Finance Ministry Takes on Tax Planning

Anna Krygina

The Russian Finance Ministry has identified two measures to reduce opportunities for tax optimization: changes in interest accounting rules for profit tax purposes, and a special procedure for carrying over the losses of reorganized or acquired organizations to future periods.

Likely Interest Accounting Changes

The Ministry has wanted changes to the rules on booking loan interest for profit tax purposes for a number of years. Now it seems determined to achieve them.

The Russian Federation Tax Policy Priorities for 2010 and the planned 2011 and 2012 periods refer to these changes as tax policy measures to be implemented in 2010 to reduce tax planning opportunities. It is highly likely that a similar measure will be in the Russian Federation Tax Policy Priorities for 2011 and the planned 2012 and 2013 period.

The potential amendments involve dropping the current rules for determining the average interest charged on loans issued in the same quarter in comparable conditions, since the Finance Ministry believes that these rules are generally difficult to apply and do not prevent tax evasion. The “market” rate of interest is to be used to determine the maximum interest bookable as an expense for profit tax purposes. These rules will apply to transactions between interrelated parties and to parties whose transactions will be deemed controlled under the Tax Code amendments governing transfer pricing.

As already noted in the press, the Finance Ministry also believes that changes are necessary to the indexes used to calculate maximum permitted interest if this method of booking for the tax purposes is chosen by the taxpayer (the Russian Central Bank refinancing rate for ruble obligations, and a fixed rate of 15 percent for foreign currency obligations). The Finance Ministry has decided that these rates do not fulfill their intended purpose of reflecting the average interest rate on obligations for which interest expenses may be deductible against profit tax. It is not yet clear what indexes the Finance Ministry will permit taxpayers to apply in determining interest bookable as expenses for profit tax purposes, if any.

Given the Finance Ministry’s approach, the amendments to transfer pricing rules expected this year will also affect thin capitalization rules. In particular, in applying restrictions concerning treatment of interest on loans from interdependent entities as expenses, new rules for determining the interdependence must be taken into consideration. The Finance Ministry plans to apply thin capitalization rules to relations among both foreign and Russian entities. This may in a number of cases change the court practice based on the double tax treaties.

As the passage of the law to govern the principles of determining prices for tax purposes already seems sure, there is reason to believe that the amendments to the Tax Code rules on booking interest for tax purposes will not be far behind.

Impending Loss Carry-Over Changes

A further measure to reduce tax planning opportunities should be new rules on carrying over the losses of reorganized and acquired organizations to future periods. The Finance Ministry plans to establish limitations on the term and the amount of profit that can be allocated to cover the losses of reorganized organizations.

The Finance Ministry has already announced that these new rules should also be introduced in 2010 in the Russian Federation Tax Policy Priorities for 2010 and the 2011 and 2012 periods; however, no amendments have yet occurred. Whether these rules will be introduced will become clear after the government approves the Tax Policy Priorities for 2011 and the 2012 and 2013 period.