Analysts recorded significant growth in the number and volume of mergers and acquisitions (M&A) involving Russian assets. Among other things, this has to do with expectations of economic growth, redution of geopolitical tensions and relatively low cost of assets. Meanwhile, investors who put off deals until better times or those who are considering investing for the first time – need to consider changes in the rules of the game.
Russian tax law and practice follow the trend of most of the largest economies. The governments of “the big twenty” countries (G20) are taking coordinated steps to a sharp narrowing of possibilities of business international operations and structures use the primary and often sole purpose of which is tax savings. Widely discussed tax claims against such giants as Apple and Starbucks in the public space are essentially a reaction to the pressure from governments that tax authorities experience in need of financing budget expenditures and calls for more equitable distribution of the tax burden.
Lets leave the assessment of the validity of claims to specific companies to the discretion of the judiciary system, but what we can talk about is that the direction created but the pressure can already be seen.
The action plan of OECD is followed by G20 countries to combat tax base erosion and profit shifting away from taxation (BEPS) in recent years has become one of the most important (and difficult) challenges for companies involved in cross-border operations and for governments of low-tax jurisdictions. Thanks to the active international exchange of information between competent authorities the level of transparency that is rapidly growing and negates still encountered “no one will know, because it’s offshore” argument.
The adoption of the deoffshorization laws by the Russian economy, the evolution of approaches of fiscal authorities, as well as a number of court decisions in recent years clearly indicate that the Russian tax system actively uses mechanisms recommended for implementation by OECD in the framework of BEPS plan. Among other things we are talking about such concepts as controlled foreign company (CFC) and the actual recipient (beneficial owner) of income, as well as the development anticlericale practice assessing the validity of tax benefits.
The effect of changes on M&A transactions involving Russian assets can be divided into two components. The first is growing risks to the buyer associated with the activities of the acquired Russian companies. Because as a result buyers may receive associated tax risks. What was considered common practice until a few years ago, it may be risky today, even in the absence of any specific legislative changes. Did the previous management and owners react to the changes? This question can be answered by conducting a comprehensive review of a potential acquisition target. In the presence of risks that do not result in the cancellation of the purchase, it is necessary to develop effective mechanisms to protect the interests of the buyer. The division of responsibility between the parties to the transaction should be clearly recorded in the contract of what called in Russian “sale and purchase agreement” (SPA). There are a number of tools that allow the buyer to claim from the seller damages arising from tax claims by authorities after the deal is closed: in particular, obligations to reimburse losses arising from unforseen taxation (tax indemnity, tax covenant), the representations and warranties and their analogues in the Russian law. The enforcement of obligations by party to the transaction is achieved through the use of mechanisms such as withholding part of the transaction value (retention), the use of conditional deposit (Escrow) and personal guarantees of the beneficiaries.
The second component are growing risks associated directly with the transaction and how the structure of ownership of the purchased asset will look like after the deal is closed.
No buyer wants to get into a situation in which a couple of years after closing the transaction the tax authorities will present their claim in the amount of 20% of the purchase price. A recent court case involving regional energy companies where the tax authorities applied the above concept of actual recipient of income – proves that this is possible in practice. Confirmation by higher courts of the correctness of tax authorities will significantly increase the risks of using one of the most common deal structures in which the sale of Russian assets involves its foreign holding company.
Attention needs to be paid to details of the future ownership structure of purchased asset and its funding. Otherwise, the tax burden on payments from Russia could be much higher than expected: the trend to stricter requirements for taxpayers wishing to apply the reduced tax rates stipulated by international agreements, is obvious. It is also obvious that the focus of tax authorities increases on any payments that have do with with the repatriation of profits or other movement of funds abroad.
It certainly makes sense to make an effort to ensure that issues related to significant unanticipated costs, diversion of resources to disputes with the tax authorities and reputation are decided at the stage when even these risks can be managed.