Russian Tax Service approves British Virgin Islands’ removal from offshore list

The Federal Tax Service (FTS) removes the British Virgin Islands (BVI) from the black list of ‘tax havens’. This change will affect the interests of Russian owners of the local companies. Leaving BVI for another offshore may help them keep their secrets, but not forever.

Removal of the BVI from the black list means that from the new year, the local authorities will be obliged to provide information on the real owners of companies registered in this jurisdiction to the Russian Federal Tax Service on a regular basis. The corresponding order has already been signed and is now registered with the Ministry of Justice, as the FTS told RBC. It is expected to come into force on January 1, 2018.

Previously, in early July, the Federal Tax Service had published a draft order to exclude the British Virgin Islands from the list of offshore states.

RBC tried to gain a better understanding of how the exchange of information on companies’ beneficiaries on the BVI will be carried out, what could be the consequences for owners of offshore business, and whether it is possible to minimize the risks.

What is the black list of the Federal Tax Service?

The Russian Federal Tax Service annually publishes a list of countries and territories whose authorities do not provide information on the owners of offshore companies at the request of the tax authority. This list became known informally as the ‘the FTS black list’. The list of countries and territories included in the blacklist for 2018 is posted on the Federal Portal for Draft Normative Legal Acts.

“The presence of an offshore zone in the black list is the reason for classifying the companies registered in it as controlled foreign companies (CFCs). As for the owners of CFCs, they are required by law to include the results of activities of these companies (including their abroad activities) in the financial statements filed in Russia, and, therefore, pay taxes on the revenues to the Russian budget. The Russian owners of companies registered in countries or territories included in the so-called black list of the Federal Tax Service may fall within the requirements imposed on CFCs,” Head of the Federal Tax Service’s Department for Standards and International Cooperation, Dmitry Volvach, said.

Thus, the exclusion of an offshore zone from the black list is favorable for companies registered in it. Their activities will not be regarded as controlled, which means that the results of those activities will be not taxed in Russia.

But at the same time, the owners of such companies have reduced opportunities for tax optimization. For example, in a situation where an offshore company conducts business in Russia without tax registration. Or beneficiaries use this company as a transit one – with the subsequent transfer of funds to the ‘black offshore’. After finding out the real owners of the companies from the white offshore, the tax authorities can identify their affiliation with a Russian counterparty fairly easily, which entails additional taxation.

Background

The reason for excluding the BVI from the black list was the complete ‘whitewashing’ of this offshore zone this year. To improve the transparency of business, the BVI authorities had taken a number of measures, foremost among which had been the launch of the centralized register of business owners – the Beneficial Ownership Secure Search System (abbreviated as BOSS) – in July 2017. The registry records data on all business structures registered on the islands, including the name, date of birth, and citizenship of the owner.

The system itself is not public, but the authorities of the BVI have automatic access to it. The same base will be used to provide information on the requests of Russian tax authorities.

The British Virgin Islands is the first offshore jurisdiction to create a state database of beneficiaries. The creation of such databases on beneficiaries is envisaged by the 4th Anti-Money Laundering Directive, AMLD4, adopted back in 2015. The databases should contain information about the real owner, i.e. the company beneficiary, even if he/she controls it through a chain of offshore firms. This is a difference of beneficiaries’ databases from such registries as SPARK and the Uniform State Register of Legal Entities, which only disclose the nominal owners.

Under Russian law, a beneficial owner is a natural person who owns or controls more than 25% of the company’s capital (such definition is given in the Law on Counteracting the Legalization (Laundering) of Criminally Obtained Money and the Financing of Terrorism).

Information exchange

Following the entry into force of the Order of the Federal Tax Service on the exclusion of the BVI from the black list of offshore zones, the exchange of information on the real owners of companies registered on the British Virgin Islands between the tax authorities of Russia and the BVI will be regularly held on the basis of the Convention on Mutual Administrative Assistance in Tax Matters.

The authorities of the BVI signed this convention in 2016. In 2017, the exchange took place in a test mode, but from 2018 onwards, after the BVI exclusion from the black list of offshore zones, it will be regular and, most importantly, fairly prompt, as the Federal Tax Service told RBC. “The next year, we expect to have a regular exchange of information with tax authorities of the BVI. We look forward to getting substantial answers to our requests from the BVI authorities, and within a reasonable time (three to four months),” Dmitry Volvach explained to RBC.

This is much faster than via the channels that existed before. According to the experts interviewed by RBC, with the assistance from Interpol, as is the case with the blacklisted offshore zones, getting the right information will take much longer. “The tax authorities have the opportunity to request information about any offshore through Interpol. But, firstly, Interpol may refuse the request, and even if it doesn’t, the response will take about a year. Secondly, the tax service appeals to Interpol not directly, but through the Ministry of Internal Affairs, which does not simplify the procedure,” Senior Advisor to Hill Consulting Ltd., Sergey Nesterenko, explained.

The Russian Federal Tax Service also plans to respond to requests from colleagues from the BVI, if any.

Possible consequences

The opinions of lawyers about whether the popularity of the BVI in Russia will decrease because of innovations, and how much it will decrease, are divided.

“The BVI has always been a very popular offshore zone. The simplicity of registration procedures and clear legislation based on English law attracted business,” Head of International Corporate Law Department at GSL Law & Consulting, Sergey Panushko, shared his experience.

“The British Virgin Islands is one of the leaders in direct investment in the Russian Federation among the offshore jurisdictions, in particular, last year, the volume of investments amounted to $1 billion,” Managing Partner of Gestion, Aleksey Gaidov, told RBC. About 700 thousand companies are registered in the BVI, that is, about 40% of all registered offshore companies in the world, he added.

“Of course, the risk of disclosure of the ownership structure for the beneficiaries registered in the BVI will now substantially increase,” Sergey Nesterenko predicted. Consequently, the risk of tax claims is growing, if the companies in the BVI were used for improper optimization of taxation, experts note.

In reviewing such cases, the courts apply the Organization for Economic Cooperation and Development’s model convention on taxes on income and capital, which introduces the concept of a beneficial owner. This concept is based on the principle that transactions are subject to tax accounting based on their real economic content, rather than the legal form.

In that respect, the case of Vladimirskaya Energosbytovaya Kompaniya PJSC (Vladimir Energy Retail Company, VEK PJSC) is a clear example. According to the tax inspection, the joint-stock company has implemented a scheme to undercut the profit tax with the involvement of companies registered in the Republic of Cyprus and the British Virgin Islands in the chain of payments.

The scheme, according to the judges, was as follows: VEK PJSC, being the final beneficiary of an offshore company on the BVI, registered purchase of 100% of its affiliated Energoservice for this company. A company registered in Cyprus was used as a mediator buyer (it was created only for transfer of funds). This made it possible for VEK PJSC to enjoy profit tax benefit, since Russia and Cyprus have an agreement allowing to avoid double taxation. As a result, the tax was 5% of the transaction, instead of 20% of the sum via direct sale to its subsidiary on the BVI. It was a source from Cyprus that helped to reveal the real buyer (the company on the BVI).

VEK filed a lawsuit, yet the courts of the first and the second instances made decision in favor of the tax inspectorate. The Court of Cassation, the Arbitration Court of the Volga-Vyatka District, by decision of August 7, 2017 left the ruling unchanged (copies of the court decisions can be found in Consultant Plus register).

If Russia could get information from the BVI at that time, the scheme would have been disclosed more quickly.

Avoid the risk

Lawyers believe, a number of companies that do not want disclosure of their data may change their jurisdiction.

Thus, companies searching for minimum risk of their owner’s structure disclosure now choose the Bahamas or American special territories, such as Puerto Rico and the US Virgin Islands, says Sergei Nesterenko. First of all, these territories have not signed the Convention on Mutual Administrative Assistance in Tax Matters. This means that direct exchange of information with them is impossible. Secondly, these territories do not belong to the British Overseas Territories and are not part of the British Commonwealth of Nations – a union of independent states, which includes Great Britain and most of its former dominions, colonies and protectorates, which members obliged to provide information at the request of British ships.

Many rich Russians own assets in the countries and territories that are part of the British Commonwealth. Assets are usually registered in the form of trusts and funds, while their management is carried out through trustees, explains Sergey Nesterenko. Beneficiaries of trusts and funds registered in countries or territories of the Commonwealth might be disclosed at the request of the English court, he adds.

Actually, this is what happened to New Zealand’s trusts (New Zealand is part of the British Commonwealth), belonging to Sergei Pugachev, the beneficiary of the largest Russian bankrupt bank – Mezhprombank. On the order of the English court, a trustee of the trust disclosed information about his assets. Connection between the banker and his assets, registered on the trust, was revealed. As it was previously reported by RBC, this allowed the Deposit Insurance Agency to apply to the High Court of London with a demand to recognize Pugachev as the beneficiary of the New Zealand trusts.

No guarantees

However, according to a lawyer of BGP Litigation, Anastasia Berman, transition to a “black” offshore does not guarantee anything. The concept of the beneficial owner, which is actively used by the courts, implies that any tax benefits provided by international agreements can be applied to beneficial owners only – the real owners of companies. While cases on challenging the status of a beneficial owner tend to be solved not in favor of a taxpayer, Anastasia Berman adds.

However, there have been cases of companies of such jurisdictions winning in courts. For example, in August 2017, the Arbitrazh Court of the Kaliningrad region made decision in favor of a taxpayer in a dispute with the tax service.

The firm took a loan from companies registered in Hong Kong and Cyprus. The tax inspection found out that control over all companies participating in the transaction is carried out through a firm registered in Jersey (included in the black list of the Federal Tax Service). Tax authorities considered that in this case, spending on the loan’s interest cannot be taken into account of profit tax in accordance with the legislation.

The company managed to prove that funds of the group of companies were used for its current activities, and were not transferred as dividends or loans to its beneficiary in Jersey, says Anastasia Berman.

However, the change of jurisdiction could be useful, but only for some period, says Stanislav Lyaptsev, the senior legal adviser to the department of legal consulting and taxation of the KSK Group. “Practice of disclosure of foreign transit companies and finding the actual beneficial owner will be trending in any case; EU Directive promotes this tendency,” he said.

Some experts don’t believe in outflow of business from the BVI in order to avoid possible claims from the tax authorities. The authorities of the BVI have always taken into account recommendations of the FATF and OECD, while banks are willingly working with jurisdictions that work in line with reasonable international trends. “We do not expect decrease in interest in the BVI in Russia,” notes Sergey Panushko. Moreover, several hundred thousand companies are registered on the BVI. So, it is physically impossible to provide information on all the companies quickly.