Thin capitalization rules as set forth in Article 269 of the Russian Tax Code were significantly amended on February 15, 2016. The introduced changes affect, among others, the following:

1. The list of debt obligations subject to thin capitalization rules has changed significantly. In particular, thin capitalization rules apply to the debt obligations to:

a) A foreign entity that directly or indirectly participates in a Russian borrower and the share of such participation exceeds 25%, or a foreign entity that indirectly owns a Russian borrower through a chain of companies with a direct participation share in each subsequent company of more than 50% (further “Foreign Owner”). It is important to note that, as opposed to the current rules, the new capitalization rules will also apply to debt obligations to foreign individuals.

b) Entities related to a Foreign Owner through ownership of shares in share capital / stocks^[1]. This means that loans from foreign sister companies are now also subject to thin capitalization rules, whereas previously only the debt obligations to the Russian affiliates of a Foreign Owner were formally subject to thin capitalization rules.

c) Any entity, if the Foreign Owner or its affiliates (see (b) above) acts as guarantor or otherwise undertakes to secure the performance of a Russian borrower’s debt obligation.

Other debt obligations may be declared controlled debt in court if it is established that payments under such obligations are intended for a Foreign Owner or its affiliates (for example, back-to-back financing). The vagueness of this provision of the law gives rise to the risk that any intra-group debt could be recognized as controlled debt.

2. The law provides that thin capitalization rules do not apply to:

a) Debt obligations to Russian parties related to a Foreign Owner, if such lender has no comparable loans to foreign group entities;

b) Debt obligations to an independent bank, if the Foreign Owner or its affiliates securing debt repayment have not repaid the debt or interest. This rule entered into force on January 01, 2016.

3. Controlled debt and maximum allowed interest are now calculated differently: all amounts of debt obligations should be taken into account collectively, as opposed to individually in relation to each creditor. This new calculation procedure could result in the application of thin capitalization rules to more debt obligations in cases where a Russian entity has borrowed from several entities.

4. The law consolidates the existing practice whereby the maximum interest amount is calculated for each reporting period and not on an accrual basis.

When amendments come into force

The new thin capitalization rules will enter into force on January 01, 2017, except for the provision that thin capitalization rules do not apply under certain conditions to the amounts owed to independent banks secured by a Foreign Owner or its affiliates. This provision entered into force on January 01, 2016.

Recommendations

We recommend evaluating the effect of the new rules and procedure for calculating maximum allowed interest on the tax liabilities of your Russian companies and changing the current financing structure, if necessary.

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[1]The definition of interrelatedness provided in Article 105.1 (2(1, 2, 3, 9)) of the Russian Tax Code applies for thin capitalization purposes.