Available Finance and the Chance of a Rate Cut are Positive Signals for Market

Commercial real estate to be taxed according to cadastral value, eliminating the opportunity to account for depreciation, as authorities seek to increase the flow of tax revenues.

Tom Mundy

National Director, Head of Research

Jones Lang LaSalle, Russia & CIS

A change in the way tax is calculated on office and retail property will increase the burden on owners from next year. The Duma deputy who sponsored the amendments to the Tax Code says tax revenues could rise by as much as 50 percent.

Changes to the Russian tax code will switch the advantage back to the government as cadastral values replace the use of book values, which take into account the depreciation of a building. This approach can result in a book value that is significantly below the market value of the property. This is good for property owners who pay less tax but not so good for the tax authorities.

Changes submitted by Duma Deputy Sergey Katasonov in July, which have now been adopted, switch the calculation from using an annual average net book value as the taxable base to using cadastral value. In addition, the amendments introduce new rates for real estate tax.

The organization representing small and medium sized enterprises, OPORA Rossii tried to postpone the bill's adoption. But the Federation Council approved the bill on October 30, after three brief readings in the State Duma.

The "Amendments to Chapter 30 of the Tax Code of the Russian Federation (The Use of Cadastral Value of Real Estate in the Calculation of the Tax Base for Corporate Property Tax)" apply different levels of tax for different real estate sectors.

In short, the new tax base (cadastral value) will apply to office and retail schemes of more than 5,000 square meters where 20 percent or more (including space used for parking inside the building) of the premises is used for office and/or retail. Industrial space will continue to use the previous version of the tax code, based on average net book value.

The amendments will start from next year only for regions where cadastral values have already been assessed. The new rates for Moscow will be 1.5 percent in 2014, 1.7 percent in 2015, and 2 percent from 2016 onwards; for regions 1, 1.5, and 2 percent respectively. The regional governments will set the exact levels, but not higher than identified by the Federal Government.

It is clearly aimed at encouraging the development of real estate assets that are heavily depreciated by increasing the tax burden on them.

The new approach will switch that advantage back to the state which expects to see a significant increase in tax revenues, particularly in the regions. Of course, it will be less beneficial to owners of large property portfolios who will see their tax burdens increase.

Indeed, Katasonov expects a 50 percent increase in property tax revenue. In addition, Moscow wants to increase tax revenue to substitute those revenues which flowed out to other regions, after large holding companies were allowed (from January 1, 2012) to pay income tax proportionately in regions where their production facilities are located.

The bill is also clearly aimed at encouraging the privatization and development of real estate assets that are heavily depreciated by increasing the tax burden on them and making it less economically viable for property owners to leave assets under-developed.

The Union of Industrialists and Entrepreneurs also opposed the amendments, claiming that industrial property will be heavily penalized if changes are made to bring industrial space into line with office and retail. We would also argue that there needs to be a clearer distinction between industrial facilities used for manufacturing and facilities used for storage.

OPORA Rossii's main concern is the increased tax burden on SMEs. Since cadastral values have not yet been assessed across all regions in Russia there will be a significant mismatch in the tax burden across the country. Indeed, even the government concedes that amendments will initially only affect Moscow.

Using cadastral values as the base is logical from a tax revenue point of view, and should lead to better use of under-developed assets. However it could have a negative effect on Russian real estate capital values by reducing net income. This is especially true for office and retail properties constructed before or in early 1990s, as their book value should significantly differ with the cadastral value.

Newer buildings have their book value very close to cadastral, so will be less influenced by the change, we think. We would recommend that buyers take time to check whether the cadastral value has been identified for a property they are purchasing and to consider carefully the difference in the current tax obligation based on book value and the future tax obligation based on cadastral value.