On 31 July President Vladimir Putin signed a law significantly changing the tax regime for IT companies’ activities in Russia starting in 2021. According to the explanatory note to the draft of Federal Law No. 265-FZ (hereinafter “Law No. 265-FZ”), the Russian Government developed the law to implement the state support measures for future development of the national IT sector which the president announced in his June 23, 2020, address to the business community. One of the stated goals of this draft law is to establish a much more beneficial tax regime for IT businesses in Russia than in such popular jurisdictions as India and Ireland.
What tax incentives will be available in Law No. 265-FZ and to what extent do they meet the declared goals? These are the questions covered in our alert.
Corporate Income Tax
Most striking is the reduction of the Corporate Income Tax (“CIT”) rate for IT companies from 20% to 3%!!! (art. 284(115) of the Russian Tax Code). This tax incentive can be used only by Russian legal entities that simultaneously meet the following criteria:
- The company is accredited as carrying out activity in the IT sector according to the procedure of Russian Government Resolution No. 758 of November 6, 2007.
- The company employs an average of at least seven employees.
- At least 90% of total income for a tax period is income from transfer of rights to use software (“SW”) and/or databases (“DB”), from provision of remote access to SW/DB via the Internet, from rendering services for development, adaptation, modification of SW/DB, installation, testing and/or SW/DB maintenance.
Some types of income are excluded from the calculation of qualifying income. These include income from granting the rights to use SW/DB, including provision of remote access to them, if such rights make it possible to disseminate advertising on the Internet, post offers for purchase/sale of goods (works, services), property rights, search for information about potential counterparties and make deals with them. Thus, it is far from obvious whether the largest B2C platforms will be eligible for this tax incentive. If the margin is shifted to their captive development teams, the tax authorities could interpret an unexplained increase in fees for support services as a form of tax evasion.
Furthermore, the one-time deduction of expenses for acquisition of computer hardware by a limited number of qualified IT companies has been abolished (art. 259(6) of the Russian Tax Code). We believe that this change will not have a significant impact on profitability given the announced CIT rate reduction.
Social Security Contributions
The amendments to art. 427(2)(11) of the Russian Tax Code reduce the social security contribution (“SSC”) rates on payroll from 14% to 7.6% for qualifying IT companies. These reduced SSC rates will now apply for an unlimited period of time (previously they applied through 2023).
The same threshold for share of qualifying income will apply for SSC just as for CIT, and with the same limitations (i.e. income from granting the rights to use SW/DB, if such rights make it possible to disseminate advertising on the Internet, post offers for purchase/sale of goods (works, services), property rights, search for information about potential counterparties and make deals with them should be disregard while calculating 90% threshold).
Value Added Tax
In our opinion, the most substantial changes Law No. 265-FZ envisages for the taxation of IT companies are in how Value Added Tax (“VAT”) is calculated and paid.
First, the previous VAT exemption for operations involving transfer of exclusive and non-exclusive rights to SW/DB (art. 149(2)(26) of the Russian Tax Code) will now apply exclusively to SW/DB included in the Unified Register of Russian Software and Databases (the “Register”). The rules for creating and maintaining the register were set in Russian Government Resolution No. 1236 of November 16, 2015, which was adopted as a subordinate legislative act to the information law and the procurement law.
Second, the exemption will not apply in any case if the rights provide the opportunity to disseminate advertising on the Internet, post offers for purchase/sale of goods (works, services), property rights, search for information about potential counterparties and make deals with them.
Consequently, income from the provision of exclusive and non-exclusive rights to SW/DB by foreign IP holders to Russian licensees, as well as by Russian IP holders whose SW/DB are not in the Register, will be subject to VAT at the standard 20% rate starting in 2021. We recommend that foreign IP holders involved in providing e-services and registered as Russian VAT payers carefully consider this issue as it impacts their obligations to pay VAT to the state.
Significant cost increases can also be expected for Russian companies in the banking and financial sector acquiring exclusive and non-exclusive rights to SW/DB from foreign IP holders (from Russian IP holders whose SW/DB is not in the Register) due to their inability to claim input VAT offset on purchases (art.170(5) of the Russian Tax Code). Russian IP holders whose SW/DB is not in the Register could be impacted in two ways: they could have much higher VAT liabilities due to what are generally small input VAT amounts and could see a substantial drop in profitability if it is not possible to proportionally increase revenue from provision of rights to use SW/DB by VAT amounts.
Comparative analysis of the impact of the new tax regime on an IT company’s tax burden
Below is an illustration of how the new tax regime will impact a Russian IT company’s total tax burden.
The income from provision of non-exclusive rights to use SW is constant: RUB 10,000,000.
The SW is in the Register of Russian Software and Databases.
Payroll expenses (constant): RUB 5,000,000.
Other G&A costs (constant): RUB 1,200,000, including RUB 200,000 of input VAT charged by suppliers.
The conditions for applying the tax incentives are met under both the current and the new regime in the IT industry.
The same data, but the SW is not in the Register of Russian Software and Databases. Other requirements for applying tax incentives are met under both the current and the new regime in the IT industry. Due to tough market conditions, the 2020 license fees cannot be proportionally increased in 2021 by 20% VAT.
 specifically, art. 12.1 of Federal Law No. 149-FZ on Information, Information Technologies and Protection of Information of July 27, 2006, and art. 14(3) of Federal Law No. 44-FZ on the Contract System in the Procurement of Goods, Works and Services for State and Municipal Needs of April 5, 2013.