The emerging free market in the Russian Federation creates various opportunities for foreign entrepreneurs to conduct their activities in the Russian Federation. Even when a foreign company does not consider a direct investment in the Russian industry as a prospective way to develop its business or does not have sufficient information to estimate whether these investments will yield a fair return the foreign company may be interested in exporting its goods or services into Russia. For such a company the appropriate way would be to establish a permanent local representation. This does not require a big investment but may create the basis for a further extension of activities in Russia.
The increasing number of representations of foreign companies which offer their goods or services in Russia improves the competition among different producers and assists to meet the home demand for high quality goods and services. So the emergence of new representations of foreign companies that are not immediately connected with large investments in the national economy should be and are favoured by the national legislation as well.
A foreign company wishing to be constantly represented in Russia can choose one of three possible forms for creating such representation. The foreign company can establish:
i) representative office
ii) branch
iii) subsidiary, which can be set up by a foreign company alone or
in cooperation with local cofounders.
1.1 Representative office
Starting a representative office ("predstavitelstvo" in Russian) is the simplest way to obtain constant representation in the local market. In general the representative office is entitled to carry out negotiations with customers, sign the contracts in the name of the parent company and perform other activities on its behalf. This form of representation was provided for already by the Soviet legislation and was the single possible way to establish an office in the Soviet Union, before the acts on joint ventures were adopted in 1987.
Although the legal framework which governs the procedure for registering (accrediting) and for operating through a representative office is by far not perfect, the majority of foreign companies prefers to choose this traditional form of representation. The reasons of this choice are: simpler rules for book-keeping and for taxation of activities which are performed through a representative office, and small risk for the parent company because of the minimal amount of necessary capital.
The disadvantage of representative offices is however, that they are strongly limited in performance of any entrepreneurial activity on the territory of Russia. The law does not entitle the representative offices to carry out the main functions of the parent company. They are not supposed to conduct any production process. Neither are they enabled to maintain the storage facilities in order to trade with goods on the territory of Russia. The services rendered by the representative office in Russia can be performed only with respect to the goods, which have been imported by the customers of the parent company.
The rights of the representative office of a foreign company to deal with Russian currency are also severely restricted. They may sell the goods imported by the parent company for Rubles, but the Ruble receipts gained in this way can be used only for supporting the representative office. The instruction by the Central Bank of Russia enables the representative offices neither to convert their Ruble income into hard currency nor to use it outside of Russia. Thus it does no make a lot of sense for a company dealing in Russia through its representative office to sell goods for Rubles. The Russian counterparts of such a supplier are faced with a problem of converting their payments into foreign currency on their own.
All customs duties connected with the import of goods must be completed by the customers as well. Since the prepayment has become the predominant practice in trading with Russian importers, the latter, when purchasing the goods of a foreign counterpart, which have only the representative office here, usually has to wait several weeks from the payment of the goods until the delivery is performed.
The emerging free market in Russia however requires from any foreign company which desires to develop its business, to give their customers wider choice in establishing their relations. The increasing number of companies represented in Russia and the growing competition among them do now allow to continue rendering the business in the same way as many years ago without loosing part of their clients. As a rule firms are successful in the Russian market under the present circumstances when they can offer the goods already stored in Russia, when they can release their clients from fulfilling the customs formalities and when they can sell their products for Rubles.
1.2 Branch
This kind of services can be offered only by establishing a branch or a subsidiary in Russia. The establishing of a branch ("filial" in Russian) is considered to be disadvantageous because this form is not deemed a legal entity under Russian laws. The parent company is liable for all obligations of the branch and this effectively prevents the foreign companies from using this type of entity. That is why only few foreign companies take a risk to choose this option.
1.3 Advantages of establishing a subsidiary of a foreign company
A much more popular decision is to set up a subsidiary with or without the participation of Russian cofounders. The subsidiary is deemed a legal entity under Russian law and generally provides for a limited liability of its shareholders. After the possibility to found the wholly owned subsidiary on the territory of Russia was introduced by the Russian legislation in the late 1990 many foreign firms prefer to establish a wholly owned subsidiary. This form, for example, in comparison with the joint venture guarantees the entire control by the parent company of the activities of its subsidiary.
In comparison with the establishment of the representative office the creation of a subsidiary in Russia gives the following advantages:
i) Possibility to store the goods on the territory of Russia and
to sell them directly to the clients from the store
The parent company can supply its subsidiary with goods to be sold to Russian customers in several ways. Initially some of the goods can be imported by the parent company as its contribution to the nominal share capital of the subsidiary. In this event the import taxes and customs duties are not levied on these goods, unless the goods are subject to excise taxes. The release from import taxes can be obtained in respect of the goods which are imported in conformity with the constituent documents of the subsidiary within one year after its state registration.
Furthermore, the goods can be imported by the parent company due to a contract which is concluded with its Russian subsidiary. In this case, the Russian counterparts of the company can purchase the goods without having to deal with the customs office, which makes the services of the company more attractive for Russian clients. Even if the prices for these goods are higher than the prices being offered by competitors the customers prefer to buy the goods stored in Moscow or in other Russian cities. Firstly, they are able to examine the stored goods before concluding the contract, and secondly, they do not have to wait many weeks for the delivery after paying for it in advance.
ii) Possibility to sell the goods for Rubles, to convert them
into hard currency and to use the gained income abroad
The effective Russian legislation on currency control does not prevent the conversion of Rubles into foreign currency through authorized banks and the performing of cross-boarding payments if they are made on the grounds of valid contracts with foreign counterparts. Thus the Ruble income gained by a subsidiary in the course of selling the goods imported by the parent company can be freely exchanged for a hard currency and may be freely transferred to the parent company on the grounds of the contract on selling of goods.
Taking into account the above named main advantages, the establishing of a subsidiary on the territory of Russia can be beneficial for every foreign company exporting any goods to Russia when this company intends to enlarge its income from that operations.
2. Operations which can be performed by a foreign company through its subsidiary in Russia
2.1 Performance of works inside of Russia
In particular the establishing of the Russian subsidiary can be efficient for a foreign company which trades with high technology products in Russia. Deliveries of complex computer or communication nets or other similar projects are usually connected with large scale mounting or tuning works which cannot be performed outside Russia.
It may also be efficient to perform the programming and engineering works in Russia where many skilled professionals can ensure the high quality fulfilment of that kind of tasks.
The involving of the Russian subsidiary in performance of the complex contracts which envisage large amount of works on the territory of Russia, is in particular advisable for the taxation reasons.
The parent company should not include the indicated works as part of the contract for delivery of the hardware equipment to the subsidiary. The Law On Corporation Income Tax of 27.12.1991 as amended determines that the foreign company is obliged to pay the tax for the income from its operations in Russia, except the income from sales of goods if the property rights in these goods are transferred to the customer before they cross the border of Russian Federation. Therefore, the works should be performed by the subsidiary and the title to the goods should be transferred to the subsidiary before the goods cross the border.
Any other income of the foreign company gained from the contracts with Russian counterparts is subject to tax according to the effective Russian laws. Under these circumstances the foreign seller should distinguish between the contract price for hardware to be delivered and the price for installation works. In other case the income tax may be levied on the entire income gained by the foreign company from the described transaction. Taking into account the problems of the double taxation under the laws of different countries which may appear for the foreign company when its income from one transaction becomes the subject to taxes of various states, the distinguishing between the entities which are obliged to pay the income tax in different states must be preferred. Thus involving of the wholly owned subsidiary in the performance of works on the territory of Russia may be helpful. In this case the parent company is free of any duties to pay income tax in Russian and the payment of the income tax for the works which are performed in Russia will be the duty of its local subsidiary.
2.2 Subsidiary as a general contractor
The subsidiary of the foreign company may be charged not only with the performance of mounting, tuning or programming works. It may be practicle to appoint the subsidiary as a prime contractor in the complex agreement with the Russian customer which includes the delivery of goods manufactured abroad and the mounting and tuning works on the place of their installation. Firstly, that can help to manage the execution of the contract works on the flexible and efficient way as well as to control the fulfilment of the customers' duties and the proper operation with the mounted equipment. Secondly, the foreign parent company acting as an associate contractor will not bear the direct responsibility for the complete fulfilment of the entire contract in respect of the consumer. Hence, the risks of the parent company to bear losses from its operations in Russia can be minimized on this way. However, the provisions of the first part of the new Civil Code (articles 56 and 105), which will be considered below do not permit to avoid the responsibility of the parent company if the subsidiary becomes insolvent as a result of any action of the former.
The delivery of hardware produced outside of Russia can be performed in this case on the grounds of a commission agreement between the parent company and its subsidiary. Otherwise the sales of these products by the subsidiary can be considered as a subject to the corporation income tax under the Russian law.
2.3 Regulation of payments through Russian subsidiary
The subsidiary of the foreign company, when it belongs solely to the latter, is deemed a resident under the Russian currency legislation. It has to observe the Russian currency legislation that imposes the general prohibition to use the foreign currency in relations among residents without the special permission by the Central Bank. On one hand this can cause additional costs for converting the Ruble payments for the equipment to be delivered and for the works to be performed under the contract. But on the other hand the customer would have to bear the same costs if he must pay for the services of the company in foreign currency. Including a correspondent conversion premium into the Ruble price of the contract does not thereby usually give rise to any objections by the customer.
However, the general prohibition of the Russian legislation to use the foreign currency in payments among residents can be avoided on the grounds of an Instruction by the State Bank of the Russia. If a 100% foreign-owned Russian subsidiary concludes the contract of commission or of agency with the Russian customer the payments to the subsidiary or directly to the parent company can be performed by the customer in foreign currency.
Hence, the legal status of the subsidiary gives a wide choice to establish the relations with the Russian customers in a very efficient manner. The practical adjustment of the contract relations through the wholly owned Russian subsidiary with regard to any particular case can bring essential benefits for the foreign parent company.
3. Amendments of the rules relating to the wholly owned subsidiary according to the new Civil Code
3.1 Legal status of the subsidiary
The first part of the new Civil Code of Russia adopted on the 30.11.1994 and "The Law on Joint Stock Corporations" implement several rules which alter the legal framework governing the founding and the activity of the subsidiaries of the foreign companies.
First of all the wholly owned subsidiary can be set up now either as a limited liability company or as a joint stock corporation. The ambiguous provision of the previously valid Law On Enterprises and On Entrepreneurial Activities which treated the limited liability company equal to the closed joint stock corporation is abolished by the new Code. The absence of means to distinguish between the two above named legal entities gave rise for several confusions. For example, since the law on Joint Stock Corporations allowed to set up a joint stock corporation with a single stockholder the authorized registering bodies refused to register the limited liability companies with one founder.
Also since the Law On Enterprises treated the founders of s limited liability company or of a joint stock corporation in plural, this gave arbitration courts the reason to deny the validity of companies with only one shareholder.
The new Civil Code implements the express rule that both the limited liability company and the joint stock corporation can be established by a single founder (articles 87 and 98 of the Civil Code). It is worth noting that a new rule was implemented which prohibits the parent company of a Russian subsidiary to be wholly owned by one party. In other words the Russian subsidiary can be wholly owned by a foreign parent company but this parent company must have two or more owners. This rule has to be observed by the foreign companies which have a wholly owned subsidiary on the territory of Russia. If the company is subject to the prohibition implemented by the Civil Code it should be advised to transfer at least one share in the parent company to another person.
3.2 Legal capacity of a company under Russian law
Paragraph 2 regarding the article 49 of the Civil Code eliminates the confusions regarding the legal capacity of companies under Russian law. Similar to the discussed above contradictory rules contained in the Law On Enterprises and in the Law On Joint Stock Corporations these acts also determined opposite regulations of the companies' capacity to close transactions which are not stipulated in their constitutional documents. The Law On Joint Stock Corporations allowed these transactions whereas the law On Enterprises acknowledged only the validity of transactions which correspond to the object of the company's activities as defined in the charter of the company.
The Civil Code 1994 establishes the general principle of the unlimited legal capacity of the companies. Any company under Russian law including the wholly owned subsidiaries being deemed as a commercial entity is enabled to obtain civil rights and enter into commitments which may be necessary for conducting any kind of activity not prohibited by the law. Thereby the clause of the object of company in the charter is at this time irrelevant. The rules on the state licensing for activities in particular areas determined by law are however to be observed in any event. These are numerous and contain for example banking, drugs etc. This constitutes an effective restriction on the unlimited legal capacity of the companies.
3.3 Exceptions to the limited liability of the parent company
Paragraph 2 of article 105 of the Civil code implements the new rule which was not known in previous Russian corporate law. It is determined that a company which is entitled to give binding instructions to another company due to the prevailing participation in its share capital or on other grounds bears the joint and sever liability together with the subsidiary for the transactions closed by the subsidiary due to instructions from the parent company. The parent company is also liable for any obligations of its subsidiary in the event the subsidiary becomes insolvent due to the fault of the parent company. Shareholders who are entitled to give binding instructions to a company may also be liable in case the insolvency of the subsidiary has been caused by actions of such shareholders.
These new regulations of the Civil Code strengthen the responsibility of the parent company for the management of their subsidiaries. These rules can endanger the principle of the limited liability for the obligations of a subsidiary and may have given reason for concern by foreign investors. At the moment it is difficult to estimate how big this danger can actually be. In any event, it is necessary that the arbitration courts work out the practice of implementing these provisions. The implementation of these rules will not result in acknowledging the parent company as responsible for all obligations of its subsidiary due to the fact only that all the stocks of the subsidiary belong to the parent company.
The liability of the parent company can be forced only in the event it is proved that a particular transaction concluded by the subsidiary has been caused by the express instruction of the parent company. The general definition of the aims of the subsidiary's activity given by the shareholder who has the majority of votes may not be considered as a sufficient reason for implementation of the discussed provision. The same opinion was expressed in the newest comments to the Civil Code which have been published by the "Yurinformzentr". In the comments to the article 105 it is stated that the parent company has two different types of power. It has the right to:
i) define the general direction for the operation of its
subsidiary, and
ii) give the binding instruction for particular transactions.
Only the latter actions by the parent company are considered as a sufficient reason of the liability of the parent company.
Thus the parent company must not be in danger to become liable for the obligations of its subsidiary when there is no evidence that the particular transaction has been closed due to its instructions. In order to emphasize that only the subsidiary bears the liability for its own obligations it can be advised to include into the constituent documents of the subsidiary the provision stating: the relations of the subsidiary to its parent company are formed on the basis of contracts. The contracts concluded between the parent company and its subsidiary may not always by the authorities considered as binding instructions of the parent company.
The new Civil Code contents numerous rules which also are to be observed by establishing and managing the Russian subsidiary by a foreign company. It should be mentioned however that the basic rules set forth in the Civil Code regarding the joint stock corporations and limited liability companies are detailed in special laws, such as for example, "The Law on Joint Stock Corporations". Definitely more developed legal grounds for operation of the entities considered in the present work will be created with the implementation of them.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
