19 December 2024

International Loan and Credit Agreements

December 19, 2024

BRACE Law Firm ©

In modern economic relations, an enterprise cannot achieve development without borrowed funds. While small enterprises may utilize domestic borrowing resources, medium and large enterprises have the opportunity to access the international financial market to obtain funds in the form of loans or credits.

In the current unstable environment, borrowed funds can resolve issues of insolvency and shortages of working capital for organizations. However, obtaining borrowed funds from borrowers in unfriendly countries is virtually impossible, and there are a number of nuances regarding friendly countries, including those related to secondary sanctions. In this regard, choosing and accounting for all aspects of the borrower's jurisdiction, as well as the timely and correct accounting and tax treatment of attracted borrowed funds, currency control when concluding an agreement with a foreign organization, and several other aspects, are of great importance.

Legal Regulation of Loan and Credit Agreements with a Foreign Element in Russia

One of the key issues in regulating loan relations is the choice of applicable law.

The law applicable to civil law relations involving foreign citizens or foreign legal entities is determined based on international treaties of the Russian Federation, the Civil Code of the Russian Federation (the "Civil Code"), other laws (Article 3 of the Civil Code), and customs recognized in the Russian Federation (Article 1186 of the Civil Code). According to Article 1210 of the Civil Code, the parties to an agreement may, upon conclusion of the agreement or subsequently, choose by agreement between themselves the law that shall apply to their rights and obligations under such agreement. Consequently, if an international loan or credit agreement contains a provision stating that Russian law applies to the relations arising from such agreement, the terms of such agreement must be determined in accordance with Russian legislation.

Note that according to Clause 1, Article 1211 of the Civil Code, unless otherwise provided by the Civil Code or another law, in the absence of an agreement between the parties on the applicable law, the law of the country where the party performing the services of decisive importance for the content of the agreement has its residence or main place of business at the time of conclusion applies. Pursuant to Subclause 8, Clause 2 of the specified Article, the party performing the services of decisive importance for the content of the agreement is recognized as the lender (creditor) in a loan agreement (credit agreement).

For instance, in Case No. A40-42565/2023, the courts established that "the creditor is a citizen of the Kingdom of Spain; therefore, the law of the Kingdom of Spain applies when considering the application."[1]

Within the framework of Case No. A40-119763/2010, "the court of first instance correctly indicated that the law of Luxembourg should apply,"[2] since the lender is a company from Luxembourg.

In Case No. A43-5715/2018, regarding a claim by a UK company to recover debt under a loan agreement, the company cited norms of Russian law in its statement of claim and objections to the defense to justify its arguments. In its written defense, the defendant also cited norms of Russian legislation. In the loan agreement, the parties specified that Russian law applies "only in relation to liability for non-performance or improper performance of obligations under the agreement and interest accrued on the loan amount not returned on time. Regarding the principal amount and interest for the use of the loan, the applicable law was not determined by the parties." [3]

The parties explained that they did not object to the application of Russian legislation to the existing relations. Taking into account the close connection of the disputed legal relationship with the territory of the Russian Federation, the courts concluded that the dispute should be considered in accordance with the legislation of the Russian Federation based on Clause 9, Article 1211 of the Civil Code. [4] This clause provides that if it clearly follows from the law, terms, or essence of the agreement or the totality of the circumstances of the case that the agreement is more closely connected with the law of another country than that specified in Clauses 1–8 of this Article, the law of the country with which the agreement is more closely connected shall apply.

It should be borne in mind that an agreement on applicable law is considered concluded if the parties to the disputed legal relationship, when justifying their claims and objections (for example, in the statement of claim and the defense), refer to the same applicable law.[5]

The International Commercial Arbitration Court at the Chamber of Commerce and Industry of the Russian Federation (the "ICAC at the CCI RF") considered a dispute involving an organization located in Russia against a company located in the Republic of Croatia regarding the recovery of funds under a loan agreement. The ICAC applied the norms of the civil legislation of the Russian Federation because "the parties agreed that the applicable law is the law of the Russian Federation."[6]

When considering a dispute between a lender from Russia and a debtor from Kuwait, the ICAC at the CCI RF recognized Russian law as applicable because there was no written agreement on the choice of applicable law; therefore, "it is possible to apply Russian substantive law as the law of the lender's country in the loan agreement, taking into account the conflict of laws rules contained in Article 1211 of the Civil Code." [7]

Thus, if the lender is a foreign company and the applicable law is not determined by the parties, foreign law will apply in accordance with Russian conflict of laws rules.

In practice, cases occur where a loan agreement is initially concluded between a foreign bank and a Russian borrower, and subsequently, the bank assigns the claims to a Russian bank, reasoning that it will be easier for the Russian bank to recover the debt. [8]

Does the clause in the agreement on the choice of law by the parties to an international loan agreement remain valid if, as a result of the assignment, the foreign element (the previous lender) is removed, and, for example, two Russian persons take the place of the lender and the borrower? Article 1216 of the Civil Code provides the answer to these questions. [9]

The law applicable to the agreement between the original and new creditors regarding the assignment of a claim is determined in accordance with the rules of the Civil Code on the law applicable to the agreement. The admissibility of the assignment, the relationship between the new creditor and the debtor, the conditions under which the claim may be presented to the debtor by the new creditor, and the issue of proper performance of the obligation by the debtor are determined by the law applicable to the claim being assigned.

The applicable law is determined similarly in the Civil Code of the Republic of Kazakhstan (the "CC RK"). Pursuant to Article 1113 of the CC RK, in the absence of an agreement between the parties on the applicable law, the law of the country of the creditor in the loan agreement or other credit agreement applies.

For example, in accordance with the Law of China On the Application of Law to Transnational Civil Relations, [10] if the parties have not chosen the applicable law, the law of the place where the party whose performance of the obligation is of particular importance for the agreement has its habitual residence applies, or another law that has the closest connection with the agreement.

We also draw attention to the position of the Supreme Court of the Russian Federation, which indicated that parties to an agreement complicated by a foreign element may, in an agreement on applicable law, choose the law of a country that has no connection with the agreement or its parties (choice of neutral law) (Clause 1, Article 1210 of the Civil Code). The parties are also entitled to choose documents containing rules recommended to market participants by international organizations or associations of states (for example, the UNIDROIT Principles of International Commercial Contracts, the Principles of European Contract Law, the Model Rules of European Private Law). Such rules apply only in the presence of an express agreement of the parties.[11]

Given that loan and credit agreements have already been studied in detail by domestic lawyers, the existing norms in Russian law dedicated to loan and credit agreements should be briefly recalled.

In Russian civil law, loan and credit agreements are regulated by Chapter 42 of the Civil Code, as well as a number of special laws. For example, Federal Law No. 353-FZ dated December 21, 2013, On Consumer Credit (Loan); the specifics of short-term loans provided to citizens by pawnshops are established by Federal Law No. 196-FZ dated July 19, 2007, On Pawnshops. Also, for example, the specifics of issuing microloans are regulated by Federal Law No. 151-FZ dated July 2, 2010, On Microfinance Activities and Microfinance Organizations.

Pursuant to Article 807 of the Civil Code, under a loan agreement, one party (the lender) transfers or undertakes to transfer into the ownership of the other party (the borrower) money, things defined by generic characteristics, or securities, and the borrower undertakes to return to the lender the same amount of money (the loan amount) or an equal quantity of received things of the same kind and quality or the same securities.

Under a credit agreement, a bank or other credit organization (the creditor) undertakes to provide funds (credit) to the borrower in the amount and on the terms provided for by the agreement, and the borrower undertakes to return the received sum of money and pay interest for its use, as well as other payments provided for by the credit agreement, including those related to the provision of the credit.

If the participants in a loan agreement or credit agreement are entities located in different states and the currency of the agreement is a foreign currency, such an agreement is considered international. We note that Russian legislation does not contain an independent concept of an "international loan agreement" or any special rules regarding a loan or credit agreement involving a foreign legal entity; therefore, the general provisions of civil legislation regarding such agreements apply.

How are Loan and Credit Agreements Regulated in Foreign Countries?

Loan and credit agreements involving commercial banks and companies are regulated by the national legislation of the countries in which they are registered.

For example, Article 715 of the CC RK provides that under a loan agreement, one party (the lender) transfers, or in cases provided for by the code or the agreement, undertakes to transfer into the ownership (economic management, operational management) of the other party (the borrower) money or things defined by generic characteristics, and the borrower undertakes to timely return to the lender the same amount of money or an equal quantity of things of the same kind and quality. According to Article 727 of the CC RK, under a bank loan agreement, the lender undertakes to lend money to the borrower on terms of payment, maturity, and repayability. [12]

According to Article 760 of the Civil Code of the Republic of Belarus (the "CC RB"), under a loan agreement, one party (the lender) transfers into the ownership of the other party (the borrower) money or other things defined by generic characteristics, and the borrower undertakes to return to the lender the same amount of money (the loan amount) or an equal quantity of other received things of the same kind and quality. A loan agreement is considered concluded from the moment the money or other things are transferred. [13]

The CC RB distinguishes a commercial loan. Article 770 of the CC RB provides that agreements whose performance is related to the transfer of money or other things defined by generic characteristics may provide for the provision of a loan, including in the form of an advance, prepayment, or deferred and installment payment for goods, works, or services (commercial loan), unless otherwise provided by legislative acts and not contrary to the essence of the corresponding obligations. There is also a convertible loan. Under a convertible loan agreement, one party (the lender) transfers money into the ownership of the other party (the borrower), and the borrower transfers to the lender shares owned by the borrower, a stake (part of a stake) in the charter fund of the borrower held on the borrower's balance sheet, or increases the charter fund by the amount of the convertible loan in the manner established by law with the transfer to the lender of shares issued by the borrower or a stake (part of a stake) in the charter fund of the borrower (Article 770.1 of the CC RB). [14]

According to the legislation of the Republic of Belarus, credit may only be issued by a bank or a non-bank credit and financial organization (the lender).

In accordance with Article 196 of the Contract Law of the People’s Republic of China, [15] a money loan means an agreement under which the borrower borrows a sum of money from the lender, returns this sum, and pays interest on it within the prescribed period. In China, a loan agreement is not gratuitous, and its object can only be funds.

In modern English and US law, there are no separate norms or laws dedicated to loan agreements or credit agreements. Loan agreements concluded under English or US law are subject to general norms concerning contracts as a whole.

Terms of International Loan and Credit Agreements

The terms of international loan and credit agreements are determined in the agreement between the lender and the borrower. A loan agreement (credit agreement) must contain certain key elements to be legally valid and clearly structured. These elements ensure transparency and guarantee that both parties understand their obligations and rights.

When specifying the names of the parties to the agreement, it should be borne in mind that "there may be various ways of writing the name of the same foreign person: in the state language of the country of the person's personal law, in transliteration, or in translation." [16]

Thus, in a claim by a Japanese firm against a Russian one for the recovery of debt under a loan agreement, the court refused to satisfy the claims, concluding that the name of the plaintiff officially indicated in the extract from the register in Japanese did not correspond to the name of the foreign person in English provided by the plaintiff to justify the claim and in the passport of the foreign economic transaction to confirm the currency operation. The appellate court concluded that the plaintiff and the company specified in the loan agreement were identical, and noted that "the presence of various ways of writing the name of a legal entity registered in a state whose state language does not use the Latin alphabet as its official alphabet should not prevent the legal entity from exercising effective judicial protection of its rights and legitimate interests in case of their violation by the unlawful actions of counterparties". [17]

Loan (credit) amount must be accurately determined and clearly stated in the agreement;
Interest, rate, and calculation method must be accurately specified in the agreement. This may be a fixed or floating interest rate, which often depends on the borrower's creditworthiness and market conditions;
Repayment terms are another important element. The agreement should contain a clear repayment schedule, which includes detailed information on the amount and frequency of repayments, as well as the total term of the loan (credit);
Loan (credit) term defines the timeframe within which the loan (credit) must be repaid. A longer term may mean lower monthly payments but usually results in higher total interest;
Special agreements may include provisions on early repayment, notice periods, or changes in interest terms. Such agreements must be clearly defined and documented;
Security terms play a key role in reducing risk for the lender (creditor) by providing protection against the risk of the debtor's inability to repay the loan (credit);
Termination terms are usually agreed upon individually. It is crucial that both parties comply with the specified notice periods and the repayment date.

To minimize currency and credit risks in the event that restrictive measures are introduced against the credit organization or the borrower that prevent the borrower from performing obligations in the currency of a foreign state committing unfriendly actions, one should be guided by the Information Letter of the Bank of Russia No. IN-03-23/116 dated September 22, 2022, On Recommendations for the Performance of Obligations under Credits (Loans) in Foreign Currency. The Bank of Russia recommends that credit organizations provide for the possibility of borrowers repaying credits (loans) provided in the currency of unfriendly states in rubles or the currency of a friendly state.

The list of unfriendly states is determined by the Government of the Russian Federation in Government Decree No. 430-r dated March 5, 2022.[18]

Terms on Rates and Fees in International Loan and Credit Agreements

International practice in concluding loan and credit agreements has developed a number of terms inherent to these agreements. For example, the interest rate on an international loan is defined as floating and consists of the sum of a fixed rate (the so-called margin) and one or more market rates. Given that a floating interest rate directly depends on the state of the market, which is occasionally subject to crisis phenomena, a condition is included in international loan agreements for such situations, according to which, in the event of a negative change in market conditions, the parties undertake to agree on a new procedure for determining the interest rate.[19]

Agreements may contain terms on various fees and payments. One of the most common fees associated with the arising of a loan obligation is the fee for the lender's commitment to provide the loan (commitment fee). An early repayment (prepayment) fee or an early termination fee for the loan obligation may also be provided. In the latter case, the fee represents compensation to the lender for the benefit the lender could have received from the payment of interest if the loan amount had been used throughout the specified term. In Russian practice, banks also impose obligations on borrowers to pay for transactions on the loan account. [20]

We note that Russian judicial practice may recognize certain transactions for the payment of fees to banks used in international banking activities as invalid. As the Presidium of the Supreme Arbitration Court of the Russian Federation previously noted, a bank has the right to receive a separate remuneration (fee) along with interest for using the credit if it is established for providing a separate service to the client; in other cases, the court must assess whether the specified fees can be attributed to the payment for using the credit.[21]

Other payments (besides fees) are aimed at reducing costs associated with performance under an international loan agreement. In international practice, the so-called "margin protection" mechanism is widely used. Because the margin — i.e., the difference between the sum provided to the borrower and the sum the borrower returns — is the lender's primary profit from the transaction, the lender will be interested in receiving its income in full. In the event that the borrower, by virtue of the mandatory norms of its national law, is obliged to make any deductions, the sum the lender ultimately receives must remain the same. Margin protection includes obligations for tax gross-up and for currency indemnity.

Another type of payment is made within the framework of the obligation to indemnify the consequences of the borrower's non-performance (default indemnity). This obligation covers the compensation of damages in case of non-performance of obligations by the borrower. Under Russian law, such obligations may be qualified as a contractual penalty (Article 330 of the Civil Code) and, as a result, the amount of such obligations may be reduced by a Russian court. [22]

Currency Control Regarding International Loan and Credit Agreements

It should be noted that international loan and credit agreements are subject to currency control.

Currency control in the Russian Federation is carried out on the basis of Federal Law No. 173-FZ dated December 10, 2003, On Currency Regulation and Currency Control (the "Federal Law No. 173-FZ" or the "Currency Control Law"). This law establishes the foundations of legal regulation and a set of measures aimed at the smooth functioning of state currency regulation bodies.

The procedure for submitting supporting documents is established in Instruction No. 181-I dated August 16, 2017, On the Procedure for Residents and Non-Residents to Submit Supporting Documents and Information to Authorized Banks when Carrying Out Currency Operations, on Unified Forms of Accounting and Reporting on Currency Operations, and the Procedure and Deadlines for Their Submission (the "Instruction No. 181-I").

Residents, when providing foreign currency or Russian currency in the form of loans to non-residents, are obliged, within the timeframes provided for by the loan agreements, to ensure the receipt from non-residents into their bank accounts in authorized banks of the foreign currency or Russian currency due in accordance with the terms of the loan agreements.

To comply with the requirement for the repatriation of funds, international agreements must specify the exact timeframes for the parties to perform their obligations under the agreements (contracts).

Residents are obliged to provide authorized banks with information on the timeframes for performing obligations to return the provided loans in accordance with the terms of the loan agreements.

If the terms of a foreign trade agreement or loan agreement do not contain specific timeframes for repatriation and/or performance of obligations, with the exception of agreements to which the repatriation requirement applies according to special economic measures, the resident is entitled to determine them in accordance with Instruction No. 181-I.

If a resident has provided a loan to a non-resident, then in determining the expected timeframe for the repatriation of foreign currency and/or Russian currency, the timeframe for credit organizations to carry out the transfer of funds is added to the timeframe(s) provided for by the agreement for the non-resident to perform obligations to return the loan and interest payments.

The expected timeframe for the repatriation of foreign currency and/or Russian currency cannot exceed the date of completion of performance of obligations under the agreement specified in the bank control statement for the contract, i.e., the date of completion of performance of obligations under the credit agreement.

For registration with an authorized bank, the amount of obligations under credit agreements, including loan agreements, must be equal to or exceed the equivalent of 3 million rubles.

The amounts of obligations are determined at the official exchange rate of foreign currencies on the date of conclusion of the credit agreement or on the date of conclusion of the latest agreement to change the amount of obligations under it.

A resident who is a party to a credit agreement must register the credit agreement no later than 15 business days after the date of crediting the foreign currency or rubles to the resident's account opened in an authorized bank. When receiving cash, no later than 45 business days after the date of carrying out the specified operation.

If settlements with the resident are carried out through its account opened in a non-resident bank, the deadline for registering the agreement is up to 30 business days after the month in which the funds were credited through the specified account.

If the amount of obligations is not determined in the agreement, it must be registered within the timeframe provided for submitting documents for that operation as a result of which the settlement amount under the credit agreement became equal to or exceeded the equivalent of 3 million rubles.

To register a credit agreement with a bank, a resident must submit the credit agreement (an extract from it) to the bank, containing information necessary for registering the contract and carrying out currency control and other information necessary for the bank to form a bank control statement. If a preliminary agreement or a draft credit agreement is submitted to the bank, the agreement itself must be submitted no later than 15 business days after the date of its signing.

No later than the business day following the day of submitting documents for accounting, the bank registers the credit agreement and assigns it a unique number and, no later than one business day from the date of registering the agreement, sends the specified information to the resident.

If the loan is interest-bearing, interest payments (excluding payments for the return of the principal debt) are indicated separately in the bank control statement. Interest payments are not taken into account when the resident reflects the amount in the general information about the credit agreement, in which only the amount of the principal debt under the credit agreement is indicated.

Thus, for the purposes of registering a credit agreement, the amount of obligations under the loan agreement is determined without taking into account interest to be accrued; therefore, the obligation to register is not related to whether this type of agreement is for consideration or gratuitous.

In addition to registering the agreement, Instruction No. 181-I establishes the cases and procedure for submitting the resident's accounting form for currency operations—a certificate of supporting documents.

To carry out currency control, authorized banks, as currency control agents within their competence, have the right to request and receive from residents and non-residents documents (copies of documents) related to carrying out currency operations and opening and maintaining accounts, in particular:

documents certifying the status of a legal entity for non-residents, and a document on the state registration of a legal entity for residents;
a certificate of registration with the tax authority;
notification from the tax authority at the resident's place of registration on opening an account (deposit) in a bank outside Russia;
documents (draft documents) that serve as the basis for carrying out currency operations, including the loan agreement and supplements and/or changes to it, etc.

It should be noted that documents directly related to the currency operation being carried out may be requested. If only part of a document is related to carrying out a currency operation or opening an account, a certified extract from it may be submitted. Requested documents are submitted to currency control bodies and agents in the original or in the form of a duly certified copy.

Upon request, duly certified translations into Russian of documents executed entirely or in any part in a foreign language are submitted. Documents originating from state bodies of foreign states confirming the status of non-resident legal entities must be legalized in the prescribed manner. Foreign official documents may be submitted without legalization in cases provided for by an international treaty of the Russian Federation.

Authorized banks are entitled to refuse to carry out a currency operation, in particular, in the event of a person's failure to submit documents, or the submission of unreliable documents or documents that do not meet requirements. The decision to refuse to carry out a currency operation is communicated to the person in writing no later than the business day following the day the refusal decision was issued.

Furthermore, if the parties to the transaction are participants in an international group of companies, they will need to take into account the requirements of tax legislation on the international exchange of financial information for tax purposes, in particular on submitting notifications of participation in an international group of companies and submitting country-by-country reports (Chapter 14.4-1, Submission of Documentation on International Groups of Companies of the Tax Code of the Russian Federation (the "Tax Code").

We note that tax liability is provided for the failure to submit this documentation (or the reflection of unreliable information in it) (Articles 129.9, 129.10, and 129.11 of the Tax Code).

For example, the unlawful failure to submit a notification of participation in an international group of companies within the established timeframe or the submission of a notification containing unreliable information entails a fine of 500,000 rubles for each instance of such violation. The unlawful failure to submit a country-by-country report within the established timeframe or the submission of a report containing unreliable information entails a fine of 1 million rubles.

Presidential Decree No. 529 dated August 8, 2022, established that until changes are made to Law No. 173-FZ, requirements regarding compliance with the mandatory form of settlements do not apply to foreign trade activities and/or the provision and return of loans by Russian legal entities and individual entrepreneurs.

It should be noted that from March 1, 2022, it is generally prohibited, in particular, to provide foreign currency to non-residents under loan agreements (Presidential Decree No. 79 dated February 28, 2022).

In addition, since March 2, 2022, a special procedure has been in effect for carrying out (performing) transactions (operations) to provide credits and loans (in rubles) to persons of foreign states committing unfriendly actions (Presidential Decree No. 81 dated March 1, 2022).

Taxation and Tax Accounting Regarding International Loan and Credit Agreements

If a foreign company that issued a loan does not have a representative office in Russia, or has one but the loan is issued to the head office, the Russian borrower must perform the duties of a tax agent, namely, withhold corporate income tax at a rate of 20% upon each payment of interest.[23]

Interest may be taxed at a reduced rate or may not be subject to taxation if so provided in an international treaty or in a double taxation avoidance agreement between Russia and the country where the foreign lender company is located (Article 310 of the Tax Code).

To apply the provisions of an international treaty, two documents must be obtained from the foreign company before the first interest payment. First, this is a document confirming the tax residency of the lender in the country with which the international treaty or agreement is in force. Formal requirements for such a document are not established; it is only noted that it must contain the following information:[24]

be issued in the form established by the law of the foreign state;
bear the signature of an authorized official of the foreign state body;
contain the name of the foreign company and an indication that it is a resident or a person with a permanent place of residence in that country;
be translated into Russian (it is not mandatory to notarize the translation).[25]

The document may also reflect its period of validity and the name of the double taxation avoidance agreement. In the absence of an indication of the validity period, the calendar year in which the document was issued is recognized as such.

When income is paid multiple times during the year, the document confirming tax residency may be submitted:

before the first payment in the year, if the document indicates that it confirms the status of a resident on a certain date (the date the document was issued);
at the end of the year, if the document states that it confirms the status of a resident for the past period.[26]

Information about the competent authority is, as a rule, specified in the international treaty itself. For example, in Kazakhstan, such an authority is the Ministry of Finance of the Republic of Kazakhstan.

The second document is a document on the existence of the right to receive income, which may be executed in the form of a confirmation letter, notification, or specified in the loan agreement. It confirms that the counterparty from abroad is the ultimate recipient of the income. This document must necessarily disclose information on the foreign legal entity's:

right to independently and at its own discretion use and/or dispose of the received income without restrictions from third parties;
obligation to pay tax on income received from sources in the Russian Federation, which the lender must settle in its country of residency;
business activities in the country of which the recipient of income is a resident.

The tax must be withheld upon each payment of interest on the loan and paid into the budget no later than the business day following the day of transferring the interest to the foreigner. The tax on loan interest must be calculated in the currency specified in the agreement and paid into the federal budget in rubles at the official exchange rate of the Bank of Russia on the date of tax payment.

In accordance with Article 269 of the Tax Code, outstanding debt on loans of a taxpayer to foreign organizations is considered controlled debt if:

the creditor — a foreign organization — is a person related to the taxpayer — a Russian organization — if such foreign person directly or indirectly participates in the taxpayer — the Russian organization;
the creditor is recognized as a person related to the foreign person;
the foreign person and/or its related person act as a surety, guarantor, or otherwise undertake to ensure the performance of the debt obligation of the taxpayer — the Russian organization.

The qualification of debt under a debt obligation as controlled and the inclusion of the maximum amount of interest in expenses are carried out by the taxpayer in each reporting (tax) period as of the last day of the reporting (tax) period—as of the last day of the first quarter, half-year, 9 months, and year. [27]

Establishing during a tax audit the fact that a loan was provided to a Russian organization by a foreign organization satisfying the conditions specified in Article 269 of the Tax Code (by other persons whose decisions to provide loans to the taxpayer the foreign organization could influence, in particular, by virtue of affiliation), as well as the fact of thin capitalization of the Russian borrower organization as of the end date of the corresponding reporting (tax) period, exempts the tax authority from the need to prove other circumstances regarding the presence of abuse of right and, as a general rule, is recognized as sufficient to limit the interest deduction when calculating income tax. [28]

At the same time, the nature of Clause 2, Article 269 of the Tax Code as a norm aimed at countering the abuse of right presupposes the need for reliable (substantive) establishment of the facts of economic activity that form the grounds for classifying the taxpayer's debt under debt obligations as controlled debt to the corresponding foreign person. [29]

An exception to this rule is provided by Clause 9, Article 269 of the Tax Code, according to which such outstanding debt is not recognized as controlled debt for a taxpayer—a Russian organization—provided that the following conditions are met simultaneously:

the debt obligation arose to an organization that is a bank (including organizations recognized as banks in accordance with the legislation of foreign states), an international financial organization created in accordance with an international treaty of the Russian Federation, or a development bank—a state corporation, which are not recognized as related persons with either the taxpayer—the Russian organization—or the persons acting as a surety, guarantor, or otherwise undertaking to perform the debt obligation of the taxpayer;
from the moment the taxpayer's debt obligation arose, there has been no termination (performance) of the specified debt obligation, both in terms of the principal amount and in terms of the payment of interest by the foreign person specified in Subclause 1, Clause 2 of this Article, and/or its related person specified in Subclause 2, Clause 2 of this Article, acting as a surety, guarantor, or otherwise undertaking to ensure the performance of the specified debt obligation.

If at least one of these conditions is not met, the outstanding loan debt is recognized as controlled. In addition, if partial repayment of the debt by a surety occurred under the debt obligation and the debt ceases to meet the conditions for applying Clause 9, Article 269 of the Tax Code, then such debt is recognized as controlled and the provisions of Clauses 3–6, Article 269 of the Tax Code apply to it.[30]

Interconnection with a foreign person—the creditor—leads to the occurrence of controlled debt in cases where:

the share of direct and/or indirect participation of the foreign person in the Russian organization is more than 25%;
the share of direct and/or indirect such participation of a foreign individual is more than 25%;
the foreign person—the creditor—either directly or indirectly participates in the charter capital of the related Russian debtor organization;
the share of direct participation of each preceding foreign person in each subsequent organization is more than 50%.[31]

Outstanding debt under a loan agreement is not recognized as controlled debt if the funds received by an organization in which the total share of direct and indirect participation of a related foreign person does not exceed 35% are directed exclusively to financing an investment project on the territory of Russia. At the same time, the place of registration (place of tax residency) of the creditor is a foreign state with which the Russian Federation has concluded a double taxation avoidance treaty (agreement, convention), and the terms of the debt obligation provide for the start of its repayment no earlier than 5 years after its occurrence.

The Tax Code provides for an exemption for a subsidiary from taxation if property or property rights are transferred to the company gratuitously, having been received gratuitously from an organization with a share of direct or indirect participation of at least 50% (Article 251 of the Tax Code).

In practice, this norm is applied in cases of debt forgiveness to subsidiaries under loan agreements. However, it must be taken into account that controlling bodies and courts consider it possible to exclude only the loan amount from income. The fact is that the amount of accrued interest cannot be considered as gratuitously received property due to the absence of the fact of transfer. The amount of interest is subject to inclusion in the non-operating income of the subsidiary on the basis of Clause 18, Article 250 of the Tax Code. [32]

Also, when applying this norm, it is necessary to consider that the position of the Ministry of Finance of the Russian Federation on this issue has changed. Upon termination of a debt obligation by debt forgiveness, the transfer of property or property rights does not occur; there are no grounds for applying Subclause 11, Clause 1, Article 251 of the Tax Code. [33] However, since this position contradicts established judicial practice, the tax risk is not high if this norm is applied in case of debt forgiveness.[34]

When determining the tax base, income in the form of property, property rights, or non-property rights in the amount of their monetary valuation received as a contribution to the property of a business company or partnership in the manner established by the civil legislation of the Russian Federation is not taken into account (Subclause 3.7, Clause 1, Article 251 of the Tax Code).

This norm exempts from taxation the value of a contribution to an organization's property, provided that such contribution is carried out in accordance with the provisions of current legislation (Article 66.1 of the Civil Code, Article 27 of Federal Law No. 14-FZ dated February 8, 1998, On Limited Liability Companies).

The decision to make a contribution to the property of a subsidiary leads to the occurrence of accounts payable for the participant, which can be offset against the subsidiary's debt under a loan agreement, including interest debt (Article 410 of the Civil Code).

We also recommend paying attention to international financial reporting standards, which are developed and published by the International Accounting Standards Board and regulate the principles for preparing financial statements. Such standards include International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) adopted by the IFRS Foundation. International Accounting Standard (IAS) 23 Borrowing Costs ("IAS 23"), put into effect in the Russian Federation by Order of the Ministry of Finance of Russia No. 217n dated December 28, 2015, relates to this topic.

Borrowing costs (interest and other costs that an organization incurs in connection with the borrowing of funds) that are directly attributable to the acquisition, construction, or production of a qualifying asset (an asset that necessarily takes a substantial period of time to get ready for its intended use or sale) are subject to capitalization, i.e., inclusion in the initial cost of the asset. Such costs may include interest expenses, interest related to lease obligations, and exchange differences.

If an asset is ready for its intended use or sale at the time of acquisition, it is not a qualifying asset. Accordingly, borrowing costs related to its acquisition are not capitalized but are accounted for as expenses (Clauses 1, 7, 8 of IAS 23).

Depending on the circumstances, qualifying assets may include (Clause 7 of IAS 23):

inventories;
manufacturing plants;
power generation facilities;
intangible assets;
investment property;
bearer plants.

An organization also has the right not to capitalize borrowing costs in the following cases (Clause 4 of IAS 23):

the qualifying asset is measured at fair value, for example, a biological asset within the scope of IAS 41 Agriculture;
inventories are manufactured or otherwise produced in large quantities on a repetitive basis.

Borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made. If an organization borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that directly relate to that asset can be readily identified (Clause 10 of IAS 23).

Identifying a direct relationship between specific borrowings and a qualifying asset, as well as identifying borrowings that could have been avoided in the absence of the specified asset, may cause difficulty. Such difficulties arise, for example, when the financing activities of an organization are coordinated centrally. Difficulties also appear if a group of organizations uses a range of debt instruments to borrow funds at various interest rates and lends those funds on various bases to other organizations in the group. The situation is further complicated by the group's use of loans denominated in or linked to foreign currencies in conditions of high inflation, as well as exchange rate fluctuations. As a result, determining the amount of borrowing costs directly attributable to the acquisition of a qualifying asset is difficult and requires the exercise of judgment (Clause 11 of IAS 23).

Borrowing costs may include (Clause 6 of IAS 23):

interest expense calculated using the effective interest method as described in International Financial Reporting Standard (IFRS) 9 Financial Instruments (put into effect in Russia in the 2014 edition by Order of the Ministry of Finance No. 98n dated June 27, 2016);
interest in respect of lease liabilities recognized in accordance with International Financial Reporting Standard (IFRS) 16 Leases (put into effect in the Russian Federation by Order of the Ministry of Finance No. 111n dated July 11, 2016);
exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

In determining the amount of borrowing costs eligible for capitalization, it must be taken into account that if borrowed funds were temporarily invested before being expended on a qualifying asset, the amount of any investment income earned is deducted from the borrowing costs incurred (Clauses 12, 13 of IAS 23).

The commencement date for capitalization is the date when the organization first meets all of the following conditions:

it incurs expenditures for the asset;
it incurs borrowing costs;
it undertakes activities that are necessary to prepare the asset for its intended use or sale.

An organization shall suspend capitalization of borrowing costs during extended periods in which it interrupts active development of a qualifying asset (Clause 20 of IAS 23).

Capitalization of borrowing costs is not suspended during a period when substantial technical and administrative work is being carried out. An organization also does not suspend capitalization of borrowing costs when a temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale (Clause 21 of IAS 23).

An organization shall cease capitalizing borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. If only minor modifications, such as the decoration of an object to the specifications of a buyer or user, are all that are outstanding, this indicates that substantially all the activities are complete (Clauses 22, 23 of IAS 23).

Thus, it can be concluded that an international loan and credit agreement is a way to attract borrowed funds from the international financial market for the purpose of an enterprise's economic growth, but at the same time, it is quite complex due to the presence of many nuances that must be known.

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References

[1] Resolution of the Arbitration Court of the Moscow District dated April 4, 2024, in Case No. A40-42565/2023.

[2] Resolution of the Ninth Arbitration Appellate Court dated November 27, 2023, in Case No. A40-119763/2010.

[3] Resolution of the Arbitration Court of the Volga-Vyatka District dated October 11, 2019, in Case No. A43-5715/2018.

[4] Ibid.

[5] Information Letter of the Presidium of the Supreme Arbitration Court of the Russian Federation No. 158 dated July 9, 2013, Overview of the Practice of Consideration of Cases Involving Foreign Persons by Arbitration Courts.

[6] Award of the ICAC at the CCI RF dated January 13, 2022, in Case No. M-58/2021.

[7] Award of the ICAC at the CCI RF dated April 1, 2005, in Case No. 125/2004.

[8] Vishnevsky P.N. Legal Regulation of International Loan Agreements. Dissertation for the Candidate of Legal Sciences degree.

[9] Ibid.

[10] Adopted at a meeting of the Standing Committee of the Ninth National People's Congress on October 28, 2010. Russian text on the website of the Modern Construction of Private International Law Project Group of the Faculty of Law of the National Research University Higher School of Economics.

[11] Resolution of the Plenum of the Supreme Court of the Russian Federation No. 24 dated July 9, 2019, On the Application of Private International Law Norms by Courts of the Russian Federation.

[12] Civil Code of the Republic of Kazakhstan (Special Part) dated July 1, 1999. Information and Legal System of Normative Legal Acts of the Republic of Kazakhstan of the Institute of Legislation and Legal Information of the Republic of Kazakhstan of the Ministry of Justice of the Republic of Kazakhstan.

[13] National Legal Internet Portal of the Republic of Belarus.

[14] Ibid.

[15] Adopted at the second session of the Ninth National People's Congress on March 15, 1999. Website of the National People's Congress.

[16] Information Letter of the Presidium of the Supreme Arbitration Court of the Russian Federation No. 158 dated July 9, 2013, Overview of the Practice of Consideration of Cases Involving Foreign Persons by Arbitration Courts.

[17] Ibid.

[18] Australia, Albania, Andorra, Bahamas, Great Britain (including the Crown Dependencies and British Overseas Territories), European Union Member States, Iceland, Canada, Liechtenstein, Micronesia, Monaco, New Zealand, Norway, Republic of Korea, San Marino, North Macedonia, Singapore, United States of America, Taiwan (China), Ukraine, Montenegro, Switzerland, Japan.

[19] Vishnevsky P.N. Content of International Commercial Loan Agreements: General Terms, Terms on the Subject Matter, Liability, and Amendment of the Agreement. Advokat Journal, 2014, No. 7.

[20] Ibid.

[21] Information Letter of the Presidium of the Supreme Arbitration Court of the Russian Federation No. 147 dated September 13, 2011, Overview of Judicial Practice in Resolving Disputes Related to the Application of Provisions of the Civil Code of the Russian Federation on Credit Agreements.

[22] Vishnevsky P.N. Content of International Commercial Loan Agreements: General Terms, Terms on the Subject Matter, Liability, and Amendment of the Agreement. Advokat Journal, 2014, No. 7.

[23] Clause 1 of Article 246, Clause 3 of Part 2 of Article 247, Subclause 1 of Clause 2 of Article 284, Clause 4 of Article 286, Subclause 3 of Clause 1 of Article 309 of the Tax Code.

[24] Letter of the Federal Tax Service of Russia No. ShYu-4-13/2243@ dated February 20, 2021, On Certain Issues of Control of Tax Calculations (Information) on the Amounts of Income Paid to Foreign Organizations and Withheld Taxes.

[25] Letter of the Ministry of Finance of Russia No. 03-08-05/83170 dated November 19, 2018.

[26] Filippova O.V. Foreign Loan and Payment of Interest Thereon – How to Be a Good Tax Agent. Glavnaya Kniga Journal, 2022, No. 15.

[27] Letter of the Ministry of Finance of Russia No. 03-03-06/1/26525 dated April 9, 2021.

[28] Filippova O.V. Foreign Loan and Payment of Interest Thereon – How to Be a Good Tax Agent. Glavnaya Kniga Journal, 2022, No. 15.

[29] Letter of the Federal Tax Service of Russia No. BV-4-7/16990 dated October 16, 2020, Overview of Judicial Practice of the Supreme Court of the Russian Federation No. 4 (2020).

[30] Letter of the Ministry of Finance of Russia No. 03-03-06/1/24053 dated April 5, 2019.

[31] Letters of the Ministry of Finance of Russia No. 03-03-07/32314 dated May 25, 2017, No. 03-03-06/1/58045 dated August 16, 2018.

[32] Letters of the Ministry of Finance of the Russian Federation No. 03-03-06/1/86629 dated November 30, 2018, No. 03-03-07/72930 dated December 14, 2015, No. 03-03-06/1/40367 dated September 30, 2013; Ruling of the Supreme Court of the Russian Federation No. 304-KG16-15623 dated November 29, 2016, in Case No. A27-12992/2015; Resolution of the Arbitration Court of the West Siberian District No. F04-16250/2015 dated March 5, 2015, in Case No. A70-4852/2014.

[33] Letter of the Ministry of Finance of the Russian Federation No. 03-03-06/1/36775 dated May 14, 2021.

[34] Kutyayeva O. Credits and Loans Issued by a Non-Resident to a Russian Organization. GSL-news website.