Russian Federation: Doing Business In The Russian Federation

Introduction

The Russian Federation ("Russia") became a recognised independent state on 24 August 1991. Its creation followed the break-up of the Soviet Union ("USSR") in 1991. Russia is regarded as the successor state to the USSR and as such inherited its permanent seat on the UN Security Council, most of its military assets, and the bulk of both its foreign assets and its foreign debt. Geographically, it is now the largest country in the world occupying territory covering some 17,075,200 square kilometres. Its land mass stretches across Eurasia from Eastern Europe to the Pacific coast and it also has coastlines on both the Arctic and the Atlantic oceans. Unsurprisingly both the topography and the climate which one may encounter within Russia are extremely diverse. The majority of the country does, however, have a northern continental climate.

Russia is now a democratic federative state based on the rule of law and a republican form of government. This is enshrined in its written Constitution which was adopted in 1993. The concept of separation of powers is a fundamental principle and state power is divided between the executive, legislative and judicial branches.

The office of President is legally distinct from all branches of power but is most closely allied to the executive branch. The President, currently Dmitry Medvedev, is elected for a six year term and is limited to two successive terms in office. He has extensive powers and is primarily responsible for domestic and foreign policy and represents Russia in international relations. He has powers of decree, legislative veto and may appoint and dissolve the government. The President also appoints Russia's regional leaders from candidates submitted by the majority party in each regional district.

Executive power rests with the government, which comprises a Prime Minister, deputy prime ministers and ministers. The current Prime Minister is Vladimir Putin.

Legislative power is vested in the bicameral Federal Assembly. This consists of the Federation Council (the upper house) and the State Duma (the lower house). The State Duma consists of 450 members elected nationwide by proportional representation via party lists. It drafts legislation, can amend the Constitution and has the power to file an impeachment motion against the President. The Federation Council consists of two representatives from each federal constituent entity. One is from the executive branch and is appointed by the regional governor. The second is from the legislature and nominated by the regional assembly. The Federation Council approves or rejects laws passed by the State Dumas and appoints high court judges.

Russia comprises 83 federal subjects. These are grouped into eight districts. Each district is administrated by an envoy of the President.

Judicial power is vested in the three highest courts which are the Supreme Court, the Constitutional Court and the Supreme State Arbitrazh Court. The Supreme Court considers criminal, civil and administrative cases and acts as the highest judicial body for all lower courts in these matters. The Supreme State Arbitrazh Court is the highest court in commercial disputes. It supervises lower arbitrazh courts and issues clarifications on interpretations of the law. The Constitutional Court is the only court in Russia with the power of Constitutional review. It functions autonomously from all other courts and whenever an issue of constitutionality of an act is raised in another court it is automatically referred to the Constitutional Court.

The legal system itself is based on statutory law.

The population of Russia is approximately 142 million people of which 62.9% are of working age. The population is slowly declining but the government is actively seeking to halt this by altering its immigration policies and through introducing incentives and programmes directed at increasing birth rates and reducing mortality levels. There are 160 ethnic groupings within the population with the dominant group being Russian (79.8%) followed by Tatars (3.8%) and Ukrainians (2%). The official language is Russian whilst English and German are widely studied as foreign languages. The study of English is compulsory in many schools. Education is a high priority for both the government and the Russian people. Consequently, primary and secondary education is compulsory, of a high standard and free to all. The success of this policy is reflected in a near 100% literacy rate and one of the highest rates of people with doctorates in the world. This well educated, highly skilled and relatively low cost workforce is a significant asset for the country.

Importantly, Russia is extremely rich in natural resources such as petroleum, natural gas, timber, furs and precious and non ferrous metals. Russia possesses more than a third of the known gas reserves in the world and its proven oil reserves account for 5% of the world total (and recent exploration results suggest that this figure will increase). The terrain of the country and the distance of many deposits from the major Russian sea ports render full exploitation of the country's resource wealth difficult. Despite this, in 2010 Russia was the world's largest exporter of natural gas, the second largest exporter of oil and the third largest exporter of steel and primary aluminium. The richness of natural resources is reflected in the dominance of commodity producers within the Russian economy and their importance to the balance of trade.

In the years following its formation Russia suffered a sustained period of economic decline as the country wrestled with the difficulty of implementing structural, political, social and economic reform of a planned economy amidst a period of political uncertainty. This included the transfer of almost 75% of the economy from the public to the private sector. From 1999 to 2007, however, the economy demonstrated a remarkable turnaround recording an average annual GDP growth level of some 7%. Key to this recovery were large price rises for Russia's main commodity exports, a devaluation of the rouble in 1998, the introduction of tax reform, a tightening of fiscal policy and significantly, greater social and political stability. The latter has been closely associated with the presidency of Vladimir Putin who first came to power on 31 December 1999. The increasing purchasing power of the Russian people during this period also resulted in a dramatic growth in Russia's retail and consumer sections of the economy.

The heavy reliance of the country on commodity exports did, however, mean that the economy was particularly vulnerable to a downturn in the world economy and the impact of the global financial crisis began to be felt in the latter part of 2008. In 2009 the economy contracted by 7.9%. However, despite the initial severity of the crisis the country had already resumed moderate growth by the second half of the year. Preliminary figures suggest that in 2010 GDP is likely to have grown by around 3.8% and the economy has stabilised. Much credit has been given to the Russian government for taking decisive actions to safeguard the economy. The Central Bank, as part of this, implemented a well ordered devaluation of the rouble thereby averting a run on the bank and encouraging import substitution. The government also introduced rescue initiatives for the largest companies and government controlled organisations acquired some banks and financial services companies. Additionally a package of tax incentives and other programmes encouraging economic activity was adopted. One of the top priorities of the stimulus package is to encourage innovation and modernisation within the industrial sector and by doing so reduce the susceptibility of the Russian economy to volatile commodity prices.

The World Bank forecasts that Russia's GDP will grow by 4.4% in 2011 and 4.0% in 2012.

The European Bank for Reconstruction and Development forecast for Russia's GDP growth in 2011 is 4.6%. The country's estimated external debt at 31 March 2011 is USD 505 billion and the government plans to reduce this deficit to zero in 2015. This is regarded as a conservative forecast by Zeljko Bogetic, the World Bank's lead economist in Russia. The Russian currency is the rouble. This is subdivided into 100 kopecks. The average exchange rates in 2010 were: EUR 1=39.09 roubles; USD 1=29.09 roubles.

Moving forward Russia is committed to a long term market-centred economic policy. Its accession to the World Trade Organisation is imminent and strongly supported by bodies such as the US Chamber of Commerce. It is now a country with much to offer prospective investors in terms of a stable political, social and financial climate, a wealth of human and other natural resources, a consumer and retail sector with significant growth potential and a desire to improve and innovate within its industrial sector.

Forms of business entity

Foreign investors seeking to operate in Russia may elect to use any of the following forms of business entity:

• A representative office of a foreign legal entity;
• A branch of a foreign legal entity;
• A partnership (with unlimited or limited liability);
• A limited liability company; or
• A joint stock company.

Formation and accreditation of most types of business organisations is governed by chapter 1 of the Russian Civil Code and the 1999 Federal Law on Foreign Investments. Joint stock companies and limited liability companies are, however, governed by separate federal laws. These are Federal Law 14-FZ of 8 February 1998 and Federal Law 208-FZ of 26 December 1995. Each form of business entity is considered below.

Representative office

A representative office of a foreign legal entity is not considered to be a Russian legal entity but rather an officially recognised subdivision of the foreign entity. Consequently, it offers the following benefits:

• Reduced administrative, taxation and state counting obligations;
• It is treated as non-resident for exchange control purposes; and
• It may be able to benefit from a relevant double tax treaty.

Importantly, however, a representative office is not permitted to engage in commercial activities in Russia. Its function is restricted to carrying out liaison and associated activities which promote and protect the interests of the parent organisation. It could therefore be viewed as a low cost method of exploring the potential market available to the parent entity.

A representative office must be officially accredited in order to operate in Russia. Accreditation is normally granted for a period of up to three years. Several bodies are authorised to grant such accreditation but the majority of applications are considered by either the State Registration Chamber at the Russian Ministry of Justice ("the SRC") or the Russian Chamber of Commerce and Industry ("the CCI"). Other bodies such as the Central Bank of Russia tend to deal with applications specific to their industry. All representative offices applying for accreditation are required to pay a processing fee of between USD 1,000 and USD 2,500 depending upon the length of accreditation required.

In order to register a representative office the CCI stipulates that the following documents are required:

1. A written application signed by the head of the parent company and sealed with the company seal. The application should include the company name, the date of its establishment, its location, the nature of its business, details of the management representing the company, the purpose for which a representative office is required, information about ties with, and proposed cooperation with, Russian partners and the actual or proposed contact details for the representative office.

2. Articles of association or incorporation papers of the parent company.

3. Registration papers or an extract from the Trade Register issued within six months prior to the application or any other evidence of the fact that the company was registered according to the adopted procedure.

4. Evidence of the company's decision to open a representative office in the Russian Federation (eg a copy of company resolution to that effect).

5. Representative office regulations that define the internal rules, rights and obligations of a representative office in respect to the foreign company. The regulations must be agreed with the accrediting body.

6. A recommendation letter of a bank serving the parent company in its own country confirming the solvency of the parent. This must have been issued within the six month period prior to the application.

7. Two recommendation letters from Russian business partners or regional chambers of commerce and industry.

8. Power of attorney for the head of a representative office drawn according to all required procedures.

9. Information about the foreign company in the form of a standard questionnaire available from the accrediting body.

A representative of a foreign company acting as its spokesman at negotiations on the opening of a representative office, should submit a power of attorney for opening a representative office, authenticated by a notary, to the accrediting body. In order to obtain permission to open a representative office outside Moscow, the parent company should have a preliminary agreement with the local executive authorities regarding its location.

If a foreign company already has an accredited representative office, it may obtain a permit for opening other representative offices by producing only the documents specified in paragraphs 1, 4, 5, and 7. The official documents listed in paragraphs 2, 3, 4, 6, 8, with corresponding seals of notary institutions of the country a foreign company was registered in, should be legalised in accordance with the Hague convention of 1961 or through the procedure of consular legalisation at a Russian consular institution, unless it is otherwise stated by the international agreements of the Russian Federation. Documents written in foreign languages must have a corresponding translation into Russian attached to them. The translation should be authenticated by either a notary public or a Russian Consulate.

In the event of the opening of a representative office, a foreign company needs to have, according to the laws of the country of its registration, a special permit from state institutions, then the copy of such permit, authenticated and legalised by a notary, should be attached to the application. A foreign company may be requested to provide additional information about its activities requested by the accrediting body. Accreditation typically takes four to six weeks although a fast track procedure which takes two weeks is available. Once it is accredited, the representative office is included in the state register held by the SRC. The certificate of inclusion in the state register confirms the official status of the representative office.

After accreditation it is necessary to do the following before the representative office can become fully operational:

Register with the Russian tax authority;

• Register with the State statistics committee;
• Register a company seal;
• Open bank accounts in Russia. These may be foreign currency or rouble accounts; and
• Register with the Russian social benefit funds.

These tasks can usually be completed within a three week period.

Branch of a foreign entity

Similar to a representative office a branch is considered to be a subdivision of a foreign entity rather than a Russian legal entity. Consequently it offers similar advantages to those previously listed for a representative office. However, a registered branch offers the additional benefit that it is permitted to fulfil all of the functions of the foreign parent including normal commercial activities.

For this reason the creation and liquidation of branches and the monitoring of their activities is supervised by the SRC. Branches may only be accredited by the SRC. Accreditation periods may range between one and five years and can normally be extended upon the expiry of the original term.

The list of documents required for the accreditation of a branch is identical to that required for the accreditation of a representative office. The immediate post registration requirements are also identical. The statutory fee payable for branch registration is 120,000 roubles (approximately USD 4,286) with a further fee of between USD 500 and USD 2,000 payable dependent upon the number of years for which registration is sought.

Many investors new to Russia choose to make use of the branch structure because a branch is relatively easy to establish and subject to less onerous reporting requirements than are placed on Russian companies. Additionally:

• Provision of funds and assets to a branch is not subject to profits tax. Contributions to a subsidiary are only tax free if they represent contributions to capital or the provision of funds or assets to a majority-owned subsidiary; and
• The repatriation of cash from a branch to the head office is made without restrictions after corporate profits tax has been paid at the permanent establishment level. In contrast, the repatriation of cash by a subsidiary is subject to Russian withholding tax (15% on dividends, 20% on interest etc) unless exempt or taxed at a reduced rate under a double tax treaty.

Despite this it may sometimes be necessary to establish a Russian legal entity because of issues surrounding licensing, customs and privatisation of state property. The main advantage of doing business through a subsidiary with several subdivisions is the option of consolidating their profits and losses for tax purposes. Such consolidation is not allowed for branches of a foreign company unless the activities of branches form a unified technological process and special approval of the Ministry of Finance has been received.

Russian partnership

Partnerships in Russia may be unlimited or limited in nature. Both are regarded as legal entities under Russian law and as such they have an identity which is distinct from that of the individuals forming the partnership. A partnership may therefore own property, enter into contracts and both sue and be sued in its own name. It will also be subject to regulation and taxation by the Russian state. However, a Russian partnership is not transparent for income tax purposes.

A full partnership is one in which each partner has joint and several liability for the obligations of the partnership. The liability is unlimited in scope and consequently a full partner may only be a full partner in one partnership. A limited partnership is one which is comprised of a mix of partners with "full" liability for the partnership obligations and partners who have a limited liability only. The liability of limited partners is restricted to their agreed financial contribution to the partnership and they do not participate in the management of the partnership's business activities. There must be at least one full partner in a limited partnership.

Upon liquidation of a limited partnership, including in case of bankruptcy, limited partners have a priority right ahead of the full partners to receipt of their investments from the property of the partnership remaining after satisfaction of the claims of its creditors. The property of the partnership remaining after this is distributed among the full partners and the limited partners in proportion to their shares in the capital of the partnership unless another procedure is established by the founding contract or by agreement of the general and limited partners.

Partnership is not a business form commonly used by foreign investors.

Limited liability company ("LLC")

The LLC form of business entity is popular with foreign investors seeking to establish a wholly owned subsidiary in Russia. An LLC may have between one and fifty participants. Where the number of participants exceeds fifty there is a legal obligation to reorganise within a year into either an open joint stock company (see below) or a production cooperative. It is not permitted to have a single participant LLC with a participant which is a single person business entity. LLCs are governed by Federal Law No 14-FZ as amended ("the LLC law").

Participants in an LLC have rights and obligations which are specified in the LLC law and in the LLC's own charter which is similar to a memorandum and articles of association. These include rights to participate in the management of the LLC, to access specified business information, participate in profit distribution, to sell or assign their participation interest to other participants in the LLC and to share in the distribution of assets after settlement with creditors following a winding up of the LLC. Obligations include the requirement to make contributions to the "charter" capital of the LLC. The charter capital of an LLC is the capital contribution made by its participants. The initial capital must be at least 10,000 rouble (USD 357) which is an amount linked to the national minimum wage. At the time of registration at least 50% of the capital must be fully paid up and the balance must be settled within one year.

LLC participation interests are not regarded as securities in Russian law and therefore there is no requirement to register them.

The highest governing body of an LLC is the general participants' meeting which is similar to a shareholder meeting in a limited company elsewhere. Daily management of the business is the responsibility of the executive body which may consist of a single general director or a general director and a management council.

LLCs must register with their local tax inspectorate. The following documents are required:

1. A standard application form.

2. The protocol of the founders' meeting.

3. The charter of the LLC.

4. A copy of the passport of the proposed general director.

5. Powers of attorney issued by the founder or founders for the establishment of the LLC and for the filing of the application for registration.

6. Evidence supporting the good legal status of the founders.

7. The charter or its equivalent of any foreign legal entity which will be a participant in the LLC.

8. Confirmation that the registration fee has been paid.

9. A certificate of foreign tax registration where founders are foreign entities.

10. A bank letter confirming the good credit rating of any foreign entity included as a founder.

11. Confirmation that any foreign entity involved has contributed to the LLC charter capital.

All documents from a foreign entity must be notarised and apostilled in the country of origin and any document supplied in a foreign language must be accompanied by a translation into Russian which has a notarised certificate.

LLCs are a popular vehicle for foreign entities wishing to set up subsidiaries in Russia. This is because relative to joint stock companies they are easier to establish and finance as there is no requirement to register participant "shares". However, it does have the disadvantage that under LLC law there are a large number of issues that require a unanimous vote of all the LLC participants. This has the potential to hinder the efficiency of the business activities of the LLC.

Joint stock companies ("JSC")

JSCs are governed by Federal Law No 208-FZ of 26 December 1995 as amended ("the JSC law"). A JSC is a legal entity which raises capital to finance its activities by issuing shares. Generally the liability of a shareholder in a JSC is limited to the amount it pays for the shares it owns. A JSC may be classed as "open" or "closed". An open JSC may have an unlimited number of shareholders whilst the maximum permitted for a closed JSC is 50. All JSCs are required to maintain a register of shareholders and where the number of shareholders exceeds 500 this task must be delegated to a licensed registrar. Shareholders may be individuals or legal entities.

Each JSC must have a charter which is effectively the company foundation document. The charter must include the following:

• The name, address, and type of the JSC (ie open or closed);
• The amount of the JSC's charter capital;
• The quantity, nominal value, and categories (common or preferred) of shares, as well as the classes of preferred shares issued and distributed by the JSC;
• The rights of the holders of shares of each category;
• The structure and competence of the governing bodies of the JSC, and their decision-making procedures;
• The procedure for preparing for and holding general shareholders meetings, including a list of issues requiring either unanimous consent or a resolution adopted by a qualified majority of votes;
• Information on branches and representative offices;
• Information on the existence of any special right of participation in the management of the company (a "golden share") vested in the Russian Federation, a constituent entity of the Russian Federation, or a municipality of the Russian Federation; and
• Other provisions required by law.

The minimum charter capital of both open and closed JSCs is linked to the minimum monthly wage in Russia. Currently the minimum for an open JSC is 100,000 roubles and for a closed it is 10,000 roubles. The founders of a JSC are required to pay 50% of the charter capital within three months of registration with the remainder payable within the first year after registration. A JSC is permitted to issue shares, bonds and issuer's options. Shares may be common or "preferred" in nature. Preferred share capital may not exceed 25% of the total charter capital. In contrast to LLCs all securities issued by a JSC must be registered with the Federal Service on Financial Markets of the Russian Federation ("FSFM RF").

A JSC is required to have two governing bodies. These are the general shareholders' meeting and the executive body. An open JSC must also appoint a board of directors if it has more than 50 shareholders. Additionally all JSCs must set up an internal audit body or elect an internal auditor to oversee financial and economic activities of the JSC.

The general shareholders' meeting is the highest governing body and its status is safeguarded in the JSC law. It is required to meet at least annually. The daily management of the JSC is delegated to the executive body. The general shareholders' meeting can opt to delegate the powers of the executive body to an external commercial organisation or individual but only if such a step has been proposed by the board of directors.

The procedure for registering a JSC is the same as that for registering an LLC. The principal difference is the requirement to register issued securities with the FSFM RF. It is also possible to pledge such securities. Where a security is pledged it must be registered as such. Since 31 May 2011 the pledge instruction may specify:

• The date on which the pledgee has the right to terminate the pledge and obtain out-of-court enforcement of the pledged securities;
• The time limit for disposal of the pledged securities; and
• The documents which the pledgee is required to provide to the registrar when seeking the termination of a pledge and out-of-court enforcement of the pledged securities.

Foreign investment

Russia is keen to promote itself as a country with an attractive and stable investment climate. Political stability, rich human and natural resources and a growing domestic consumer market have all contributed to a large increase in direct foreign investment into the country. Constraints on foreign businesses are being steadily removed. However, the government has restricted access to 42 sectors of the economy which it deems to be of strategic importance and constraints exist on participation in the banking sector.

Legislative framework

The Russian Constitution, the Russian Civil Code and the laws on joint stock and limited liability companies and insolvency provide the general legal framework for trade and investment in Russia. Of additional importance to the foreign investor are:

• The Federal Law on Foreign Investments in the Russian Federation, dated 9 July 1999 ("the Investment Law") as amended; and
• The Federal Law on the Procedures for Foreign Investments in Companies of Strategic Significance for National Defence and Security, dated 29 April 2008 ("the Strategic Investment Law").

The Investment Law

The Investment Law is intended to attract foreign materials, financial resources, and technology and management skills to improve the Russian economy, by creating a stable environment for foreign investors. It states that while foreign investments should generally be treated no differently from domestic investments, certain additional limitations may be imposed in order to protect the country; the Russian constitutional system; public morality; public health; the rights and legal interests of other entities; and the security of the Russian state. The law does not apply to the investment of foreign capital in banks, credit organisations, insurance companies or non-commercial organisations. Such investment is governed by different legislation.

The Investment Law allows foreign investment in most sectors of the Russian economy. It allows for:

• Participation in the capital of enterprises established by Russian legal entities and Russian citizens;
• Establishment of enterprises fully owned by foreign investors and establishment of branches of foreign legal entities;
• Acquisition of enterprises, property, buildings, shares in enterprises, stocks, bonds and other securities and property which may be owned by foreign investors under Russian legislation;
• Acquisition of land tenure rights and rights to use other natural resources;
• Acquisition of other property rights;
• Any other investment activity which is not specifically prohibited by Russian law, including provision of loans, credits, property, and property rights.

Importantly, the Investment Law includes a number of broad protections and guarantees for foreign investors in order to assure them that their investment will be legally protected in Russia. These include the following:

• The right of access to the Russian courts to defend their interests.
• The right to purchase stocks; participate in the privatisation process; transfer their property rights to third parties; and acquire real property.
• The right to transfer profits abroad. The Investment Law also states that foreign investors have the right to export property, electronic records and other company documents that were originally imported into Russia as investments.
• The protection that their property can be nationalised only in accordance with existing Russian law. In cases of nationalisation, the foreign investor must be compensated for the lost property and any other losses.

Additionally, Article 9 of the Investment Law introduces a tax stabilisation clause ("the Grandfather Clause") for foreign investors. The Grandfather Clause applies to the following:

• Foreign investors that are implementing "priority investment projects";
• Russian companies with more than 25% foreign equity ownership; and
• Russian companies with some foreign participation that are implementing "priority investment projects".

The Investment Law defines a "priority investment project" as a project with foreign investment of at least one billion roubles, or, where a foreign investor has purchased an equity interest of at least 100 million roubles. The investment project must also be included in a list of projects approved by the Russian government.

The Grandfather Clause states that any change in customs duties, federal taxes or contributions to non-budgetary funds that has a negative impact on a foreign investor will not be enforced until initial investments have been recouped. This guarantee applies for a maximum period of seven years unless the Russian government chooses to extend it. Key exceptions to the Grandfather Clause exist for protective customs tariffs on commodities, excise tax, VAT on domestic goods, and Pension Fund payments. The Grandfather Clause will also not be enforced if a Russian law or normative act is enacted to defend the Russian constitutional system; public health; the rights and legal interests of other entities; or the security of the Russian state. In addition, the government has yet to establish the criteria by which it will determine that a change in legislation has had a negative impact on a foreign company.

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