Subtleties of taxation of a controlled foreign company that does not carry out activity
Our client is an owner of a company registered in Mauritius. However, the company does not perform any activity and is virtually abandoned. The client needed to know how to legalize the controlled foreign company (CFC) and find out information about risks are connected with such a legalization.
CFC income determined based on its financial statements and under the Chapter 25 of the Tax Code of the Russian Federation (TC RF) is treated as income of individuals recognised as controlling persons of the CFC and such income shall be taken into account when the controlling person determines the tailored personal income tax base.
Hence, controlled foreign company is a foreign organisation that meets two conditions simultaneously (Item 1 Article 25.13 of the TC RF):
1) the organisation is not recognised as a tax resident of the Russian Federation;
2) controlled person of the organisation is an organisation and/or individual recognised as a tax resident of the Russian Federation. In particular, foreign organisations with a place of management located in the Russian Federation are recognised as tax residents of the Russian Federation unless otherwise provided in an international tax treaty of the Russian Federation (Article 246.2 of the TC RF).
Item 2 Article 246.2 of the TC RF provides criteria for determination of a place of management of a foreign organisation; such criteria include, in particular, management of day-to-day activities of the organisation on the territory of the Russian Federation. According to the information provided, the company located in Mauritius does not perform any activity and, therefore, it is not managed. In our opinion, the company may not be recognised as a tax resident of the Russian Federation.
The following legal entities/individuals are recognised as controlling persons (Item 3 Article 25.13 of the TC RF):
1) individual or a legal entity with a membership interest in the organisation exceeding 25%;
2) Individual or a legal entity with a membership interest in the organisation (for individuals: jointly with spouses and minor children) exceeding 10% or, if the membership interest of all persons recognised as tax residents of the Russian Federation (for individuals: jointly with spouses and minor children) exceeds 50%.
In the situation in question, if membership interest in the foreign company exceeds 25%, the company is recognised as a controlled foreign company (CFC).
Controlled person takes into account CFC income determined from the beginning of periods starting in 2015 (Item 2 Article 4 of the Law No.376-FZ). It means that CFC income that was not distributed by 1st January 2015 is not taken into account when determining controlling person’s tax base (Letter of the Ministry of Finance of the Russian Federation dated 25.05.2015 No.03-08-05/29888).
However, if the established threshold level is exceeded, CFC income shall be accounted for. Hence, CFC income for the tax period shall not be taken into account by a taxpayer (controlling person), if CFC income for such tax period is less than:
– 50 million Roubles (for 2015);
– 30 million Roubles (for 2016);
– 10 million Roubles (for periods starting from 2017 (Item 7 Article 25.15 of the TC RF, Part 2 Article 3 of the Law No.376-FZ)).
As the company located in Mauritius does not perform any activity, it has no profits in the form of CFC income subject of the personal income tax.
However, controlling person shall provide the tax authority with two types of notifications (Item 1 Article 25.14 of the TC RF):
- Notification of membership interest in foreign companies; such a notification shall be provided no later than within three months from the date of occurrence of (change in) membership interest in such foreign company;
- Notification of controlled foreign companies controlled by the said person; such a notification shall be provided no later than on 20thMarch of a year that follows the tax period when the controlling person recognised profits in the form of CFC income in compliance with the Chapter 23 of the TC RF.
However, in the opinion of the Ministry of Finance of the Russian Federation, notification of CFC shall be provided irrespective of profits of such CFC (Letter of the Ministry of Finance of the Russian Federation dated 21st March 2017 No.03-12-11/2/16199). In the Decision of the Arbitration Court of Moscow dated 21.12.2017 as per the case No.А40-178867/17, the Court also specified that controlling person shall submit the notification of CFC in order to inform tax authorities for enabling them to carry out their controlling functions. Such an obligation does not arise from any financial result of CFC.
Therefore, our client is obliged to provide the relevant notification even if the CFC does not perform any activity and has no profits.
If the notification of membership interest in a foreign company is not provided in due time, fine is imposed in the amount of 50 thousand Roubles; if notification of CFC is not provided, fine will amount to 100 thousand Roubles.
However, the client may avoid the fine, if such notifications are submitted together with a special declaration under the Law No.140-FZ.
In addition, there is a three-year Statute of Limitation on liability for tax offences.