatory. A tax rate of 30 percent applies to income earned by non-residents as defined by the tax code, which are legal entities or individuals from another country, operating in Russia, but registered and/or permanently residing abroad.
Taxation of Foreigners and Foreign Investments
In Russia, individual income tax is levied at a rate of 13 percent for residents and 30 percent for non-residents. One is considered a Russian tax resident if the residence has been established for at least 183 days during a calendar year. If residency requirements are satisfied, tax on income will be levied at 13 percent, and on dividends at 9 percent. If a person is present in Russia for less than 183 days in a calendar year, tax will be levied at 30 percent and 15 percent respectively.
Current tax law makes a distinction between a foreign-owned branch operating in Russia and a subsidiary. Foreign branch offices in Russia are taxed upon general conditions and may choose either to use the accounting standards of their country of incorporation or Russia. The transfer of funds between a branch and an overseas head office are not considered taxable income or deductible expenses and as such, are not subject to withholding tax. The withholding tax rates for payments in Russia are 9 percent on dividend payments to residents and 20 percent on interest and other payments (royalties, etc.)
A Russian subsidiary of a foreign legal entity is considered to be a domestic taxpayer and the transfer of funds between a subsidiary and its parent may be subject to withholding tax. Payments from a parent to its subsidiary may also be considered taxable income.
Taxation is not applied equally to transfers and loan repayments. A narrow capitalization regulation commences when foreign shareholder subsidiaries begin paying interest on loans from shareholders, instead of remitting after-tax dividends. According to the Code, these companies are required to reclassify excessive interest into non-deductible dividends.
Despite the fact that there are no exemptions available on an IT business’ profits, a lenient taxation mechanism that reduces the amount of a IT company’s mandatory government social security contributions began at the end of 2010. Any reduction in this type of expense is an important issue for Russian IT businesses—a sphere in which labor costs can account for 80 percent of overall expenditure, in contrast to an average of 13 percent for other industries.
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The laws that direct the collection of tax by the government are accumulated in Russian Tax Code (except Social taxes which are established by separate Federal law). However, the Russian tax legislation is in a constant state of flux. Trestle Group strongly recommends the engagement of an international tax advisor with specific work experience in Russia.
Value Added Tax (VAT) rate is established as 18% (also 0% and 10% for specific types of operations). Purchase/sale of computer software could be exempted from VAT if such transactions performed under concluded license agreements. IT services (development of computer programs) will be liable to Russian VAT (18% rate) in case the buyer of the services is a Russian legal entity, in case the buyer is a Foreign legal entity (without registration in Russia) such services will be non-VATable.
Corporate Profit Tax (CPT) is currently levied at a standard rate of 20% on pre-tax profits. While a company's tax on dividend is set at 0% (for dividends received by Russian organization under specific conditions), 9% (for dividends paid by Russian and foreign organisations to Russian organisations) and 15% (for dividends paid by Russian organisations to foreign organisations). Double Tax Treaties between Russia and Foreign States could provide reduced tax rates (in particular: for dividends. In many DTT tax rate for dividends is reduced down to 5%).
Social taxes are made up of currently 34% and are the highest single expense for Russian business. However, under the decision of the President of Russian Federation Medvedev D.A. the tax rate should be reduces in 2012. Currently the tax rate in the amount of 27% is under discussion. Under specific conditions currently IT-companies could apply reduced rate at 14%.
Personal Income Tax (PIT) is levied on an individual's gross income. For tax residents and highly qualified specialists the tax rate is established at 13%, for non-residents it is 30%. The tax is withheld by employers so that individuals are not required to file a tax return themselves if they have no other income.
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Ulf Schneider founded RUSSIA CONSULTING in 2003 and is their Managing Partner. The firm assists international company with business set-up and development in Russia, Ukraine, Belarus and Kazakhstan with services such as Accounting Outsourcing, Tax Consulting, IT-/ERP-Structures, Recruiting and Sub-Lease. With five offices in CIS, RUSSIA CONSULTING employees 250 experts.
Before having founded RUSSIA CONSULTING, Ulf Schneider worked for Allianz Insurance as their CFO in Russia and prior to that for Procter & Gamble at locations in Germany and Brussels. Ulf Schneider is economist and tax expert and visited the Kiel University in Germany and the University of Illinois in the US.