16.10.10

Russia's Simplified Taxation
Part I: The Basics of the System 
Galina Karagodina, Internal Auditor, Methodologist,
Alinga Consulting Group

With the current market realities, companies are focusing more than ever on cutting costs, including taxes. One possible method of tax reduction in Russia is to switch to the simplified tax system (STS). While this may seem simple enough at first in reality STS has shortcomings that can actually increase, not decrease, expenses. This article will lay out the basics of what every company manager considering transferring to STS should know. Positive and negative aspects of the system are examined in Part II: Advantages and Disadvantages.

Before committing to such a transition, company management must thoroughly consider whether the company’s current activities, expected future development, and types of expenses are compatible with STS.

STS may be adopted at the beginning of the fiscal period, if the company qualifies (see the list of requirements below). Applications are submitted to the Tax Authorities from Oct. 1-Nov. 30 of the year preceding adoption.

Qualifying for STS

Russia’s tax code [1] lists several requirements that companies must meet in order to use STS. These include:

Revenue threshold: 

In order to qualify for STS in the period up until 09.30.2012, company revenue must not exceed 45 million rubles during 9 months of the year before STS is adopted. From 10.01.2012 through 12.31.2013, the revenue threshold will be determined based on the limit that the account was indexed to in 2009 (43,428,077 rubles).

If, during the course of the accounting (fiscal) period, the company’s revenue exceeds the 60 million ruble limit (in effect through 12.31.2012), it will be disqualified from using STS for one year. From 01.01.2013 through 12.31.2013, the revenue limit will be determined based on the limit that the account was indexed to in 2009 (57,904,103 rubles);

No Branches or Representative Offices:

If a company has a branch or representative office, it cannot adopt STS. Article 55 of the Civil Code defines branches and representative offices as subdivisions, separate from the company (legal entity) which:

• are located separately from the company;
• represent the company’s interests or carry out its functions (or part of its functions);
• are allocated assets by the company;
• act according to approved by-laws of the company;
• have an appointed head who acts on the basis of a power of attorney from the company;
• are indicated in the company’s founding documents;

If a company has subdivisions that do not meet this definition, then the company may still qualify for STS.

Business Sector:

The following types of companies are not allowed to use STS:

• banks;
• insurance companies;
• non-governmental pension funds;
• investment funds;
• securities market participants;
• pawnbrokers;
• organizations involved in the production of excisable goods or involved in the mining and sale of raw materials with the exception of "common commercial minerals" (such as those used in building materials);
• organizations involved in the gaming industry;
• privately practicing notaries or lawyers who have established legal offices, as well as other forms of legal practice.

Company Structure and Ownership:

If more than 25% of a company's charter capital was contributed by other legal entities, that company is ineligible for STS, with the exception of certain non-profits dedicated to the disabled and certain consumer cooperatives.

State-financed companies are ineligible for STS.

Companies not registered in Russia are also ineligible for STS.

Limit on Number of Employees:

The average number of employees during the fiscal (accounting) period should not be more than 100 persons [2].

Asset Limitations:

The depreciated book-value of fixed assets and intangible assets should not be higher than 100 million rubles. The depreciated value is determined according to the accounting data, and only for fixed and intangible assets that are subject to amortization and are recognized as amortizable assets under Chapter 25 of the Tax Code.

Other Considerations:

• Companies involved in production-sharing agreements are ineligible for STS.
• Those companies which have adopted the tax system for producers of agricultural goods are ineligible.

Disqualification from STS

If, during the course of the accounting (fiscal) period, the company does not meet one of the eligibility requirements, it is disqualified from using STS for one year and must adjust its books accordingly beginning from the quarter in which the infraction took place. This often means incurring fines and penalties.

"Optional" Accounting Under STS

Under STS there are some discrepancies regarding how the accounting records should be maintained and presented. Federal Law actually frees those using STS from maintaining accounting records [3].  However, the Ministry of Finance has stated that it is necessary to maintain accounting records and prepare accounting statements in accordance with Russian legislation no matter what tax system is used.

In reality, it is impossible to comply with the law or run a successful business without maintaining accounting records. For example, companies cannot compare net assets with capital, distribute profits, or prepare distributive and liquidation balance sheets for purposes of reorganization without accounting records. If a company is disqualified from using STS or elects to discontinue STS, accounting records would need to be reconstructed for those periods spent under STS.

Taxation under STS

Organizations using STS are exempt from:

• Profit Tax, except for tax due on dividends and interest on securities [4];
• Property Tax;
• Value-Added Tax (VAT), except for VAT paid on goods imported into Russia, as well as VAT paid on transactions according to simple partnership agreements (joint venture agreements), fiduciary management agreements, or concession agreements in Russia.

Instead of the above-mentioned taxes, the organization pays a single tax, the rate of which depends on the chosen object of taxation. The object of taxation is either aggregate income or income minus expenses. The process of choosing this basis will be discussed further in the next section.

STS taxpayers may choose to be taxed on income or income minus expenses.  As of Jan. 1, 2009 the Tax Code allows the organization to change the object of taxation (i.e. whether they are taxed on income or income minus expenses) yearly, per a notice drafted according to the recommended form N 26.2-6, established by FTS Order N MMB-7-3/182@ from 13.04.2010. To do so, the organization must inform the Tax Authorities of its decision by December 20 of the year prior to making the switch.

All other taxes must be paid as usual, including payments for compulsory social insurance against industrial accidents and occupational illnesses.

For companies using STS in 2010, smaller contributions are required for temporary disability insurance and pregnancy leave and mandatory medical insurance. According to Article 57, Part 3, Point 2 of Federal Law #212-FZ dated 07.24.2009, those using STS only contribute to the Pension Fund at a rate of 14%. However, beginning January 1, 2011, this reduced rate will no longer be in effect.

Note that application of STS does not relieve the company from its duties as a tax agent. If a company makes a sale to a foreign organization that is not registered with the Russian tax authorities, for example, the Russian organization that made the sale is responsible for paying any related taxes all of which must be paid as usual.

The Object of Taxation and Income

The taxpayer can chose between two methods of defining the object of taxation:

• income;
• income minus expenses.

Income is determined according to Chapter 25 of the Tax Code. In both cases the cash method is recognized. This means the date of actually receiving the income is recorded as the day the funds or other assets are received or the day a debt is repaid.
Income in foreign currency is calculated into rubles according to the exchange rate of the Central Bank of Russia on the date of receiving the income or paying the expenses. Income in-kind is calculated according to market price.

Expenses under STS differ from those as used under the regular taxation system. These should be carefully considered before selecting an object of taxation. 

Before a company selects its taxation object, a thorough study of its planned expenses for the next year should be undertaken, since the taxation object will determine the company’s tax burden.

General Expenses under STS

Under STS, the following are not deductable as expenses [6]:

• the cost of consultation services and information services;
• entertainment expenses;
• losses due to defective goods;
• expenses on current market research;
• expenses for fines related to violations of contract obligations or debt liabilities;
• expenses for the voluntary personal insurance for employees;
• expenses for employee recruitment;
• expenses for outsourcing employees to outside organizations;
• expenses in the form of discounts;
• losses from previous years, as detected during the current accounting period;
• losses from unrecoverable debts.

Expenses may be recorded only after their actual payment. In addition, special rules of recognition apply for separate types of expenses:

• material expenses (including for acquiring raw and other materials), labor expenses, loan and credit interest, and expenses for rendering payment to third parties can be deducted as soon as payment is sent;
• expenses for goods acquired for future sale are recorded once they are sold. To evaluate the purchased goods any of the following methods can be used – FIFO, LIFO, average cost, or the unit cost;
• expenses for paying taxes and duties are recognized in the amount of what is factually paid by the organization within the limits of the assessed amounts of taxes and duties. For instance if an organization overpaid taxes, income is not decreased by the amount of these overpayments.

Asset Purchase and Amortization under STS

Acquisition expenses (construction and production) of fixed assets, further construction, further equipping, reconstruction, modernization and technical upgrading of fixed assets, as well as expenses for the acquisition expenses (made by the taxpayer himself) of immaterial assets are reported on the last day of the accounting (fiscal) period in the amount of the sum paid.

Under the regular tax system, fixed and tangible assets are expensed (depreciated) over the useful life of the asset. Assets acquired under STS are written off as expenses as a lump sum at the moment the fixed assets come into service or at the moment immaterial assets are entered into the accounting records.

If fixed assets were acquired before the transition to STS, they are expensed in the following manner:

• assets with a useful life of up to 3 years – within the first year of applying STS;
• assets with a useful life from 3 to 15 years – 50% of the cost within the first year of applying STS, 30% within the second year, and 20% within the third year;
• assets with a useful life greater than 15 years – cost of the fixed assets applied equally over the first 10 years of applying STS.

During the transition from the general to the simplified tax system (STS) the depreciated value of fixed and intangible assets is determined by subtracting the total amount of amortization from the cost of the acquisition [7]. 

If fixed or intangible assets are sold earlier than three years after they are expensed, the tax base for the entire period of use should be recalculated, likely resulting in additional taxes and interest. This would apply to assets with a life of over 10 years as well.

Taxation under STS

Once it is determined if most of a company's expenses will be recognized under STS, the related tax rates must be considered.

For those who choose income, the tax rate is 6%. For those who choose income minus expenses, the law allows the individual governments of the subjects of the Russian Federation (regions, krais, republics, etc.) to set graduated rates from 5 to 15%. If the "income minus expenses" base is used, taxes paid cannot amount to less than 1% of total revenues calculated when determining the tax base. This so-called minimum tax is paid if the sum calculated according to the standard tax procedures is less than the sum of the calculated minimum tax during the fiscal period.

The table below outlines the tax rates of the major taxes due under STS and the regular tax system.

Tax	STS	Regular Tax System
Profit Tax	---	20%
VAT	---	10%, 18%
Property Tax	---	maximally 2.2%
Pension Fund Contribution	14% in 2010; 26% as of 01.01.2011	20% in 2010; 26% as of 01.01.2011
Mandatory Social Insurance Contributions	0% in 2010; 2.9% beginning 01.01.2011	2.9%
Mandatory Medical Insurance Contributions	0% in 2010; 5.1% beginning 01.01.2011	3.1% in 2010; 5.1% beginning 01.01.2011
Single Tax	If income is chosen as the object of taxation, the tax rate is 6% of income, minus the contributions to the pension fund and to mandatory social insurance for work accidents made in that period; and beginning in 2011, contributions to temporary disability insurance, maternity leave, and mandatory medical insurance funds will also be included. However the sum cannot be reduced by more than 50% in total. If income minus expenses is chosen, then the tax rate is usually 15% of profit (but not less than 1% of income).	---
Other taxes	As per legislation

Organizations that choose to tax profit have the right to lower their income over a period of up to 10 years on losses received in prior periods of using STS, and as such lower their tax base. As of Jan.1, 2009, the 30% limitation on this type of loss carry-forward was removed, and now the tax base can be decreased by full amount of the previous loss.

As of 2011, the amount of unified tax may also be lowered by the amount of the company’s contributions to the disability insurance, maternity leave, and mandatory medical insurance funds paid (within the limits of the calculated amounts) during the time period specified by Russian law.

Organizations make advance tax payments according to the results of the quarterly accounting period based on the accrued tax base and applicable tax rates. For taxpayers that have opted to have income taxed (6%), the sum of the tax due can be offset by 1) the sum of premiums paid during that period to the mandatory pension fund and 2) the sums paid for disability benefits, sick leave, etc. However the amount of tax due can be reduced by more than 50% in total. Therefore the effective tax rate may be as low as  3% of the turnover.

One of the biggest benefits of using STS is the greatly reduced accounting burden. As of Jan.1, 2009, companies using STS no longer need to submit quarterly tax declarations. Companies may file once – at the end of the year and covering the entire period. This needs to be submitted by March 31 following the last tax period.

Not as Simple as You Thought?

Certain business will find STS to be an effective cost-cutter in terms of taxes paid and reporting required. However, it is most certainly not true that all business that qualify for STS will find it advantageous. The second part of this article will look at the advantages and disadvantages of STS in greater depth.

Russia's Simplified Taxation - Part II: Advantages and Disadvantages >>

[1] See Articles 346.12 and 346.13 of the Tax Code.

[2] Established in 2009 by an order of the State Statistics Service on Nov. 11, 2008, № 278.

[3] Point 3 of Article 4 of Federal Law № 129.

[4] Point 4 of Article 284 of the Tax Code.

[5] Point 1 of Article 346.14 of the Tax Code.

[6] Article 346.16 of the Tax Code.

[7] Chapter 25 of the Tax Code.

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