By David M. Wack
On July 9, 1999, President Yeltsin signed into law the new Russian Foreign Investment Law (FIL). The new FIL replaces the previous FIL, which had been in effect since 1991. In general, the new FIL offers many of the same protections provided by the previous law, with a few notable additions, including a new tax stabilization clause and greater detail on the use of branch offices in Russia. Although the new FIL offers protection to all forms of foreign investment, a number of its provisions are expressly designed to promote “direct” foreign investment, which is defined as (1) the acquisition of a more than 10 percent stake in a Russian commercial entity, (2) investment in a branch of a Russian legal entity, or (3) leasing of certain electric and transportation equipment (including aircraft). In response to the financial crisis of August 1998, Russia is encouraging such forms of direct investment as preferable to portfolio investment.
Tax Stabilization Protection
The tax stabilization protection of the new FIL is its principal innovation. Although the protection is fairly strong, its efficacy is still somewhat uncertain, particularly in the absence of implementing regulations and the presence of ambiguities in the law. Under the new FIL, the enactment of any new laws or regulations that change the amount of certain federal taxes, customs, and other mandatory payments, or amendments to existing laws and regulations that increase the total tax burden on or otherwise limit foreign direct investment, is not applicable until recovery of investment (as determined by implementing regulations to be enacted by the Russian Government). Protection under this clause appears to be available only to Russian commercial entities engaged in “priority investment projects,” which are defined as projects in which total foreign investment is at least $40 million, or foreign equity investment is at least $4 million, in industry sectors specified by the Russian Government. However, the language of other provisions in the new FIL suggests that tax stabilization is intended to apply to all direct foreign investment projects in which foreign investors hold a 25 percent equity stake, regardless of size or industry. This ambiguity will need to be addressed in implementing regulations or through amendments to the new FIL.
Although the stabilization protection covers the majority of applicable federal taxes, a few significant taxestax (VAT) on domestically produced goods and Pension Fund contributions. In addition, it should be noted that the stabilization protection does not apply to regional or local taxes. However, regional and local governments have considerable authority to grant tax incentives for these taxes.
The new FIL calls for the Russian Government to enact a series of regulations implementing the tax stabilization protections, including regulations governing the procedures for: determining whether a change in law has an adverse or limiting impact; registering priority investment projects; and oversight of foreign investors’ compliance with investment commitments.
Other Relevant Provisions of the New FIL
1. Application and Definitions. The definition of foreign investor in the new FIL includes legal entities, noncorporate entities, and individuals, as well as international organizations acting under international agreements and foreign governments. Investment is defined broadly to include cash, securities, property, property rights, intellectual property, services, and information. Specifically excluded from the definition are investments in banks and other credit organizations, insurance companies, and nonprofit organizations for the purpose of socially desirable objectives, which are to be governed by separate laws. The protections of the new FIL also apply to branches of foreign investors and commercial entities in which foreign investors participate, but not to subsidiaries or affiliated companies of the latter.
2. National Treatment. Under the new FIL, foreign investors are guaranteed the same legal rights and privileges available to Russian residents, subject to limitations or benefits that may be established by Russian law.
3. Expropriation and Compensation of Losses. Like the previous law, the new FIL protects foreign investors against expropriation and nationalization of their property. However, unlike the previous law, it does not enshrine the principle of “prompt, adequate and effective compensation,” which is widely regarded as the international standard; rather it merely requires that the investor be compensated for the value of its property without indicating the timing, method of determining value, or currency of compensation.
4. Repatriation of Profits. Under the new FIL, a foreign investor is guaranteed unrestricted use of its after-tax income, both within Russia and abroad.
5. Preferential Treatment. Except for tax stabilization protection, the new FIL does not grant any tax or customs concessions to foreign investors. Priority investment projects are eligible to receive tax and customs benefits in accordance with Russian tax and customs law. Currently, however, Russian tax and customs laws do not contemplate any special tax concessions for large-scale investments. The new FIL underscores the ability of regional and local governments to offer tax and other incentives to foreign investors.
6. Foreign Personnel. Unlike the 1991 law, the new FIL does not explicitly address the issue of employment of foreign personnel, but implies that such employment is permitted by stating in the preamble that one of its purposes is attracting foreign managerial experience. Moreover, unlike the previous law, the new FIL does not guarantee import customs duties exemptions for personal effects of expatriate employees.
7. Dispute Resolution. The new FIL provides that a foreign investor is guaranteed the right to settle disputes arising out of its investment or business activities in Russian courts or through arbitration in Russia or abroad. Unlike the previous law, the new FIL does not differentiate between disputes with private entities and the Russian Government.
8. Registration and Accreditation. The new FIL removes the separate national registration requirement of the previous law for Russian companies with foreign investment. It now appears that such companies are to be registered with the local registration bodies in the same manner as purely Russian companies. In addition, the new FIL spells out in greater detail the procedures for accreditation, operation, and liquidation of branch offices of foreign companies, an area that previously lacked any meaningful legal guidance.
On the whole, the new FIL reiterates in a more succinct fashion many of the protections that have been available to foreign investors in Russia for over 8 years and eliminates a number of provisions of the previous law that became inconsistent with subsequent Russian laws. The new FIL’s principal innovation—the tax stabilization provision, although not without its flaws, is a positive step toward mitigating one of the greatest uncertainties related to investment in Russia.
David Wack is a member of the CIS Practice Group of Squire, Sanders & Dempsey LLP in Washington, DC.
For a lengthier analysis of the new Russian FIL, visit BISNIS Online at www.bisnis.doc.gov/bisnis/isa/isa.htm#Kisa.