Nuances embedded in Russia’s participation exemption
Russian legal entities that make capital gains from the sale of shares are eligible for a 0% tax rate, yet the criteria for satisfying this arrangement may not always be so simple.
If a seller, who is a Russian legal entity, obtains a capital gain from the sale of its shares or participation interest in a Russian company, then that capital gain may be subject to a zero percent tax rate. However, this is only if certain criteria are met. One important criteria is that the shares or participation interest should have been acquired after January 1 2011. Another is that it should have been held for at least five years. At first glance, these requirements may look straightforward, yet their application in practice raises various questions.
Interpretation of the term “acquired”
In the view of some officials, the term “acquired” is not that simple. Let us explore how interpretation of the term “acquired” has evolved in the authorities’ letters. In 2011 and 2013, the Finance Ministry issued two letters of interest. In letters on February 1 2011 (No. 03-04-05/0-48) and December 2 2013 (No. 03-03-06/1/52260), the Ministry stated that the term “acquired”, for the purpose of the participation exemption, means a purchase. No other means of receiving or obtaining shares or participation interest are considered, such as a receipt of shares or participation interest because of increasing the charter capital.
Then in 2016, one of the authors of the Ministry’s aforementioned letters issued another letter (after they had left the Ministry) stating that the term “acquired” should be understood more broadly. According to this new interpretation, the meaning should include not only purchase, but also other grounds by which ownership over shares or participation interest is gained.
Furthermore, in a more recent letter on July 9 2018 (No. 03-04-05/47619) related to exemptions from personal income tax (PIT), the Ministry stated that for the purpose of this exemption, it is irrelevant whether the interest was purchased under a share purchase agreement (SPA) or was obtained as a result of company formation.
The aforementioned letters suggest there is no unified approach regarding how the term “acquired” should be understood. This can lead to different interpretations, and as a consequence, to disputes with authorities.
Five-year holding period
The authorities’ position towards the application of a zero percent tax rate (if nominal value of the seller’s stake changed) may not be characterized as sustainable or consistent. The Ministry of Finance’s letter of June 28 2017 (No. 03-03-06/1/40916) states that the zero percent tax rate is applicable if the characteristics of the seller’s interests (such as size and nominal value) have remained unchanged for the required five-year holding period.
Otherwise, the sale of the interest does not qualify for the zero percent tax rate. A year later, the Ministry of Finance (Letter No. 03-03-06/1/43480 of June 25 2018) expressed a slightly different view: the zero percent tax rate remains valid if the change in the size and/or nominal value of the participation interest was caused by the purchase of additional participation interest from other participants in a company. In the letters of September 20 2018 (No. 03-03-06/1/67389) and October 23 2018 (03-03-06/1/76034), the Ministry supported its earlier conclusions, but added that the zero percent rate applies only after expiration of the five-year holding period from the date when the additional participation interest was acquired.
Interestingly, at almost exactly the same time as the aforementioned letter, another department within the Finance Ministry issued a letter with a different view. The letter addressed PIT consequences in a situation where an individual had owned a 100% stake since 1997 and then increased the nominal value of the stake in 2012. Although the question explored was not cited in the response, it seemed to be whether the increase in 2012 allowed the individual to claim the PIT exemption. One could have expected that based on the Ministry’s view above (the change in nominal value affects the stake’s characteristics and restarts calculation of the five-year holding period), the answer would be that the exemption applies after the five-year holding period has expired (since the increase of the stake’s nominal value).
However, the Ministry replied differently, stating that the change in the stake’s nominal value does not affect the terms of exemption. This position suggests that either the interest’s nominal value is not a characteristic of the interest, or that change to the nominal value of interest should not affect its characteristics.
The above demonstrates that although participation exemption rules may look straightforward, in practice, they can be interpreted in various different ways. This creates uncertainty and may lead to disputes with the authorities.
This article was written by Dmitry Garaev (firstname.lastname@example.org) and Denis Gamiy (email@example.com) of KPMG Russia and CIS.