Every foreigner coming to work in Russia has numerous points of interest regarding the Russian social security and personal income tax consequences that may arise for him and his employer as a result of his assignment. Here is a brief overview of many of the requirements in Russian tax law that need to be considered with regard to an individual assigned to work in Russia. However, the Russian tax system is fluid, requirements apparent in the law may not be what happens in practice, and there is wide scope for different interpretations by different chief accountants, tax inspectorates and tax inspectors. There is therefore, a real need to avoid assumptions and to check carefully before determining the likely tax consequences of any particular event.
Tax Residency, Rates and Scope
The starting point for analyzing an individual's Russian tax position will tend to be his tax residency status. This affects both the scope of income subject to tax, and the tax rates to be applied in Russia. However, there is a problem in this area, in that practice is not consistent with the Law. Under the Law, a tax resident is a person who is physically present in Russia for more than 182 days during a consecutive twelve month period. There is provision for absences caused by situations such as medical illness to continue to be counted as presence in Russia. However, the tax authorities view residency as determined with reference to presence in a calendar year (which was, interestingly, the old rule before the Law was changed).
Therefore, based on the tax authorities' current interpretation of the residency rule, if an individual spends at least 183 days in Russia in a calendar year, then he is tax resident and is taxable in Russia on most types of his worldwide income at the resident tax rate of 13%. Otherwise, he is a non-resident taxable in Russia at the 30% non-resident tax rate on his Russian source income.
Russian source income is generally defined as income arising from assets in Russia, or earned in Russia, irrespective of where the income is paid. There is also some debate as to the definition of a day of presence in Russia. The conservative position would be that days of arrival do not count in determining total presence in Russia, whilst days of departure do. However, a number of letters from the Ministry of Finance indicate that a taxpayer is viewed as present in Russia on both days of arrival and departure.
The general philosophy of the Russian tax system is that all income is subject to tax, but there are nuances beyond this. To create the general picture on what may be included in the taxable income for Russian tax purposes, the most common income items subject to Russian income tax are set out below.
Employment income consists of compensation, whether received in cash or in kind, including, but not limited to, salary, bonuses and various expatriate allowances and benefits. Tax residents are entitled to certain types of deductions from income. Sometimes, reimbursements, which might be viewed as business expenses in other jurisdictions can be viewed as taxable income in Russia. The only material tax exempt type of income is employer provided insurance, but the details of this need to be checked dependent upon the specifics of each employer's programs.
TAXATION OF EMPLOYER-PROVIDED STOCK
Options and Equity Programs
Based on general tax principles, at the time of exercise of an employer-provided stock option, an employee recognizes income equal to the excess of the fair market value of the stock over the exercise price. Stock Grants are generally viewed as received for tax purposes at the point that all restrictions are lifted, and the value at that date is used to determine income. However, there are no specific rules for the taxation of, or sourcing of the income from, equity programs, so great care needs to be taken with the specifics of each particular plan.
Self-Employment and Business Income
The income of individuals engaged in self-employment activities is subject to income tax. Tax is levied on the individual's annual self-employment income, which consists of gross income, less documented expenses associated with the performance of the work. Under certain circumstances, a simplified tax regime may apply.
Dividends received by residents are subject to tax at a rate of 9%. Russian dividends received by non-residents are subject to tax at a rate of 15%. At the time of writing, consideration was being given to removing the 9% rate and reverting to 13% for residents.
Interest income on bank deposits held in the Russian Federation that exceeds the Central Bank's refinancing rate increased by 5 percentage points on rouble deposits (or for foreign-currency deposits, interest that exceeds 9%), is subject to tax at a penalty rate of 35%. Most other bank interest is exempt from tax.
Income from the disposal of assets is included in regular income and from this it is possible for tax residents to deduct costs related to the asset's acquisition and sale. Special, but similar, rules apply to income from the disposal of securities. A separate capital gains tax does not apply.
Income received by foreign nationals working in Russia may be subject to tax withholding at source if delivered by a company registered in Russia. Under current tax law, all Russian companies, and foreign organizations operating in Russia through a representative office or a branch must act as a tax withholding agent, which usually means they must withhold the personal income tax at source.
The tax authorities view tax residency as ultimately being determined for a calendar year. However, for withholding, the tax agent must review the presence of the recipient of the income over the preceding twelve months. This potentially means that all newly arrived individuals are considered non-residents for Russian tax withholding purposes until they reach 183 days in Russia in the twelve months prior to a particular payment; thus, the non-resident tax rate of 30% applies to their income for tax withholding purposes. Individuals who arrived in Russia at the end of a previous year may be subject to 13% tax rate in the next year upon confirmation of their exceeding the 183-day period. However, future intention to stay in Russia for 183 days or more in the following twelve month period, even if he or she has a signed contract for this period with a company operating in Russia, does not allow an employer to use the 13% resident rate starting from the day of arrival of this individual. This rate can be applied only after the individual has actually spent 183 days in Russia in a 12-month period. At the time of each payroll payment during the year, the employer must verify the residency status of each employee and withhold income tax at the appropriate rate in accordance with the number of days the employee has spent in Russia in the 12-month period preceding the date of payment.
If Russian income tax is withheld from the expatriates' entire remuneration, then he may not be required to file a tax return in Russia, unless he has received other income subject to tax in Russia, but not subject to tax withholding.
Double Tax Relief and Tax Treaties
Russia has an extensive (and continuously expanding and revising) network of double tax treaties with many jurisdictions around the world.
Under these treaties taxpayers may be either exempt income from the payment of Russian tax or foreign tax paid may be credited against Russian tax payable, but the foreign tax credit may not exceed the Russian tax payable on the same income. To obtain an exemption or a tax credit, the taxpayer must submit a Russian tax return actively claiming the benefit, and present a certificate of residency from a country with which the Russian Federation has a double tax treaty, and a document certified by the tax authority of the foreign country proving that the income was received and the foreign tax was paid.
In practice, obtaining such reliefs can be problematical, and care needs to be taken in optimising the chances of success for any such claim.
The Russian Tax Code foresees standard, social, professional and property-related tax deductions available for tax residents.
Social Tax Deductions
These deductions include annual deductions for certain charitable contributions (up to 25% of income), education expenses for the taxpayers and their children (up to 50,000 Rbs per child per taxpayer), medical expenses for the taxpayers and expenses related to contributions to licensed Russian non-state pension funds.
Property-Related Tax Deductions
The most visible tax deductions are related to property. Income received from the sale of real property, which was in the ownership of a taxpayer for three years is effectively exempt from taxation in Russia, though this must be actively claimed on a tax return. If, however, this minimum holding period is not met, the gains derived from the sale of property are taxable in Russia as regular income (gross income less documented expenses). The ability to deduct costs or obtain special tax benefits tends to apply only to tax residents.
The taxpayer may alternatively elect to pay tax on the proceeds less a fixed annual deduction. In the case of real estate held fewer than three years, the maximum fixed deduction is 1 million roubles; in the case of other property (except securities) held fewer than three years, the maximum fixed deduction is 125,000 Rbs (250,000 Rbs starting January 2010). Income derived from the sale of securities is subject to special rules.
Income from the sale of a car which was owned by an individual for more than three years is no longer taxable from 2010.
Also, each tax resident individual claim a property-related tax deduction for the expenses incurred to construct or purchase certain real estate in Russia on a "once in a lifetime" basis. The deduction is limited to 2 million roubles. Mortgage and certain other interest payment are deductible in addition to the 2 million roubles.
Starting January 2010, tax residents are entitled to additional property-related tax deductions in the amount of interest on loans used for the acquisition of a plot of land, where residential real estate is located/constructed; in the amount of interest on the refinancing of loans used for the new construction/acquisition of a house; and in the amount of expenses incurred in connection with the preparation of design for residential real estate.
Tax Filing and Payment Procedures
The tax year in Russia is the calendar year. Tax returns must be filed by both tax residents and non-residents, who have at least one source of income subject to tax in Russia on which income tax has not been withheld by a tax agent. The final tax return must be submitted by 30 April of the year following the tax period with no extension available. The final tax must be paid no later than 15 July of the following year.
If a foreign individual plans to cease to engage in activities that generate income taxable in Russia and then leave the country, the individual must submit a departure declaration no later than one month before the individual leaves Russia. Tax due on the basis of the departure tax declaration must be paid no later than 15 days after the declaration is filed with the tax authorities.
Whilst there are no specific restrictions on amending tax returns, such amendments will inevitably attract attention, particularly, if the level of income is reduced, and the general course of prudence is to ensure that a return is correct before it is filed.
Currently, individual taxpayers pay taxes on a self-assessment basis. The Russian tax authorities are not obliged to issue official tax assessments. However, sometimes they do issue tax notifications (effectively the same thing), and very rarely, there may be some discrepancies between tax assessments made by the individual and the tax authorities.
Paying tax can be quite complex, and is best done directly from the personal Russian rouble bank account of the taxpayer directly to the accounts of the tax authorities. Importantly, companies cannot safely settle the personal tax liabilities of their expatriates, which presents logistical issues for those on net pay or tax protected or equalised compensation programs. There are numerous different accounts and other reference numbers and codes, and the taxpayer needs to make sure these are correctly included on the payment order. Payments often go missing within the tax authorities' system, and it is worthwhile checking that they have been properly credited to the taxpayer's account a few weeks after the payment is made.
Sanctions for Non-Compliance
There are certain fines established for non-compliance with the tax rules. Failure to submit tax returns after the filing deadline would result in a fine of 5% of the tax due under the return for each full or partial month of delay for the initial 180 days of delay and accelerating to 10% of tax due per full or partial month thereafter with no cap. Fines of 20% or 40% can also be imposed for under-declaration of income dependent upon whether this was accidental.
Late payment interest is charged for each day of late payment of the tax and is calculated as the amount of underpayment multiplied by 1/300 of the current Central Bank refinancing rate (currently 1/300 * 10%) per day.
Social Security Contributions
Under the current Russian law, all Russian companies or foreign organizations operating in Russia through a representative office or a branch, which make payments to individuals (including foreign individuals) under the employment or civil-law agreements are obliged to pay Unified Social Tax (UST) from the income delivered to the employees. The tax is paid entirely by the employer and there is no concept of matching employee contributions in Russia.
Due to the recent changes in the Russian law, starting January 2010, the UST will be replaced by social security contributions to the Russian various statutory funds, including the Pension, Medical and Social Insurance Fund. However, the remuneration paid under employment agreements and civil-law contracts to foreign citizens temporarily located in Russia (most expatriates on assignments in Russia who do not hold temporary or permanent residency permits) will not be subject to social contributions, since such foreign citizens are not entitled to the relevant benefits financed by the social funds.
In addition to the UST (or social security contributions starting January 2010), an employer must pay separate contributions to the Social Insurance Fund on behalf of all its employees, including foreign employees, insuring against accidents at work and professional diseases (the rate depends on the class of the professional risk for specific employer and vary from 0.2% to 8.5%). For most office employees the rate is 0.2% and this will continue for foreign nationals under the new regime.
In current Russian tax system, there are various pitfalls, which the unwary may encounter. Some of the most common of these are set out below in what is a far from comprehensive list.
The 183 Day Myth
There is common understanding that no tax would apply if an individual stays in Russia for fewer than 183 days. This may or may not be true. Non-residents are still taxed in Russia on their Russian source income. If all income subject to tax in Russia delivered through the local payroll, then tax would be withheld at source with no further need to submit tax return. If, however, the individual is paid by an offshore employer for his work in Russia, then it may be necessary to submit a Russian tax return.
No tax would apply if the individual's assignment and pay structure satisfies certain provisions of the relevant Double Tax Treaty (if this is the case). However, even in this situation, tax relief technically needs to be applied for by means of tax return submission. In order to claim a relief, an individual has to go through the long procedure of submission of various documents without any guarantee of the positive result.
Russia Only Has 13% Taxes Myth
This is not true. The tax rate for residents is 13%, but it is 30% for tax non-residents. Given that the definition of a tax resident is a matter for technical debate, great care is needed to ensure that the 13% rate will apply, particularly, for expatriates in the year of their arrival or departure. Whether a person arrives in the second half or the year or leaves in the first half of the year, achieving the necessary presence in Russia to be a tax resident can be logistically impossible. Many expatriates are also surprised to find that, even where they qualify for the 13% rate for a particular year, they do not receive the benefit of this immediately through payroll, at least in the early part of their assignment, but, instead, have to wait until they have been physically present in Russia for over 183 days. They then receive the refund of the "over-withheld" 17%, but the cash flow disadvantage can be an unpleasant surprise.
No Tax Deductions for Non-Residents
The current Tax Code does not foresee tax deductions for tax non-residents. These are available for tax resident individuals only. In this connection, tax non-residents cannot benefit from the most visible deductions related to the purchase or sale of a property in Russia. This is a particularly unpleasant surprise for persons disposing of property after they have left Russia, especially, where they have been waiting to qualify for the three year exemption before selling. There is a significant difference between paying no tax at all, and paying 30% on the full proceeds of sale without even a deduction for what one originally paid for the property.
Investment Income is not Tax Exempt
Offshore income received by Russian tax residents can be relieved from Russian tax in case the individual is either a tax resident in another jurisdiction or has paid tax there and a relevant Double Tax Treaty is in place. Depending on the situation, Russia might have the right to only tax income earned in Russia, or may give a credit for foreign taxes. However, offshore income is not just "tax free" as of right, and care needs to be taken to manage liabilities in this regard.
Equity Income May be Taxable in Russia, but No-One Really Knows How
There is great uncertainty as regards the taxation of various different types of employee equity plans. Such plans are usually operated by the employing group, but often by a (non-Russian) entity (or employee benefit trust) other than the actual employer. It is very rare that such programs are managed locally with tax withholding through Russian payroll. This places the requirement to determine tax treatment onto the individual, and he will have difficulty determining how much income he has received, when he receives it and to what duties this income relates. It is hard to determine the "right" answer to these questions as whatever arguments could be used could be countered through different logic. In reality, many taxpayers have used the arguments that suit them best, which would tend to analyses that suggest they have no receipt of income, or that the income has nothing to do with Russia, or that the level of that income is as low as possible. This has led to something of an urban myth that income from equity programs is exempt from Russian tax, but this can be a dangerous assumption. There is increasing transparency in Russia with regard to the allocation of the costs of corporate equity programs; hence, aggressive or even non-compliant tax filing positions that may have proved successful in the past are no longer safe.
How Will They Know?
In a self declared, self assessed tax system, where tax scrutiny tends to fall upon those who file tax returns rather than those who do not, some individuals may well ask the question of why they should file a return and what tools the tax authorities may have to find out about non-compliance if they do not.
There has been a general drift to improved compliance in recent years, particularly, amongst expatriates. This has been partly driven by corporate policy of good governance, but also because with its low tax rates, declaring income and paying tax in Russia has proven good tax planning in assisting with the avoidance of tax on that income in other jurisdictions. This does mean the tax authorities have been improving their knowledge, because they are seeing more. The quality of the record keeping at the tax authorities is also improving, and becoming more computerized (the authorities are asking for individual tax returns for 2009 to be submitted with an electronic copy, as well as the traditional paper forms), making data easier to find.
However, greater risks arise through the increased transparency of accounting and corporate recharging, where the costs of an expatriate's remuneration paid outside of Russia need to be made more explicit and clear at the level of the host Russian business so as to minimize the level of risk of that business being denied a corporate tax deduction. Whilst the specifics of tax cases are different, the general trend has been for corporate taxpayers to win in court, where the documentation for recharged costs is clear and open, but to lose where it is opaque and the costs of expatriates remain more obscure. Hence, an assumption by an expatriate that the authorities will not know about his offshore paid income is dangerous, as his employer may well be providing documentation that specifically evidences this.
Recent years have also seen a significant rise in the level of contact between the Russian tax authorities and other jurisdictions, with voluntary sharing of data about persons with tax affairs in both. Particular contact has been noted with France, Germany and Finland, with countries using the mutual co-operation provisions of tax treaties to help them identify potential tax evasion. This trend echoes a more general global pattern, and whilst Russia remains well behind many other jurisdictions in the sophistication of its tax control, it is improving quite rapidly. Non-compliance is increasingly risky, whilst the tax cost of actual compliance is low, even if the administration of it remains burdensome.