What One Should Know About Foreign Invested Enterprises in Russia

What One Should Know About Foreign Invested Enterprises in Russia

In recent years, foreign direct investment in the economy of Russia has been steadily declining, while the flow of funds abroad has increased. The main reasons are the international sanctions, the growth of crisis trends, and the aggravation of the geopolitical situation in the world. Under the new conditions, venture business benefits, and there emerge enterprises with foreign investments from China, India and South Korea. Currently, it is crucial to attract capital from abroad, and it requires particular attention.

What is Meant by Foreign Investments?

Most citizens of the Russian Federation believe that foreign investments are, first of all, inflows of foreign currency funds from abroad to obtain profits in the future. But in reality, the picture is more complicated. There can be not only cash investments, but also, for instance, intellectual or property investments. Foreign investors can be foreign branches of domestic firms or offshore companies belonging to Russia’s oligarchs. It would be more appropriate to describe the concept of «foreign investments» as any assets (material and intellectual) that are invested by non-residents of the Russian Federation in the Russian economy for financial gain.

Investments can be:

  • direct — when buying 10 or more percent of the shares of a certain enterprise with the investor’s active involvement in its business;
  • portfolio — when holding less than 10% of shares without active involvement;
  • real — investing in active projects;
  • credit, non-material (acquiring trademarks, patents), etc.

See the article «Foreign Investments» for more information on this subject.

Foreign Investment in Russia: Legal Regulation

For business people who invest in another country, there is always a danger of losing their investment. Therefore, they need legislative protection of their interests, certain safeguards — for reinvestments, the right to pay taxes only once in a given country, additional customs privileges, etc.

The RF Government has an interest in attracting foreign capital. Investors’ interests are protected by a number of Federal Laws — No 160-FZ of July 9, 1999 «On Foreign Investments in the Russian Federation», No 7-FZ of January 12, 1999 «On Non-Commercial Organizations» and other legislative acts of the RF subjects.

The activities of credit institutions with foreign investments are subject to the regulations of banking legislation — Federal Law No. 86-FZ of July 10, 2002 «On the Central Bank of the Russian Federation», the Regulation «On the Specifics of Registration of Credit Institutions with Foreign Investments» (CBR Regulation No. 437 of July 10, 1999) and others.

As a practical implementation of this policy, the RF has established 25 special economic zones where foreign investors receive legislative preferences.

To learn more about the mechanisms for protecting funds from abroad, please, read the article «Legal Regulation of Foreign Investments in Russia».

A Foreign Investor: Who Can Become One?

The legislation of the Russian Federation (Article 2 of the Law of the Russian Federation No. 160-FZ of July 9, 1999) clearly defines who can become a foreign investor:

  • a foreign organization — a legal or unincorporated entity, formally established and legally operating in its country, authorized to make investments abroad. With the exception of foreign companies managed by a Russian citizen or a legal entity from Russia;
  • a foreigner, competent and legally capable to act, who is entitled to invest abroad in accordance with the legislation of the country of residence, except for individuals having a second Russian citizenship;
  • a stateless person who, in accordance with the laws of the country of residence, can invest abroad;
  • an international organization;
  • a foreign country.

Foreign Invested Enterprises in Russia: Organizational and Legal Forms

The Russian legislation, as far as organizational and legal forms of business are concerned, does not categorize residents and non-residents of the Russian Federation. All investors who want to register this or that form of business in the state registry of legal entities of Russia have to follow the same laws and rules. This approach ensures that every entrepreneur can expect to receive foreign investments.

Successful business activity that involves foreign investment substantially depends on the right choice of the form of doing business. Everything depends on the goals and nature of the activities. For example, foreign direct investment (FDI) can be for-profit and non-profit.

For-Profit Legal Entities

For-profit organizations are legal entities set up to generate maximum earnings for shareholders (Article 50 of the Civil Code of the Russian Federation). Foreign investment can increase income.

Foreign invested for-profit entities can take various forms — companies (LLC, JSC, ALC), business partnerships (full and limited liability), farming enterprises, artels, various co-operative societies and others.

The state may also enter into investment treaties with foreign investors concerning municipal or state-owned facilities (Federal Law No. 115-FZ «On Concession Agreements» of July, 21, 2005, amended on August 3, 2019).

Non-Profit Organizations (NPOs)

Article 50 of the Civil Code of the Russian Federation specifies NPOs as those which do not consider profit and its subsequent distribution as the main goal, but satisfaction of spiritual, social, scientific, educational and other needs. They include:

  • religious organizations (communities, missions, monasteries, etc.);
  • public organizations (communities, associations, etc.);
  • political parties;
  • charitable foundations;
  • associations, unions;
  • educational, cultural and other organizations.

The Civil Code of the Russian Federation does not limit the number of organizational and legal forms of non-profit organizations. NPOs as a form of organizations involving foreign capital act in accordance with the provisions of Federal Law No. 7-FZ «On Non-Commercial Organizations» of January 12, 1996 (amended on July 29, 2019). Thus, Article 6 of the law describes non-profit organizations that are involved in political actions or influence public opinion in Russia, while receiving foreign investments in the form of money, property, as those that perform functions of a foreign agent. Such companies are obliged to register in a special state registry before starting their activities. Religious associations receiving assistance from abroad are obliged to provide a detailed annual report on the funds received (Article 25.1 of Federal Law No. 125-FZ «On Freedom of Conscience and Religious Associations» of July 26, 1997, amended on February 05, 2019).

Types of Foreign Invested Enterprises in Russia

Foreign invested enterprises are classified according to the amount of shareholders’ investments. Thus, self-managed business involves investing not only the investor’s capital, but also his or her labor, knowledge and time. In this case 100% of profit will also belong to him/her.

Equity participation in business has become more widespread. When partners are equally involved, the enterprise is based on parity. Depending on the extent of such participation, the investor’s impact on the company can be defined as:

  • controlling (if there is a controlling interest);
  • considerable;
  • inconsiderable.

Wholly Foreign Owned Enterprises

The fact that there are 51–100% of funds from abroad in the authorized capital of the FIE ensures the right of a foreign investor to become a controlling person or owner of the enterprise. For this, it is necessary to found a company or buy shares from the owners of an established company. This is provided by Federal Law of the Russian Federation No. 160-FZ of July 9, 1999. At the same time, it should be taken into account that this law does not apply to strategically important enterprises, defense, aircraft industry, etc., educational, scientific and religious spheres.

The effect of this regulation is also limited for investments in the banking system. Thus, Article 18 of Federal Law No. 395–1 «On Banks and Banking Activities» as amended on August 3, 2019, prescribes that the highest possible participation of foreign capital in credit institutions is 50%. If this quota is exceeded, the license will be revoked.

Such restrictions serve, first of all, to protect the national interests of the country (including domestic producers) from foreign competitors.

Joint Ventures

The term «joint venture» (JV) was introduced in Russia in 1920. It became widespread in the late 1980s and was in use in 1990. Law No. 1545–1 of the RFSSR of 1991 stated that legal entities involving a foreign component were subjects of international law. That is the case with JVs — for-profit entities where foreigners are involved. Today, the term JV is not used in economic and legal terminology. Federal Law No. 160-FZ of July 9, 1999 uses a different, more comprehensive term — foreign owned enterprises (FOEs). Moreover, not only money, but also modern technologies, equipment, securities, etc. can become investments.

A domestic entity gets the status of a FOE when one/ several foreign shareholders join its founders (the share should not be less than 10% of the authorized capital). From then on, the organization is subject to the above-mentioned Federal Law No. 160-FZ. In joint ventures the property of foreign investors is protected by law and cannot be expropriated (Article 8).

You can learn more about all the pros and cons of setting up a FOE if you read the article «Joint Venture with a Foreign Company».

Representative Offices and Branches of Foreign Legal Entities

According to Article 4 of Federal Law No. 160-FZ of July 9, 1999, foreign legal entities engaged in business in Russia have the right to establish their representative offices and branches. For this, it is necessary that the parent company is directly in charge of all its commitments made in Russia, and the subdivision created by it obtains accreditation.

If the parent company has no intention to engage in actual activities — produce goods, sell services, etc., but there is a need to represent its interests in a particular region of Russia, it makes sense to open a representative office. The topic is covered in more detail in the article «A Representative Office of a Foreign Company in Russia».

A branch can perform both representational and trade and production functions. Subdivisions as integral parts of the parent company are also subject to Federal Law No. 160-FZ of July 9, 1999. They enjoy all the relevant safeguards and preferences.

Structure of Entities with Foreign Investments in Russia

As already mentioned, non-resident investors in Russia enjoy the same rights as Russians.

All powers, procedures for monitoring and managing a FOE should be stipulated in the charter.

The most common ones are:

  1. FOEs with an equal share of control — when the partners have equal rights, the founders are not actively involved in management, delegating these functions to professional managers. The managing director is appointed at the constituent assembly of the shareholders. Their rights and duties (representing the interests of the company, entering into contracts, executive powers, etc.) are determined in the constituent documents (Article 274 of the Labor Code of the Russian Federation).
  2. FOEs where one of the founders has the dominant control. The owner of the company may independently manage and lead the company or appoint a manager.

The structure of a FOE is determined by the foundersy, according to the chosen organizational and legal form. For example, the common structure of a JSC includes:

  • shareholders’ meeting as the supreme body;
  • the board of directors (3, 5 or more, but necessarily an odd number) — to run the business between meetings;
  • management — appoints the board of directors;
  • CEO with prime authority to sign;
  • audit team.

Selection and hiring of employees are subject to the Russian Labor Law. The head of a FOE can be both a Russian citizen and a foreigner who has an employment permit in Russia. The head office appoints the management of the representative offices and branches.

Goals and Objectives of a FOE

Using foreign investments in joint ventures involves several objectives, the most important of which is to derive profit. This is essential not only for those directly involved in the cooperation. Thanks to FOEs, the following objectives will be achieved nationwide:

  • stream of new high-quality products/ services and therefore import phaseout;
  • foreign exchange earnings;
  • innovation and acceleration of modernization processes in the economy;
  • new job opportunities for the regions, and others.

The top priority for founders and shareholders of a joint venture is mutual financial gain. Foreign investors, besides, pursue a number of other goals:

  • to expand the market for their products and find new partners;
  • to establish themselves in the area hoping for a more favorable situation in the future;
  • to take advantage of highly qualified and cheap local labor;
  • to access cheap energy and other raw material resources.

With investments from abroad, Russian entrepreneurs expect to increase productivity, implement advanced technologies, increase employees’ material interest in the results of their work, decrease financial risks, optimize marketing at enterprises involving foreign investments, and enter the world market. Acquiring the status of a FOE will make it possible to exercise the right to benefits, etc.

What Should One Know About Taxes?

The Russian state guarantees fiscal stability for the period of up to 7 years to enterprises having 25% and more foreign capital in their authorized capital. Foreign legal entities have to be registered with Tax Inspectorate when starting their activities in Russia.

The following benefits are valid for FOEs:

  • total income tax rate — 20% (Article 284 of the Tax Code of the Russian Federation);
  • tax holidays for two years;
  • the possibility to get an investment tax credit at a reduced rate, when the entity pays the budget as it settles the accrued interest, principle of the loan and the amount of income tax within 1–5 years.
Federal Law No. 160-FZ introduced the notion of «cumulative tax burden». It means the total amount which is necessary to pay federal taxes (except for VAT on Russian products and excise duties) and fees to state non-budgetary funds (except for the Pension Fund of the Russian Federation) from the date of investment inflow. On the whole, tax pressure does not contribute to the increase in foreign investments in the Russian economy.

For more information about Russia’s fiscal policy with regard to FOEs, see the article «Taxation of LLC with Foreign Investments».

On Accounting at Foreign Invested Enterprises

Accounting and all reporting at foreign invested enterprises (FIEs) in Russia should comply with the requirements of Russian legislation. It is prohibited to transfer reporting documents abroad, and they have to be in the Russian language. Management of the FIE is fully responsible for accounting, and the accounting policy is approved at the shareholders’ meeting. The division of profits among shareholders is an internal affair of each enterprise, but any required taxes on income have to be transferred to the budget. At the end of the year, all FOEs are audited and submit accounting reports to the fiscal and statistical authorities.

Summing Up

Despite the negative impact of the sanctions imposed by the US, Canada, Australia and EU countries, foreign investors’ interest in Russia does not diminish. Instead, the geographical coordinates have shifted — Europe is losing its position, while Asia (primarily China) is gaining strength.

Of the capital investments, direct investments in mining and manufacturing, agriculture, knowledge-intensive technologies, etc. prevail. The Russian government is interested in inflow of funds and new technologies from abroad, job creation, therefore, it provides legal protection of foreign investors’ rights. FOEs have gained the greatest popularity.

For-profit legal entities with foreign participation are subjects of international law. Such companies arise owing to:

  • the creation of a new company or the purchase of an existing one;
  • the purchase of stocks or shares of the enterprise (equity participation);
  • the opening of branches and representative offices under the current legislation of the Russian Federation.

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