2020 brought many events and, as usual, changes in tax laws were among them.Senior Assosiate of the Tax practice Ekaterina Smolovaya goes over the most important changes that have an impact on the taxation of individuals, and identify the main points that should be considered when planning your future activities.

Individual approach 

Starting February 1, the Russian Federal Tax Service is establishing a new inspectorate to administer taxpayers with annual income of over RUB 500 million. 

Higher rates 

Starting January 1, 2021, a higher personal income tax rate has been introduced with respect to annual personal income exceeding RUB 5 million (from 13% to 15%). 

Personal income tax on deposit interest 

Starting January 1, 2021, income from deposits exceeding the non-taxable interest amount is subject to personal income tax. The non-taxable amount is calculated as RUB 1 million multiplied by the key rate of the Bank of Russia as of January 1 of this year (in 2021, the amount of non-taxable interest will be RUB 42.5 thousand). For the first time, depositors will have to pay this tax for 2021 only in 2022. 

Fixed rate for controlled foreign companies 

Earlier, we wrote about the option to apply a fixed personal income tax rate to profit from a CFCs; see here. We will once again go over the main provisions and assess the prospects of applying this regime. 

Cancellation of tax incentives for accrued interest 

Starting 2021, accrued interest on all bonds is subject to personal income tax at the 13% rate for tax residents of the Russian Federation. All previous incentives for bond holders are canceled, but there are alternative options. 

New opportunities for selling shares in foreign companies 

Now, an incentive allowing tax exempt ions on share sale gains can be applied to shares  in foreign companies. 

Individual approach

According to the media the Russian Federal Tax Service announced that starting February 1, 2021, it is establishing a new specialized tax inspectorate for major individual taxpayers in the structure of tax authorities (Interregional Inspectorate No.10  of the Russian Federal Tax Service for major taxpayers).

The inspectorate is planned to administer individual taxpayers with major income (over RUB 500 million) taking into account such additional criteria as CFCs, foreign transactions, accounts abroad, and taxable investment transactions.

The need for the new inspectorate in the Federal Tax Service is justified by the fact that administrating individuals with a large income requires special competence due to the complexity of financial transactions and application of international tax treaties.

At the same time, the specialized inspectorate is expected to provide a better analysis of tax obligations of such individuals and ensure higher compliance with the requirements of tax laws.

Currently, it remains unclear  which criteria are to be used for assigning particular individuals to this inspectorate and whether such assignment somehow depends on the taxpayers’ will  or requires them to take additional actions. Hopefully, good intentions of this initiative will actually allow taxpayers to expect  that tax authorities  will have a more competent understanding of the specifics of transactions and will help simplify the process of interaction with tax authorities, rather than the opposite.

We will keep you informed of this matter as it develops.

Higher rates

The conventional wisdom says that "lowering" is bad for health. Probably, lawmakers proceeded from the same postulate when introducing a higher personal income tax rate starting from January 1, 2021 in relation to annual income of individuals of over RUB 5 million (from 13% to 15%).

This procedure is to be applied to the so-called “main tax base,” which includes a wide range of income (e.g. individual wages, dividends, accrued interest on bonds, foreign income, income from securities, including from their sale, income from business operations, etc.), except for income attributed to a separate tax base.

The tax rate remains the same for income of individuals (tax residents of the Russian Federation) from the sale of their property or shares in it, for income received as a gift, as well as for taxable income received by individuals as insurance or pension payments, and income for which a different rate is provided (e.g.,35% or 9%).

In order to apply the 15% rate to the relevant income an “aggregate tax base” must be calculated for determining whether the threshold of RUB 5 million has been exceeded. If, for example, annual income is RUB 6 million, then the  personal income tax will be charged at the 13% rate on RUB 5 million (RUB 650 thousand), and at the 15% rate on the remaining million (RUB 150 thousand).

Payment procedure

• If separate amounts of income paid by (one or more) tax agents does not exceed RUB 5 million, at the end of the year the tax authority will calculate the aggregate amount subject to personal income tax exceeding RUB 5 million and will send a notice to the taxpayer.
• If an individuals declares income on their own, they shall determine the amount of tax payable without taking into account income received from tax agents, but taking into account the amount exceeding the  threshold of RUB 5 million. Then, the tax authority will summarize the information received from the taxpayer and tax agents and will send the relevant notice to the taxpayer.

The introduction of the progressive personal income tax rate is expected to add RUB 60 billion to the state budget annually. Meanwhile, the authorities promised to take advantage of such additional amounts for medical treatment of children with “rare, so-called orphan diseases.”

Personal income tax on deposit interest

From January 1, income from deposits held in banks on the territory of the Russian Federation is subject to personal income tax at a 13% rate, regardless of residency (instead of 35% for residents and 30% for non-residents). However, the tax base is to be calculated differently.

The taxable income will be determined as the difference between the amount of income in the form of interest received by the taxpayer during the tax period on all Russian deposits (account balances) and the threshold calculated as RUB 1 million rubles multiplied by the key interest rate of the Central Bank of Russia in effect on the first day of the tax period.

Therefore, it will be calculated as follows :

• Calculating and summarizing all interest on deposits (aggregate interest income);
• (aggregate interest income) minus (RUB 1 million × Central Bank key interest rate);
• multiplying the result by 0.13.

Theoretically, taking into account the effective key rate of 4.25% (as of December 2020), any interest income (including in different banks) exceeding RUB 42,500 will be taxed at a 13% rate.

However, such changes do not apply to ruble deposits with an annual interest rate of 1% or less or to escrow accounts.

Prior to the changes, there was a general rule that only interest exceeding the amount of interest at the key rate of the Central Bank of Russia by 5% was subject to taxation.

Despite such changes taking effect from 2021, taxation under the new rules will take place only in 2022. Under the new rules, banks are obliged to notify the tax authority at the place of their registration about the interest paid to individuals during the reporting period no later than by February 1 of the year following the reporting period, i.e. starting in 2022.

Then, all information received by the tax authority will be summarized for calculating the tax and sending the relevant notice to the taxpayer. The specified tax must be paid by the individual by December 1 of the year following the year when  they received income in the form of interest.

Fixed rate for controlled foreign companies

Briefly

The new regime provides that the aggregate amount of CFC profit is fixed at RUB 38.4 million for 2020, and at RUB 34 million for subsequent tax periods. Therefore, this allows the controlling person to pay about RUB 5 million annually (i.e. personal imputed income tax) for all CFCs in aggregate with no obligation to calculate the amount of the  imputed income and tax for each of the companies. This procedure can be applied from 2020.

The procedure is voluntary and serves as an alternative to the current procedure. However, in the event of switching to it, the taxpayer will be obliged to apply this regime for a particular period: if switching in 2020 or 2021 - for at least for 3 years; later, i.e. in 2022, - for at least 5 years.

Advantages

• Fixing the amount of personal income tax in respect of all CFCs, no obligation to pay personal income tax from the CFCs’ actual profit;
• No obligation to submit financial statements and auditor's report, and no risk of liability for failure to provide these documents;
• Significant reduction in the administrative burden and costs on preparing CFC reports;
• Possibility to account for CFCs’ losses before switching to this regime and after its termination.

Disadvantages

• Distributed dividends do not allow to reduce the a CFC's profit, based on which personal income tax is calculated;
• CFC's fixed profit does not reduce the amount of the distributed dividends subject to personal income tax for the relevant periods when this regime is applied;
• Personal income tax on the CFC's fixed profit cannot be reduced by the amount of other CFC taxes, including withholding taxes;
• In the event one CFC is controlled by several individuals, each of them will be obliged to pay tax on the fixed profit.

Cancellation of tax incentives for accrued interest

From January 1, 2021 incentives are cancelled with respect to accrued interest taxation of several types of bonds.

Previously the following categories of income were exempt from taxation :

• Income from state treasury obligations, bonds and other securities of the former USSR, member states of the Union State, constituent entities of the Russian Federation, as well as bonds and securities issued by decision of representative bodies of local governments;
• Income from circulating bonds of Russian companies that have been issued since 01.01.2017 and denominated in rubles, if the accrued interest does not exceed the refinancing rate increased by five percentage points (and only the amount exceeding  the threshold was subject to personal income tax at the 35% rate);
• Income in the form of a discount received upon redemption of circulating bonds of Russian companies denominated in rubles and issued after 01.01.2017.

Starting this year, these incentives are no longer in effect. Now the rate is 13% for tax residents of the Russian Federation and 30% for non-residents. However, it does not matter when the shares were purchased (before or after 2021). What matters is the fact of income being paid after January 01, 2021.

Even though these changes have an adverse effect, one should keep in mind the tax incentives for investors that remain in effect and can be used  as an alternative :

• Type B deduction (for income) allows to exempt income from tax as to transactions with securities and derivatives (including accrued interest and discount).
• Type A deduction (for contributions) allows to deduct personal income tax of up to RUB 52 thousand annually + together with the purchase on an IIA of such conservative instruments as federal loan bonds (OFZ), it also allows aggregate income exceeding the bank deposit yield.