24.07.09

Debt Refinancing: Tax and Accounting Issues in Russia
Galina Klimenko, Audit Department Head, Alinga Consulting Group

Holding debt has become a much greater risk due to the financial crisis. Russia has seen several high-profile cases, such as food retailer Sedmoi Kontinent and truck manufacturer Kamaz default on debt and subsequently struggle to survive. In light of these examples, many companies are now looking to refinance their debt on more favorable or stable terms.

The motivation to quickly refinance can be high. This was especially the case at the beginning of the financial crisis, when the ruble lost a third of its value against the dollar, and debtors in Russia with loans denominated in foreign currencies saw their principle balances and interest payments effectively skyrocket as it required more of the rubles they earned to pay off the dollars and euros they owed. A company wishing to refinance may have one or several goals in mind:

• To lower the cost of loan resources (including the interest rate and currency conversion fees);
• To increase the loan term so as to decrease the monthly payments;
• To receive additional funds for the same security;
• To change the lending bank.

While the exchange rate has stabilized, many companies continue to refinance their loans into a currency denomination matching that in which they earn their incomes. This not only minimizes currency risks, but can also eliminate currency conversion fees that may be applied to each payment.

In addition to the usual concerns of, for example, if the loan can be refinanced and if there will be penalties for early repayment of the original loan, companies in Russia should be aware of various tax and accounting issues related to refinancing in the Russian Federation.

Refinancing a loan is procedurally similar to receiving one. The borrower will have to gather the same documents, pass similar approval procedures and pay the necessary fees. The bank also has the right to change the interest rate and charge additional fees. Whether this effort in time and money will be worthwhile is a decision that each company will need to make on an individual basis.

There are two ways by which a loan may be refinanced. First, a new agreement can be drawn up which cancels out the old (and provides for enough capital to pay off any outstanding amount from the original contract).  Otherwise, an amendment to the original contract may be drawn up and signed.

Most banks and creditors will choose the first option above. Loans between private companies are more often done by altering the original contract. However, we recommend the first option as there are fewer pitfalls related to it.

Amendments to the contract must specify that they are dependent upon the prior contract and must specify a date that the amendments will enter into force.

If the supplemental agreement establishes a fixed currency exchange rate for the loan retroactively, then the book-keeping and tax accounting must be recalculated for the affected periods and revised profit tax declarations must be submitted.

Also, if a company transfers its loan into rubles without negotiating a new contract and the contract provides for an interest rate increase, it may create difficulties with the Tax Authorities in declaring the accrued interest as an expense. According to Article 265, Paragraph 1, Subparagraph 2 of the Tax Code of the Russian Federation, only interest accrued during the actual use of loaned funds and the initial interest yield established by the lender in the contract, but not exceeding the actual established amount, is recognized as an expense. Therefore, companies may only count the amount of interest originally established by the loan (credit) agreement as an expense for tax purposes.

The decision to refinance requires the borrower to carefully consider all pros and cons. Besides the usual questions of making sure that the refinancing is economically and legally feasible, businesses in Russia must also consider whether the refinancing, the method of refinancing, and how the refinancing is accounted for may attract the attention of the tax authorities.

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