Due to events known to all, at least some Latvian companies have been forced to suspend business with their Russian partners. Even if business has not stopped completely, transactions are hampered and may require additional exit actions. Recognising this situation, the Latvian Tax Authority (VID) has issued guidelines on transactions with Russian companies which outline the problems but do not provide solutions.

In this article, we look at the potential problems in dealing with Russian companies, including if the decision is taken to exit the business with minimal losses, including, minimal tax losses.

Receivables

Latvian companies selling goods or providing services to clients in Russia face problems with their receivables. These situations arise when Russian banks are unable to make payments to Latvian creditors or Latvian banks refuse to make transfers.

Therefore, when a receivable is created, which, according to the provisions of Section 9 of the CIT Law, must be included in the taxable base for income tax purposes, is included if it meets one of the following criteria:

1) a provision for the doubtful debts has been created in its amount, it is included as a cost in the profit or loss statement, and the debt has not been recovered within 36 months (within 60 months if insolvency proceedings have been commenced for the debtor) from the day of the creation of the provision, or the exemption referred to in Paragraph three of this Section is not applicable thereto in this period;

2) it has been included in losses (expenditure) if, prior to this, a provision has not been created for the relevant debt of debtor, and the exemption referred to in Paragraph three if this Section is not applicable to the amount of debt;

3) a provision for doubtful debts has been created thereon, it is included as a cost in the profit or loss statement, and the debt has not been recovered within 60 months, counting from the day of arising of the debt when the recipient of goods and services should have settled accounts with the supplier of goods or provider of services, but the payment was not made, and the exemption referred to in Paragraph three of this Section is not applicable to the debt amount.

In this case, in order not to lose the full amount of the claim and not pay CIT on the lost debts, the Latvian company may use a strategy involving assignments of claims. It should be remembered that in assignment transactions the transfer of the debt will usually be at a discount, i.e. if, say, the principal amount of the debt is 1 000 EUR, the assignor will receive a lower compensation when assigning it. This means that there will be a loss on the assignment, which is taxable under Section 8(2)(d)(12) of the CIT Law, except in the following case.

Paragraph two, Clause 12 of this Section shall not be applied if the first two conditions and one of the other conditions referred to in this Paragraph are met:

  • the assignee is a corporate income taxpayer or a payer of tax equivalent to the enterprise income tax;
  • the assignee is a resident of European Union Member State or a state of the European Economic Area, or a resident of such state, with which Latvia has entered into a convention for the avoidance of double taxation and the prevention of fiscal evasion, if such convention has come into force;
  • the assignment transaction does not involve a related person;
  • the value of the assignment transaction corresponds to the market price (value) thereof which is calculated according to the methods determined by the Cabinet of Ministers.

This means that the assignee must be an unrelated party or, if the assignee is a related party, an assessment of the assignment transaction must be carried out, i.e. the compliance of the discount with the market value must be assessed.

Payables

Problems may also arise in transactions between Latvian and Russian companies if the payer (service receiver/ goods purchaser) is a Latvian company. Especially in cases where banking activities are restricted or prohibited. In such a situation, the solution may be to assign the Russian creditor’s claims to another country where a transaction is possible.

The Latvian company will not have any additional tax considerations, in principle, it does not matter whether the payment is made to the creditor or to the assignee, but it should be remembered that the payment to the assignee is in any case considered a payment to a low tax country, for the reason that the payment reduces the liabilities to the former creditor (the Russian company). Therefore, when making payments under an assignment agreement, all the considerations that are relevant when making payments to a Russian company must be taken into account, including the arm’s length nature of the transaction, obtaining permission from the Latvian Tax Authority, etc.

Investments by Russian companies in Latvia

For subsidiaries of Russian companies in Latvia, repartition of profits becomes completely disadvantageous because, in addition to CIT, the payment of dividends to a low-tax country will be subject to a 20% withholding tax.

In general, for a Latvian company calculating dividends from January 1st 2018 onwards, the dividends are subject to CIT. So, if a net dividend of 1 000 EUR is paid, the amount of CIT payable is 250 EUR.

Regardless of whether the dividend is paid to a member who is a resident of Russia (legal entity or natural person), CIT is withheld from the dividend at the rate of 20% at the time of the payment. For transactions with persons in Russia, the withholding tax is calculated by multiplying the tax rate (20%) by the amount of the dividend to be paid, and the withheld CIT is paid to the budget by the 23rd day of the following month. This means that the additional tax payable increases by 1000 x 20% = 200 and total 450 EUR. This undeniably is quite painful. Russia tax structure

To avoid overpaying tax, the simplest solution is not to pay dividends, which will accumulate in the Latvian company. Of course, this is only a short-term solution; in the long term, it is advisable to transfer the ownership of shares in a Latvian company from Russia to another country, for example by investing Latvian company’s shares in the share capital of another company (holding company) or by selling them. However, this issue is a matter for Russian legislation and does not concern the Latvian company.

For all amounts paid to non-resident (including dividends), the payer shall submit to the Latvian Tax Authority’s electronic declaration system a CIT report in income earned by the non-resident and tax paid in the Republic of Latvia (in accordance with Annex 6 to Cabinet of Ministers Regulation No 677 of November 14th 2017 “Regulations Regarding Application of Provisions of the Corporate Income Tax Law”).

Investments by Latvian companies in Russia

If the company has investments in Russia, the situation may become even more complicated. The risk and unpredictability of the investment may lead to a need to review business strategy. A Latvian company may have to sell its investments in Russia. Sales to related parties should be at market price. If the investment is sold to a related company below market value, the difference is subject to CIT.

It should be mentioned here in particular that the trend is for companies to exit the business by selling investments in Russia to other Russian companies (e.g. bought out by employees or competitors) and the sale price is forced, often several times lower than the price it would be under normal circumstances. It should be remembered here that the transaction, even if sold to a Russian company, must be at market value, for the reason that all Russian companies are considered to be related companies. When selling investments to non-related companies in other countries, the market value does not have to be applied, but the value of the transaction must be such that it cannot be qualified as fictitious.

Given that risks in the Russian market have increased significantly, it is likely that the market value of the investment has fallen substantially (perhaps even several-fold). Consequently, when selling investments that result in losses, transfer pricing documentation with a valuation of the investment is required. If the total amount of the transaction exceeds 250 000 EUR, it is necessary to prepare it, but if it exceeds 5 000 000 EUR, the preparation and submission of such documentation to the Latvian Tax Authority is mandatory.

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