Deep in debt


The Russian economy appears to be showing the first, timid signs of recovery; yet getting out of the recession is likely to be a hard, lengthy and at times confused process. If there is a lesson to be learned, it is that borrowing is a highly treacherous thing.

It is worrying that Russian foreign non-government debt is $425.4bn and that it keeps rising. It is alarming that the bill for this borrowing binge will, at least in part, be footed by the public - just another way for shifting wealth from the poor to the wealthy. Yet, the problem is that debt has got so far of control not because the system has broken down, but because this is how it works.

Companies can raise money by selling shares (equity financing) or borrowing. In theory, the tax system must be neutral: a company should be able to decide the best way of financing based on economic considerations, not on taxes. In reality, the tax law skews the decisions companies make in favour of debt rather than equity.

Dividends are not tax-deductible and are generally subject to tax, known as withholding tax. In other words, it is paid twice: first the company’s profit is taxed by the corporate income tax then upon distribution abroad the dividend is taxed again.

Foreign companies load their Russian subsidiaries with debt and repatriate profit through the interest

Interest, on the other hand, is deductible and withholding tax is restricted or eliminated completely by a relevant double tax treaty. Thus, taxes in Russia can be kept at a minimum.

Foreign companies exploit this debt bias to the full. They load their Russian subsidiaries with debt and repatriate profit through the interest, often to tax havens where it is not taxed on receipt. In effect, for every dollar of interest paid a twenty four cents tax subsidy is given by the Russian taxpayer.

It is not surprising then that domestic companies, which are otherwise in a disadvantageous position, do the same: they create offshore structures to minimise their Russian taxes and obtain more flexibility in dealings with shareholders. And here the problem goes beyond taxation: companies that operate on the Russian market are regulated by foreign law and are outside the reach of Russian courts.

It is frustrating that the government plays its part in this process. It is not that it makes companies finance their business through debt or go offshore. Of course, it does not, but it certainly nudges them in this direction.

If truth be told, the Kremlin seems to be aware of the problem. Since the early 1990s a foreign shareholder has been entitled to bring in equipment as a contribution into the capital of its Russian company free of import duties.

Yet, what looks good on paper does not always work out: the customs seem to take it as a personal insult if it works as it should. The bureaucratic burden is nightmarish and, unless a lawyer and a customs broker have been in this situation before, the whole thing does not seem worth the effort.

The situation is not easy to change. Debt bias is a wide-spread disease, but for Russia change could be dire. Yet the biggest hurdle is, in a way, psychological. Russia must admit that it is, after all, a developing economy - it imports capital, not exports it, and so needs to adjust its policy accordingly. And above all, it must eliminate strange, stifling, and unbelievably superfluous bureaucratic barriers.


February 5, 2010
text: J. Vermin
picture: NatalyArt -



TEXT: Anton Pevnev, Consultant, Tax&Legal, KPMG in Russia and the CIS
Russian customs legislation stipulates certain concessions for foreign-trade companies when carrying out investment-oriented import–export operations in the Russian Federation.

The most notable of these is the exemption from import customs duties on goods imported as a contribution by a foreign owner to the charter (joint) capital of a Russian company. However, such operations require careful preparation, since specific statutory conditions must be met when carrying out these operations.

In a number of cases, when it is necessary to make temporary use of foreign goods in Russia, for example when organizing an exhibition or when importing goods for the use of the representation offices of foreign legal entities in Russia, Russian customs legislation stipulates the possibility of using the “temporary import” customs regime.

Under this regime, foreign goods are used in compliance with certain conditions established by customs legislation over a defined period within Russian customs territory, with partial exemption for the payment of customs duties and taxes and without the application of such prohibitions and economic restrictions as are established in accordance with Russian law on the state regulation of foreign trade. This regime is also applicable within the framework of financial relations under a lease agreement.

As part of Russian legislation on special economic zones (specific territories of the Russian Federation on which special rules for business activity apply), the customs regime of “free economic zone” is envisaged. Under this regime, foreign goods are exempt from customs duties and taxes, provided certain statutory conditions are met.



Russian law encourages borrowing, while it should stimulate equity contributions


Debt collection is a growing trend in a world where individuals aren't often able to meet their financial obligations. With this growing group, many individuals are finding themselves being harassed by debt collectors and lawyers. These agencies are perhaps threatening, and in some cases acting on the threats of physical violence. This has brought about a whole new world of consumers suing the debt collection agencies. We would not need a private loan to pay these debts off if we spent half the cash we spend on lawsuits in this country on just fixing the problem.