Are Risks in Russia Uncontrollable?: Are Risks in Russia Uncontrollable? Legal Structures for Creating a Successful Business in Russia
Philipp H. Windemuth
Partner
Russia’s Perceived Pros and Cons: Russia’s Perceived Pros and Cons
A. Economic Cooperation between Russia and Japan: A. Economic Cooperation between Russia and Japan
Japan, the world’s 2d largest economy, Russia’s 8th largest trade partner
Political tensions may be resolved in 2005/2006
Russia is ready for Japanese investment and has a favorable view of Japan
Leading Japanese companies are already invested in Russia
B. Legal Reform under the Putin Administration: B. Legal Reform under the Putin Administration
Foreign press unfairly criticizes President Putin for slow progress in legal reform
President Putin has implemented an impressive legal transformation, which is continuing
1. Tax Reform : 1. Tax Reform
Most important reform
Under Yeltsin, hundreds of taxes, intrusive audits and excessive penalities
Under Putin, OECD-type system of rules, with favorable tax rates
Taxes established by federal law, must have an economic basis, not be arbitrary and not interfere with constitutional rights
All ambiguities resolved in favor of taxpayer
No retroactive effect
International treaties prevail
As of Jan. 1, 2005, closed list of 15 taxes throughout Russia
Tax authorities continue aggressive enforcement of tax laws
Putin promises amendments to curb powers of tax authorities
2. Currency Reform: 2. Currency Reform
Entered into effect in June 2004
All transactions are permitted, unless specifically restricted
Forced conversion percentage reduced from 25% to 10%
Ruble becomes convertible in 2007
3. Securities Legislation: 3. Securities Legislation
Transparent securities market
US-style disclosure rules
International Accounting Standards
Significant increase in international IPOs and foreign debt offerings
Russian companies to raise US$ 35 billion by the end of 2006
Foreign offerings lead to improvement in corporate governance and accounting practices
4. Real Estate: 4. Real Estate
Reforms have helped create a boom in housing and other real estate construction
The 2001 Land Code provided underpinnings for real estate market
Nation-wide cadastral system
Laws on mortgage-backed securities, law on change of land categories
reduction of fees and elimination of VAT for sales of land and residential real estate
On Jan. 1, 2005, Civil Code amendments to protect good faith purchasers
State authorities fully liable for false information
5. Banking: 5. Banking
In 2004, S&P concludes that banking reform has begun to move in Russia
Putin enacts law on deposit insurance and manadatory reserves
Increase in capital adequacy requirements
Central Bank revokes licenses of non-conforming banks
Number of banks reduced from over 2000 in 2003 to 1,500 in 2005
6. Subsoil Law: 6. Subsoil Law
New law to enter into effect in 2006, stronger basis for investments, investor guarantees, allows pledge and transfer of licenses
Restrictions on foreign participation for strategic fields, on a case-by-case basis
Russia remains interested in promoting foreign investment in the oil sector
7. Court System: 7. Court System
One of the weakest parts of the Russian legal system
Substantial improvements if compared to the Yeltsin years
New Civil and Arbitration Procedure Codes streamline jurisdictional rules to reduce corruption
Corruption and arbitrary enforcement remain problematic
Putin acknowledges the problem in his 2005 Presidential Address
8. Administrative Reform: 8. Administrative Reform
Became top priority in 2004
Reduction in number of ministries, introduction of three-tier system of ministries, services and agencies
Significant internal opposition, requires extensive further work
Putin acknowledges « blatant racket » of officials
Plans do not include handing over the country to the inefficient rule of a corrupt bureaucracy
9. Other: 9. Other
Law on Communications
Customs Code
Labor Code
Law on Credit Histories
Reform of Natural Monopolies
WTO Legislation
Law on Toll Roads
Banking system, accounting standards and further administrative reform
3-year statute of limitations on privatizations
Foreign participation – largely unrestricted
C. Political Trends: C. Political Trends Concerns about political control and state involvement in the economy
Yukos affair, federal appointment of regional govenors, increased state participation in the oil sector – worries that Russia is drifting towards autocratic regime
Putin’s moves must be seen in political and economic context
Putin did not inherit a democracy, but a cleptocracy, on the brink of economic collapse
Yeltsin allowed corrupt transfer of most valuable property to small group of insiders and corrupt bureaucrats
By the end of 2000, Russia had collapsed economically and may have been on the verge of political disintegration
Putin reversed this process, turning Russia into Europe’s fastest growing economy, GDP grew by 7.1% in 2004, slowing to 5.5% in the first half of 2005, urgent measures are being taken to return to higher growth
Control over Media: Control over Media
Russian government controls television, but the press remains largely free and aggressively critical
Major newspapers controlled by Wallstreet Journal and Financial Times, and by ex-oligarch Berezovski
When compared with many US channels, even Russian TV appears surprisingly objective
D. Structuring of Investment: D. Structuring of Investment 1. Investment Vehicles
a. representation office
b. commercial branch
c limited liability company
d. joint stock company
Slide17: a. Representation Office
non-commercial presence
not a spearate legal entity
not subject to Russian profits tax
b. Commercial Branch
commercial presence
not a separate legal entity
may encounter difficulties with operating licenses
Slide18: c. Limited Liability Company
most flexible and most widely used type of investment vehicle
legal entity, with up to 50 participants
if single participant, such participant must have at least 2 owners
governed by meeting of participants and executive, board of directors optional
LLC shares are not securities, not subject to securities regulation
sale of LLC shares to 3d parties are subject to right of first refusal by other participants
LLC participants may exit the company at any time, with compensation payable at book value.
Slide19: d. Joint Stock Company
closed or open type JSC
closed JSC can have up to 50 shareholders
if single participant, such participant must have at least 2 owners
governed by meeting of participants and executive, board of directors optional for closed JSC
in closed JSC sale of shares to 3d parties subject to right of first refusal by other shareholders
shares in JSC are « securities » and hence subject to RF securities regulations
Slide20: 2. The Joint Venture
Used by most foreign investors
Russian partner can provide access to qualified personnel, customer and distribution networks, and assist with licenses and permits
Joint ventures are often problematic, due to problems between shareholders
To minimize problems, obtain control, and implement careful legal documentation, including allocation of authority and « put » or « call » options
Interested party transactions
Use of non-Russian JV holding company
Slide21: 3. Purchase of Existing Company
Used by large industrial companies which do not yet have an established customer base or distribution network in Russia
Raises issues similar to Joint Venture
Requires careful due diligence, including privatization, ownership rights and hidden liabilities (including tax)
Develop list of warranties, and secure with escrow payment where necessary
Use ERBD, IFC or Japan Bank as lender/co-investor
Slide22: 4. Greenfield Projects
a. Introduction
Used by investors who already have an established customer and distribution network
Local authorities are eager to attract foreign investors for greenfield projects
Recommended regions are Moscow Oblast (Egorievsk, Klin, Solnechnogorski and Stupino), Leningrad Oblast, Nizhnegorod Oblast and Tula region
Few restrictions on foreign investors
No notarization requirements for agreements, low transaction costs
Slide23: b. Ownership of Land
Most land remains under state and municipal ownership
Procedure of allocation of ownership among federal, regional and municipal ownership just begun
c. Zoning
Land divided into different use categories
A greenfield project may be built only on industrial land, or settlement land zoned for industrial purposes
Most land still zoned for agricultural purposes and must therefore be rezoned
Rezoning requires regional Government Decree, state permits and state expert review
Slide24: d. Acquisition of State and Municipal Land
Ownership or lease rights may be acquired through auction or tender proceeding
Lease rights may be acquired by direct negotiations
Slide25: (i) Auction or Tender
Prior to auction or tender, the plot must be prepared by:
Completion of land survey and determination of borders of the plot
Registration of plot in the Russian land register
Preparation of town-planning documentation determining the conditions for construction on such plot
Determination of technical conditions for infrastructure connections
Thereafter, the land plot is sold to the highest bidder
Few plots available for sale via auction or tender
Purchaser in auction or tender faces risks in construction process
Slide26: (ii) Non-Tender Proceeding
Grant to specific investor under long-term lease for a strictly defined facility
Complex procedure takes up to 12 months
Following completion of the construction, the investor should have the right to purchase the land plot
Steps for non-tender proceeding (costs payable by investor):
Application
Identification of plots
Preliminary approvals and publication
Act of selection of land plot
Survey and registration
Rezoning
Approvals for construction
Appraisals
Decision to grand the plot, and signature oflong-term lease agreement
Regional differences in procedure
Slide27: e. Infrastructure
The majority of land plots lack proper utilities connections
Investor to pay for infrastructure
Seek advice from technical consultants
f. Practical Approach
Arrange meeting with Governor or Deputy Governor of the relevant region, and head of the relevant local administration
Perform on-site inspections of land plots proposed by the relevant authorities
Reach a preliminary understanding with the relevant authorities with respect to the land plot to be proposed for acquisition
Slide28: g. Due Diligence
Prior to commencing discussions, perform a standard due diligence investigation including:
the validity of the owner’s rights to the land plot
a review of the land plot designation and type of permitted use;
possible third-party interests resulting from prior land use, privatization or other agreements;
liens and other encumbrances
review of documents and information on the availability of infrastructure and utilities
obtain technical and ecological study of land plot
Slide29: h. Purchase Price
Purchase price established by regional authorities as a multiple of Russian land tax
Multiple depends upon the population in the given area, set by regional governments within certain limits established by federal law
i. Title Insurance
Title insurance is permitted and available from licensed Russian insurance companies
Insurance premiums are between 1% and 4.5% per year of the market value of the insured property
E. Taxation: E. Taxation
1. Profits Tax
24% imposed on the differences between revenues and deductible expenses
May be reduced to 20% under regional laws granting tax privileges to defined groups of investors
2. VAT
Imposed at 18%, with a 10% rate applying to certain food items, childrens’ goods, medical products and related services
Imports are subject to VAT, most exports are exempt from VAT
3. Property Tax
Tax rate up to 2.2%, applies to all fixed assets, may be reduced by regional legislation
Slide31: 4. Payroll Taxes
Unified social tax on a regressive scale (from 26% to 2%) of relevant salary expenses
26% rate applies to salaires up to 280,000 R (approximately EUR 9,000) per year
2% rate applies to salaries over R 600,000 (EUR 20,000) per year
5. Workplace Insurance
Levied at industry-specific rates, based on work hazard levels
Standard rate for retail trade employers is 0.2% of the relevant wage payments
Slide32: 6. Dividend Withholding
15% under local law, reduced to 5% under most double taxation treaties
Treaty between Russia and Japan includes no such reduction
Best to invest via a European subsidiary with a favorable tax treaty with Russia (Cyprus or Holland)
7. Interest Withholding
10% under the Russian/Japanese treaty
0% under most Russia-European tax treaties (including Cyprus and Holland)
8. Customs Duties
Paid by importers on the customs value of goods and range between 5% and 10% for most goods
F. Conclusion: F. Conclusion
With GDP growth of 7.1% in 2004, Russia today is Europe’s fastest growing economy
Despite inefficient bureaucracy and wide-spread corruption, 80% of foreign investors are successful in achieving their business plans in Russia
In 2004, 75% of foreign investors posted profit increases in excess of 10%
Japanese companies are welcome in Russia and a number of leading companies have already made significant investments
Japanese companies are market leaders in many of the products which Russia needs most
President Putin has implemented and is continuing to implement significant legal reforms, in order to improve Russian investment climate
Reforms in the area of tax, currency, securities, real estate, banking and other areas are helping Russia to integrate into international financial and commercial markets
Slide34:
Much of the current criticism of Russia’s political developments under President Putin is overstated
Following the chaotic Yeltsin years, the thrust of Putin’s reforms has been to reestablish order in Russia and to put Russia back on the path towards economic prosperity, a task in which he has been extremely successful
In the current climate, investors will be successful if they have a good understanding of the legal situation, know their industrial sector and, where necessary, seek strategic alliances with Russian partners
Foreign investment can take the form of joint ventures, purchases of existing companies or establishment of new production facilities, depending upon the particular needs of the investor.