Legal Developments in the Russian Federation by James T. Hitch, III and Evgeny Astakhov, Baker&McKenzie, Chicago and St. Petersburg

New Regulation on the Tax Registration of Foreign Legal Entities
On September 20, 1996, the Russian State Tax Service adopted Regulation No. VA-4-06/57 "On the Procedure for the Registration with the Tax Authorities of Organizations Established in Accordance with the Legislation of Foreign States and International Organizations" (the Regulation"). The Regulation, which came into force on November 15, 1996, introduced new tax registration and notification procedures for foreign legal entities carrying out activities in Russia.

According to the Regulation, a foreign legal entity must register with the Russian tax authorities in the following situations:
(i) if a foreign legal entity carries out activities on the territory of Russia for a period exceeding one month;

(ii) if a foreign legal entity carries out activities in Russia through a dependent agent (either an organization or an individual) located in Russia;

(iii) if a foreign legal entity receives Russian-source passive income (e.g., dividends, interest, or royalties);

(iv) if a foreign legal entity has property located on the territory of Russia;

(v) if a foreign legal entity carries out transactions subject to Russian VAT, and the foreign legal entity is not otherwise required to register; or

(vi) if a foreign legal entity opens a bank account in Russia.

In addition, the Regulation governs the registration with the Russian Tax authorities of diplomatic institutions and international organizations.

Most importantly, the Regulation clarifies the instances in which a foreign legal entity must register with the Russian tax authorities and specifies in detail which documents a foreign legal entity or its representative should submit when it registers with the tax authorities.

Tax Issues Associated with "Financial Assistance"
Under recent amendments of the Russian tax legislation, "financial assistance," which is defined as the gratuitous transfer of monetary funds, has become a viable method of inter-company financing and, in particular, is a viable alternative to charter capital increases and loans. Financial assistance is exempt from the profits tax if it is provided by a parent company to its subsidiary, and the parent company has more than a 50% interest in the subsidiary's charter capital. Furthermore, financial assistance will not be subject to VAT if it is not associated with the sale of goods, works, or services between the transferor and the recipient of the funds.

Ideally, the transferor and the recipient should have no contractual relationships with each other. Otherwise, the situation should be examined carefully before any funds are transferred as financial assistance. For planning purposes, it should also be noted that a gratuitous transfer of non- monetary assets is still arguably subject to the profits tax, even if it is made by a qualified parent company to its subsidiary.

New Bilateral Tax Treaties to Come into Force
In recent years, Russia has been actively negotiating new tax treaties, both with countries which had old tax treaties concluded with the former Soviet Union, and with countries which had not had such earlier treaties. In particular, Russia has signed new tax treaties (still awaiting ratification) with the following countries: Albania, Belarus, Belgium, Canada, China, Croatia, Denmark, Finland, Germany, Hungary, Israel, Italy, Mauritius, Moldova, Mongolia, Norway, Slovakia, Slovenia, the Ukraine, the Philippines, the Republic of South Africa, Switzerland, and Yugoslavia.

Russia's new tax treaties generally follow the OECD Model Treaty. All of these treaties provide for "income correction procedures," under which the competent tax authorities may apply an "arms-length" principle to re-calculate the amount of taxable income paid by a resident of Russia to its affiliate in a treaty country (and vice versa). Some of the treaties, e.g., the new Germany-Russia Federation Tax Treaty, guarantee that qualified Russian subsidiaries are entitled to deduct certain expenses, regardless of any limitations under the applicable Russian domestic tax legislation. Finally, a number of these treaties contain a dual withholding tax rate for dividends, whereby the applicable rate depends on the absolute amount of the taxpayer's investment and/or its percentage ownership in the Russian payor of the dividends.

For more information, contact: Mr. Hitch in Chicago at One Prudential Plaza, Suite 3500, 130 E. Randolph Dr., Chicago, IL 60601. Tel: (312) 861-2976, Fax: (312) 861-2899