Russia Tax: Spring thaw for investment?

Foreign investors in Russia, both actual and potential, have long complained about the tax and legal barriers to doing business in the country, with few government incentives to counterbalance the otherwise discouraging picture. Worst of all, some of these barriers personally touch the foreign individuals sent to manage these businesses, helping to perpetuate the country's negative investment image.

Recent developments, however, suggest that we might at last be seeing a change in approach by the Russian authorities. A raft of measures has emerged from government ministries over the past few months which, taken together, could deliver a significant improvement in the business and investment climate. While some measures have not yet been formulated into draft legislation, let alone enacted, others have already passed into law with extraordinary speed.

One theme that is emerging is that the government is relaxing its view of what is "strategic" industry, aiming for the privatization of state assets and possibly attracting foreign investors into previously "off-limits" businesses. Another theme is President Medvedev's call for modernization and innovation – a project that is gaining significant support and impetus from different areas of government.

For example, the new Skolkovo management school, just outside Moscow, has been chosen as the site of an "innovation zone" where there is an intention to grant companies tax holidays, reduced social taxes and preference for government orders. Innovation zones in other parts of Russia may follow, as well tax incentives generally to encourage innovation, research and development, etc. A capital gains tax exemption (after five years) for venture capital investments in technology companies is aimed at attracting external capital into the field.

Of equal interest, although perhaps less worthy of headlines, are changes that are starting to make Russia's tax system look more predictable and more like its international counterparts. A system of court precedent is developing, which will hopefully encourage consistent – and litigation free – interpretation of law by the tax authorities; transfer pricing rules along the OECD model seem almost certain to come into force in 2011, as is a tax consolidation regime, albeit for only the very largest taxpayers. Of practical interest to large investors is the new short-cut VAT refund procedure, which should remove the VAT cash flow burden suffered on capital-intensive projects that take time to generate a revenue flow.

Returning to the more personal, few foreigners in Russia (and their employers) have not been inconvenienced by the current immigration rules, including advance notification and documentation requirements, medical tests for obscure diseases and, not least, the fact that work permits are region-specific, placing a question mark over business travel around Russia. A recent agreement with France has significantly relaxed the system for many French citizens, and this lends some credence to the proposal to extend the approach to foreign managers and specialists generally. From the beginning of 2011, therefore, we may see three-year work permits valid throughout Russia, although it is probably naïve to believe that all the troublesome issues will be resolved overnight.

The President's message – that Russia needs to modernize and that it needs foreign investment to help achieve this – seems to be getting through and change is in the air. While the foreign investor's "wish list" will likely remain a long one for years to come, the sharp rebound in Russian GDP expected in 2010 could well encourage many foreign businesses to reconsider investment plans for Russia.