A Q&A guide to construction and projects law in the Russian Federation.
The Q&A gives a high level overview of the main trends and significant deals; the main parties; procurement arrangements; transaction structures and corporate vehicles; financing projects; security and contractual protections that funders require; standard forms of contracts; risk allocation; excluding liability, including caps and force majeure; contractual provisions covering material delays and variations; appointing and paying contractors; subcontractors; licences and consents; projects insurance; labour laws; health and safety; environmental issues; corrupt business practices and bribery; bankruptcy/insolvency; public private partnerships (PPPs); dispute resolution; tax and mitigating tax liability; the main construction organisations; and proposals for reform.
To compare answers across multiple jurisdictions, visit the construction and projects Country Q&A tool.
This Q&A is part of the PLC multi-jurisdictional guide to construction and projects law. For a full list of jurisdictional Q&As visit www.practicallaw.com/construction-mjg.
The general trend in 2011 was a continuation of the upturn started in 2010 in the construction industry, with the number of construction projects increasing and suspended construction projects restarting. The most dynamic results were demonstrated in retail projects. Frozen in the past, logistic projects also attracted a lot of interest, especially taking into account the current average 3% to 5% vacancy rates for Class A warehouses. Following drastic limitations of new development in Moscow, developers focussed on regional development projects. In addition to retail, other popular segments were residential construction and hotel and leisure facilities' development. Surprisingly, regional airport facilities and infrastructure renovation and reconstruction projects demonstrated a very high interest of investment, predominantly from the local core investment groups. Finally, in the industrial segment a high level of investment activity was demonstrated by the automotive and pharmaceutical corporations in their processing plants projects.
Following replacement of mayors both in Moscow and St. Petersburg, practically all development projects in these cities were subjected to a careful reconsideration procedure, which resulted in almost one quarter of all investment agreements being terminated. New priorities declared by the administration are:
Public roads and parking.
Public transport.
Hotels.
Engineering (such as, subway, energy generating facilities and communal utilities, waste treatment facilities, and so on) and social infrastructure.
In 2011, the Supreme Commercial Court expressed a principal legal position that completely changed the interpretation of the investment agreement concept, which was until then extremely popular among developers. Investment agreements are now treated by the Court as a sale of future property subject to development.
Positive amendments were introduced to the Town-Planning Code permitting assessment of the design documentation for construction to be implemented either by a state or non-state expert on discretion of the applicant, except for specific or dangerous facilities subject to the state expert assessment exclusively. The statutory term of recording of mortgages with the Realty Registry was reduced to five business days for residential and 15 business days for other properties. Finally, conveyance of the effective building permit to a purchaser of the land plot was significantly simplified.
The main projects included:
Launch of the development of the Fashion House Outlet Centre north of Moscow and two Outlet Centres by Hines International.
Unveiling of Large X5 Retail Group's plans to build one million square metres of warehouses across the country to cover their own needs.
Re-started development by Ghelamco of its Logistics Park close to Dmitrov.
Regional expansion of IKEA, Auchan, Metro Group and DIY store operators.
The main parties involved in a project are the:
Developer. The developer is the key party in the overall process. The developer must either own or lease the relevant land plot. Generally, the developer engages other professionals, the main ones being:
a project designer;
a general contractor/contractors for certain types of works; and
a technical employer (engineer).
Project designer. This is a professional responsible for preparing the design documentation and, as a rule, organising expert assessment of the design documentation. The project designer can engage sub-designers to elaborate specific sections of the design documentation.
General contractor. The general contractor's main role is to provide for the organisation and co-ordination of construction process on site and be liable for the safety requirements on site. The general contractor usually also carries out the bulk of the work and for specific work employs subcontractors.
Technical employer. This is the party with expertise in exercising construction supervision (for example, the inspection of completed works and their quality).
The developer generally enters into the following agreements when implementing a project:
A contract with the designer for development of the design documentation.
A construction contract with the general contractor for construction of the facility.
A contract with the technical employer for technical supervision over the design and construction, selection and involvement of third parties to implement the project, reporting to the supervising authorities, and so on.
The following forms for transactional relations are also frequently used:
A single contract for design and construction. This form is inconvenient due to the requirement for the general contractor to have a Certificate of Admission (a type of licence) both for design work and for general contracting work.
Construction on a turnkey basis (that is, the facilities are constructed and delivered ready to use) at a fixed price, including engineering, procurement and construction (EPC) (see Practice note, Procurement route: EPC or split EPC (www.practicallaw.com/3-383-4959)).
Agreement on a comprehensive construction management including engineering, procurement and construction management (EPCM).
These arrangements are generally the same if some or all of the main parties are international contractors or consultants.
The main forms of transactional structures and vehicles are relatively simple:
Construction contract. Employment of a construction contractor by a developer.
Shared construction agreement. This is a heavily regulated variation of the investment agreement. It aims primarily to protect investors' interests and public order. This type of agreement is mandatory for residential development involving investments by individuals. Companies can agree to use this agreement. However, developers are not enthusiastic about using this agreement, because of the burdensome reporting and liability obligations.
Corporate forms. If a special purpose vehicle (SPV) is created for the purposes of the project, the traditional corporate form used is a limited liability company (LLC).
Transaction structures are generally the same for both local and international contractors or consultants. However, international projects involve more sophisticated corporate and finance structures. In particular, corporate structures managed from a foreign jurisdiction (for example, Cyprus, BVI, Jersey, Guernsey and The Netherlands) are increasingly used. Vertical structures are sometimes used, made up of several special purpose companies, to comply with statutory limitations on foreign involvement.
Before the downturn, most real estate projects were funded through bank loans, where the role of international banks was hard to overestimate. Currently, the most active on the real estate market are the largest local banks and professional investors who lend for development of the most marketable projects that are close to completion. Another standard financing method is equity.
Initial public offerings (IPOs) are not currently considered, due to the current economic situation. In addition, instruments such as mezzanine finance, forward financing and bond issues are currently less common.
Funders typically require that one or several of the following forms of security be used to protect their investments:
Mortgage. The most commonly used security is a mortgage over the land plot on which construction is carried out (or a mortgage of the lease right if the plot is held on a leasehold basis), together with a mortgage over the construction facility.
Pledge. This is a pledge of shares in the company constructing the facility and owning the land, or in that company's parent.
Other forms of security. These include a pledge over assets, a pledge of bank accounts and receivables, bank guarantees and parent company guarantees. In addition, a pledge of the employer's rights to contract for construction has recently been introduced to secure guarantees. However, this instrument is insufficiently covered under Russian legislation and relevant enforcement practice has not been established to date.
If the investments drawn into the construction project are subject to foreign law, contractual tools such as warranties, step-in rights and assignments of contractual rights are used.
There are no Russian standard forms of contracts. Major local industrial projects, particularly those financed by foreign banks and financial organisations, generally use standard forms of contracts developed by the International Federation of Consulting Engineers (Fédération Internationale Des Ingénieurs-Conseils) (FIDIC). For more information, see Practice note, FIDIC Forms of Contract (www.practicallaw.com/7-384-6521). However, these require thorough adaptation to local reporting, tax and bookkeeping requirements, among others.
Construction contracts for international projects usually consist of FIDIC models adapted to Russian legislation. This applies, in particular, to infrastructure and industrial projects. For more information, see Practice note, FIDIC Forms of Contract (www.practicallaw.com/7-384-6521).
The main risk the contractor faces is that of accidental loss of, or accidental damage to, the construction facility before its acceptance by the employer/developer (except in cases where the construction facility is destroyed or damaged because of poor quality material or equipment supplied by the employer, or the execution of incorrect instructions from the employer). This risk is normally managed by taking out insurance.
In relation to the materials and equipment provided by the contractor, the contractor bears the risk of accidental loss or accidental damage, and the risk of being unable to use those materials and equipment in the construction. These risks can also be mitigated by insurance.
If the price of the contractor's work is fixed under the contract with the contractor, the contractor bears the risk of additional unforeseen costs arising in the course of construction. This applies even in relation to costs that cannot be accurately calculated when the contract is concluded.
Liability for non-performance and bearing of risk are differentiated under law. That is, in the event of force majeure (see Question 11), the contractor is released from liability but continues to bear the risk of accidental loss of, or accidental damage to, the construction facility.
The contractor can limit its liability to the following:
Reimbursement of actual damage only (excluding lost profits). As a rule, this restriction is used in the construction of large scale industrial facilities, such as power plants.
Reimbursement of direct loss only.
Liability if found culpable only. Under Russian law, in relations with commercial organisations, liability is usually implied irrespective of fault, unless the parties agree otherwise.
In most cases, the law does not prohibit the parties from setting a cap on liability, including a fixed amount. However, in practice, a monetary limit is applied very rarely and the parties usually limit their liability by other means (for example, they provide for reimbursement of actual damage only, without covering lost benefits, interest and so on (see Question 9)).
Under Russian law, force majeure releases parties from liabilities. Russian law outlines key characteristics that constitute force majeure, but does not list force majeure events specifically. Situations that are urgent and irresistible can constitute force majeure. The following events may be treated as force majeure:
Natural disasters.
Acts of war.
Blockades.
Embargoes.
Acts of public authorities.
Other public events relating to the force majeure circumstances.
In addition, the law specifies circumstances that cannot be considered force majeure, in particular:
Breach of duty by, for example, subcontractors and suppliers of materials and equipment.
Lack of a sufficient market for supplying the goods, including materials, construction and equipment.
Lack of funds.
The parties usually establish a penalty for delayed construction. The penalty can be determined as either a:
Percentage of the amount of work not completed on time.
Fixed amount for a specific period of delay.
Russian legislation provides for the employer's right to terminate a contract if the contractor either:
Delays commencement of the work.
Performs the work so slowly that it is impossible to meet the deadline.
In addition, the contract often provides for the employer's right to terminate the contract if there is a significant delay in the contractor's execution of the works. In this case, the employer can also claim damages from the contractor.
Performance bonds, insurance, banks and parent company guarantees are also used in large scale projects.
Construction and related works should be carried out in accordance with the design and technical documentation defining the scope, content and other related requirements. This should be supplied with a calculation of the cost of works. The employer has the right to amend the design and technical documentation under the condition that the cost of any additional work caused by the amendment does not either:
Exceed 10% of total costs listed in the calculation.
Change the nature of the works under the contract.
Revisions of a greater scope are subject to agreement between the parties.
The following terms and conditions are the most heavily negotiated:
Costs and payment schedule in relation to the works (for example, advance, interim and final payments).
Timing of work performance and liability for failure to meet intermediate deadlines.
Parties' liability for failure to meet contractual terms and conditions.
Order of the conveyance of risks and works acceptance (that is, whether the employer/developer accepts the works and relevant risks phase by phase, or accepts all the works and risks only on completion).
If the employer is a commercial organisation, contractors and other construction professionals are usually selected by either a:
Binding tender (concurs). The employer and the best bidder must conclude a contract. It is not mandatory to hold a tender procedure in relations between commercial organisations, although bidding is frequently used in practice.
Non-binding tender (request for proposals). The employer collects proposals from potential contractors and retains the right to refuse to enter into a contract with the best bidder.
In the public sector, selection of a contractor is usually made on the basis of a binding bidding procedure. The procedure is usually very formal, strictly regulated and differs from the tender procedures held by commercial organisations.
The procedure for paying for construction work is based purely on the contractual provisions. It is similar in most construction projects and consists of the following:
An advance payment (or several advance payment instalments, usually used for site preparation, purchase of materials and so on). The advance payment does not usually exceed 10% to 15% of the total cost of the work and is usually secured by a bank guarantee. These advances are usually proportionately set off during subsequent payments.
Interim payments for interim works carried out as construction progresses. These payments can be made periodically (for example, on a monthly basis, on acceptance/inspection of completed works at the main stages of construction or according to a schedule). The interim payments are decreased by the proportionate amounts of the advance payment and retentions.
Retention payable on completion and the employer's final acceptance of the facility. The size of this retention is usually 5% to 10% of the total cost of the work.
Retention payable on expiry of the guaranteed operating period (usually amounting to no more than 5% to 10% of the total cost of the work). This retention generally is replaceable with a bank guarantee in the same amount.
See above, Methods of payment.
The general contractor generally engages subcontractors to perform certain types of work without seeking the employer's prior consent. The parties can agree that the general contractor should seek the employer's prior consent for engaging subcontractors or agree on the list of potential subcontractors in advance. For example, information on approved subcontractors can be specified in the general contractor's offer for participation in the tender.
In both cases, the general contractor continues to be liable towards the employer for work performed by subcontractors as if it performed the work itself.
The employer does not usually interfere in the relations between the general contractor and its subcontractors. However, the general contractor and the employer can agree that the employer will employ and pay the subcontractors directly. In this case the general contractor is not liable for the works of the direct contractors, such direct contractors are liable towards the employer.
In certain cases, subcontractors must have a Certificate of Admission issued by a relevant self-regulating organisation (SRO) (see Questions 3 and 20).
On 1 January 2010, the reform of regulation of construction activities and the transition from licensing of construction activities to self-regulation was launched. The key regulation governing self-regulation in construction works is the Town Planning Code of the Russian Federation. Construction work affecting safety can now only be performed by parties holding a Certificate of Admission issued by a relevant SRO (see Question 19). The SRO consists of professional developers. Before the reform, licences were issued by the state agencies.
There are more than 370 types of work requiring a Certificate of Admission, ranging from engineering surveys and preparation of design documentation to specific construction works to works associated with organising construction.
In most cases, the general contractor, the designers and the technical employer should be members of an appropriate SRO, and hold a Certificate of Admission issued by one of the relevant SROs.
Before construction work starts, a project must obtain all of the following:
A town-planning plan of the land plot. This is a territorial zoning document identifying the main characteristics of the site, including the types of permitted use and permitted construction options. The developer obtains the town-planning plan.
The requisite set of design documents and a positive expert's opinion on these. This is not required in some minor projects. Usually, it is the designer who organises the state expert's assessment.
The technical conditions for connection to the public utilities infrastructure (that is, electricity, gas, water, waste water, and so on).
A construction permit issued by local or federal authorities, depending on the project's scale. The construction permit, as a general rule, is received by the developer.
During construction, the construction supervisory authority (either regional or federal, depending on the project) makes inspections in accordance with the schedule specifically issued for each construction site. For some minor construction projects, state construction supervision is not carried out.
On completion, a project must obtain all of the following:
A report on the facility's compliance with the requirements of the technical regulations and design documentation (this report is commonly referred to in Russia as a ZOS). The ZOS is issued by a state construction supervisory authority on final inspection. The general contractor usually obtains the ZOS.
An operation permit for the facility. This is the main, key document issued to the developer by the state authority or local government, confirming completion of construction and the facility's capacity to operate. The operation permit is issued on the basis of the ZOS and a number of other requisite documents (including a confirmation from the utility suppliers that the utility connections are properly implemented).
The SROs generally establish insurance requirements. In practice, the parties also agree that additional insurance must be maintained. The duty to maintain insurance is usually imposed on the contractor, although it is sometimes imposed on the employer, for example, when the construction is covered under the employer's general insurance (including international insurance, primarily if the employer is an organisation that operates in several countries).
The following types of insurance are usually maintained:
Insurance of construction risks. This includes the risk of accidental damage to, or accidental loss of, the facility under construction and materials, equipment and other property located on the site.
Liability insurance for injury caused during the work (third party liability insurance).
SROs require insurance to be maintained as a condition for membership and also to reduce the burden on SRO funds. This is because, under legislation, a SRO is subject to secondary liability for damage caused by its member and must pay out of its indemnification fund.
No special insurance is generally taken out by employers as the General Contractor is the party that effectively controls the construction site.
Local construction workers must:
Be at least 18 years of age to perform work under certain particular professions (the list of professions is established by the federal government).
Pass any relevant health examinations, for example when working in hazardous locations.
Have relevant permissions required for performing work on a certain mechanisms, equipment or machines.
Certain hazardous professions cannot be occupied by women (the list of such professions is also established by the federal government).
There are no other general limitations on the employment of Russian citizens.
Foreign nationals can be employed if they have a work permit issued by the Federal Migration Service. Work permits are issued for a term not exceeding one year (or three years for highly skilled workers), based on migration quotas that the federal government fixes annually. Quotas do not apply to all highly skilled workers and regular workers of certain positions, a list of which is annually established by the Ministry of Health and Social Development. A foreign employee is likely to be considered highly skilled if his/her average annual income is not less than RUB2 million (as at 1 April 2012, US$1 was about RUB29).
Foreign nationals can work without a permit provided:
They are employed by a foreign company that is engaged in producing or selling goods.
Their work involves:
equipment installation services;
technical support services; or
warranty services or technical support for equipment delivered to Russia.
The federal Labour Code is the main legislation regulating labour relations. This establishes mandatory requirements on maximum working hours, night work, payments and so on. For example (Labour Code):
The normal duration of a working week cannot exceed 40 hours.
Salary should be paid at least every two weeks.
Holiday entitlement is at least 28 days per year.
Additional guarantees (for example, shortened working week, prohibition of work at night and overtime work, and so on) are provided for certain categories of employees (women, minors, and so on).
Employees can be engaged on either a:
Fixed-term contract. Under this, there is no statutory payment of compensation on expiry of the fixed term.
Employment contract for indefinite term. Under this, employees can be dismissed by the employer exclusively in cases stipulated by the Labour Code. Depending on the situation, a maximum statutory redundancy payment can be up to five months' salary.
Health and safety laws are set out in numerous laws and standards. The main health and safety regulations applicable to construction work are set out in the:
Labour Code.
Construction Standards and Rules 12-03-2001 on work safety in construction.
Sanitary Regulations and Standards 2.2.3.1384-03, which sets out sanitary rules for construction work.
Technical regulations on fire safety requirements, established by the federal law dated 22 July 2008 No. 123-FZ.
Government Regulation on health limitations for working in construction for women as of 25 February 2000 No. 162.
Government Regulation on health limitations for working in construction for minors as of 25 February 2000 No. 163.
The employer's basic obligations are to:
Provide working conditions meeting the standards of the occupational health and safety, work and rest regime established by the labour laws.
Purchase special clothing for employees' personal protection.
Give technical training for employees on safety.
Ensure periodical medical examinations of employees.
Ensure testing and certification of workplaces.
Appoint special labour safety officer.
The following local laws, among others, regulate projects' effects on the environment:
Federal law of 10 January 2002 No. 7-FZ "On Environmental Protection". This is the main piece of legislation.
The Land Code, the Town-Planning Code, the Water Code and the Forest Code.
Federal law of 14 March 1995 No. 33-FZ "On Natural Areas of Preferential Protection".
Federal law of 4 May 1999 No. 96-FZ "On Protection of Atmospheric Air".
Federal law of 30 March 1999 No. 52-FZ "On the Sanitary and Epidemiological Welfare of the Public".
Federal law of 24 June 1998 No. 89-FZ "On Production and Consumption Waste".
Federal law of 11 July 2011 No. 190-FZ "On Radioactive Waste Handling".
Federal law of 24 July 2002 No. 101-FZ "On Farm Land Turnover".
See above, Local laws.
See above, Local laws.
See above, Local laws.
See above, Local laws.
See above, Local laws.
Russia has no legislation regulating carbon emissions or climate change targets. Russia acceded to the Kyoto Convention in 2010. The application of the Convention will commence after a transitional period of three years, during which the national legislation should be modified.
There are no construction-specific corruption laws in Russia.
Individuals can be penalised for:
Taking bribes. Depending on the circumstances of the crime, punishment can range from a fine to imprisonment for a maximum of 12 years.
Giving bribes. Depending on the circumstances of the crime, punishment can range from a fine to imprisonment for a maximum of eight years.
Intermediation in bribery. Depending on the circumstances of the crime, punishment can range from a fine to imprisonment for a maximum of 12 years.
Legal entities can be held administratively liable with a fine of up to one hundred times the amount of the bribes, but not less than RUB1 million. In addition, a legal entity's officers can be criminally prosecuted.
Illegal transfer of money or any other assets to a company's manager to take actions in the interests of the transferor is punishable with a fine up to seventy times the amount of transfer or imprisonment for up to six years.
Illegal receiving of money or any other assets by a company's manager to take actions in the interests of the transferor is punishable with a fine up to ninety times the received amount or imprisonment for up twelve years.
A contractor's bankruptcy or insolvency does not generally constitute grounds for the other party's unilateral withdrawal from the contract, under law. For the employer, the main consequence of the contractor's bankruptcy is that:
The contractor's obligations become due and payable (if the contractor has payment liabilities).
There will be a change of the contractor's management at certain stages of bankruptcy (for example, the replacement of the company's chief executive officer (CEO) with a bankruptcy manager appointed by a court).
However, contractual agreements usually provide for the right of unilateral withdrawal from the contract in the event of the contractor's bankruptcy or insolvency.
In the last few years, Russia has increasingly considered PPPs and the need to develop them further.
A number of major PPP projects involving construction of plants for waste processing, road construction and upgrading of airports have recently been launched. These projects, with a few exceptions, are structured as concession agreements. PPP is also used at the local level in municipalities, mainly in relation to utility services and social welfare facilities.
However, Russian legislation requires amendments to provide for the implementation of PPP models commonly used worldwide (for example, build, own, operate, transfer (BOOT) and build, transfer, operate (BTO) models, and so on). A legislative framework is currently being developed for the application of some of the PPP tools, such as concession agreements, production-sharing contracts and so on.
Major laws governing PPPs are the:
Federal law of 21 July 2005 No. 115-FZ "On Concession Agreements".
Federal law of 21 July 2005 No. 94-FZ "On placing orders for goods, works and services for state and municipal needs".
Federal law of 18 July 2011 No. 223-FZ "On procurement of goods, works, services by certain types of the legal entities".
Federal law of 30 December 1995 No. 255-FZ "On Production Sharing Agreements".
Federal law of 25 February 1999 No. 39-FZ "On Capital Investments in the Russian Federation".
Regional legal acts on PPP.
In 2010, to develop PPP in Russia, the PPP Expert Council of the State Duma (lower chamber of the Federal Parliament) developed a model law on PPP. This encouraged the regions to adopt their own regional PPP legislation. As of March 2012, over 50 regions out of 83 have adopted regional PPP legislation.
In addition, a series of amendments to the federal legislation aimed at further strengthening and developing PPP in Russia is currently under discussion. It is expected that the Federal Law On PPP will be adopted during 2012.
The procurement/tender procedure is regulated by statute for a few PPP forms and differs depending on the PPP form:
Concession agreements. Conclusion of concession agreements is based on a tender with pre-selection (that is, before the bids are analysed, the bidders' qualification is verified). Standard concession agreement patterns for certain facilities (for example, transport facilities) require federal government approval.
State orders. Placement of state orders is usually based on bidding (although other processes can also apply). The procedure for bidding is regulated by law and each bidding stage, including the time lines, is regulated in detail. The bidding process includes:
publication of an invitation to bid;
submission of bids by the bidders;
consideration, evaluation and comparison of the bids;
selection of the winner.
Production sharing agreements. A special tender procedure, usually an auction, exists in relation to conclusion of production sharing agreements. However, this form is now not used in practice.
Some Russian regions' laws also include rules governing tenders for the right to conclude PPP agreements.
The tender procedure is currently controversial and disputable in practice. This is because certain different laws establish inconsistent and separate rules for tendering, for example in relation to land procurement.
The majority of disputes are settled in state arbitration courts.
If the contract includes commercial arbitration clauses, disputes between the parties are referred to the appropriate court of arbitration (see below, Courts and arbitration organisations). The arbitration court's decision is binding and can generally only be challenged in state court on procedural grounds.
There are no special courts to deal with construction disputes. These disputes are usually resolved by state arbitration courts.
Foreign parties often establish a contractual clause requiring adjudication in an arbitration court of the International Chamber of Commerce (ICC), the International Commercial Arbitration Court (ICAC) at the Chamber of Commerce and Industry of the Russian Federation or other international arbitration institutions.
For more information on arbitral institutions, including the ICC, see Practice note, A quick guide to the rules of the leading arbitral institutions (www.practicallaw.com/3-381-8450).
In 2010, the Federal Law "On Alternative Dispute Resolution Process Involving a Mediator (Mediation)" came into force and appropriate changes were made to the Arbitration Procedural Code. In particular, mediators can now be engaged in resolving disputes even if the Court of Arbitration has already begun the trial. The main purpose of the law is to offer a fast and convenient method for resolving disputes, which is flexible and ensures that enforceable decisions can be made during mediation to save costs.
VAT on transfer (sale) of real estate generally applies at 18%. No other transfer or turnover taxes apply to the transfer of real estate except for nominal stamp duties and profits tax charged at 20% on any realised gain.
Sale of land plots is VAT exempt.
Special rules exist on VAT calculation in cases of investment agreements, construction funded with the developer's own resources and other specific types of agreement.
Developers face a considerable amount of input VAT during construction, which can be refunded on completion. The Russian Tax Code allows developers to recover the difference between input and output VAT in cash. However, the tax authorities tend to refund large amounts of input VAT only through a court order (that is, litigation is required).
Recently, though, improvement has been seen in this area with many clients reporting increased chances of getting refund in cash without litigation.
Many double taxation treaties (DTTs) signed by Russia establish a period within which a construction site cannot be deemed to be a permanent establishment of the developer. Income tax is not due during this period. However, the conditions for application of tax benefits under the relevant DTT should be carefully reviewed, as the Russian tax authorities' practice tends to challenge the application of these tax privileges.
Interest deduction for loans is limited to:
For foreign currency loans: 0.8 times the Central Bank rate. Based on the current Central Bank rate of 8% per year, the interest deduction is effectively limited to 6.4% per year.
Rouble loans: 1.8 times the Central Bank rate. Based on the current Central Bank rate of 8% per year, the interest deduction is effectively limited to 14.4% per year.
The Central Bank rate is determined at the date of receipt of the borrowed funds (for borrowings establishing a fixed rate for the duration of the loan) or at the date of interest deduction (for other borrowings). Certain DTTs allow for unlimited deduction of interest as long as it is at arm's length.
Russia also has thin capitalisation rules. These apply to Russian companies with direct or indirect foreign ownership exceeding 20% of the Russian company's capital. For these companies, deduction of interest is restricted on loans either:
Received from its direct or indirect foreign parent or Russian affiliated companies of its parent.
Guaranteed by such a parent or Russian affiliated company.
In this case, deduction of interest arising under controlled loans is restricted if the loan exceeds three times the borrower's net assets (or 12.5 times for leasing companies), calculated according to Russian accounting rules. The interest exceeding these limitations is reclassified as dividends for profits tax (withholding tax) purposes.
Historically, courts granted protection against thin capitalisation rules under various interpretations of DTTs' provisions. However, in a recent landmark case the Supreme Commercial Court ruled that non-discrimination provisions as well as other DTT provisions do not prevent domestic anti-abuse regulations, including thin capitalisation rules, to apply (for example, Resolution of the Supreme Commercial Court No. 8654/11 dated 15 November 2011 (Severny Kuzbass case)). In another recent case the cassation court upheld extension of the rules to loans from a sister company (that are technically out of the scope of the rules due to their wording) based on the general argumentation that the arrangements had a conduit nature (for example, Resolution of the Federal Commercial Court for the Moscow District No. A40-1164/11-99-7 dated 27 February 2012). The overall trend of courts to scrutinise transactions under the substance over form approach could jeopardise use of various intercompany arrangements aimed at avoiding the thin capitalisation rules exposure. Based on the mentioned case law developments compliance with the thin capitalisation is going to become an issue to consider in structuring financing for the projects.
The following methods are commonly used to mitigate tax liability:
Establishment and use of a special purpose foreign legal entity (SPV) in a jurisdiction, with which Russia has signed a DTT. This SPV acts as a parent (holding) company of the Russian developing company. In the case of exit from the project, the shares in the Russian developer or the shares in the SPV itself can be sold, allowing the avoidance of Russian tax on realised capital gains.
The use of internal borrowing to increase the additional tax-deductible interest expenses (see Question 34).
The construction and use of real estate through a branch of a foreign company having a permanent establishment in Russia. This avoids Russian withholding tax on distribution of profits out of Russia, limitations on distributions of the originally invested capital as well as technically exempting the foreign company from Russian thin capitalisation rules.
There are a number of regional investment incentives that allow for reduced profits tax and reduced property tax rates for investors providing capital investment in selected industries and /or above certain thresholds on amounts.
Costs of land regeneration and environmental protection reduce profits tax base.
Since 2010, companies that perform design and construction no longer need to be licensed in Russia. Currently, these companies must become members of an SRO and obtain a Certificate of Admission to perform the relevant works (see Question 20). This applies equally to both Russian and foreign companies.
Real estate construction is generally regulated by national legislation. In particular, this greatly affects the application of the FIDIC model contracts, which are subject to material adaptation and adjustment.
In addition, the rules for employing foreign and Russian workers must be complied with (see Question 23).
The current legislation on construction and projects may be affected by the overall reform of the civil law, which is now under discussion. This includes significant amendments to the Civil Code, for example in terms of rights to land plots for construction, authorised construction and the rights to real estate facilities under construction.
A substantial reform of the land and town-planning legislation is currently being considered as well. The proposed changes include limiting opportunities to get title to public land with tender procedure. However, a few exceptions are expected including:
Allocation of land for, for example, social and cultural facilities by decision of the Federal President or the Federal Government.
Obtaining title to the land plot by the owner of a registered facility located on that land plot.
Provision of a land plot instead of a land plot withdrawn for public needs, and so on.
The changes are also aimed at distributing duties more clearly between authorities responsible for land formation and for town-planning regulation.
Lawmakers are discussing the opportunity to use design documents for construction, that have passed examination in the EU, for use in Russia without local examination, thus avoiding double examination.
Finally, the laws regulating PPPs are under discussion for amendment, for example, to increase investment attractiveness of PPP projects.
Main activities. This has executive authority in relation to industrial safety, atmospheric protection and environmental expert checks.
W www.gosnadzor.ru/osnovnaya_deyatelnost_gosudarstvennyi_stroitelnyi_nadzor_sro_reestr (website in Russian only)
Main activities. This is an example of an accredited self-regulating organisation (SRO) in the construction industry. (There are more than 230 accredited SROs in the construction industry, more than 160 accredited SROs in the design industry and 28 accredited SROs in the civil engineer surveyors industry.)
W www.sro-mas.ru (website in Russian only)
T +7 495 287 4444
F +7 495 287 4445
E vitaly.mozharowski@gblplaw.com
W www.gblplaw.com
Qualified. Russia, 1997
Areas of practice. Real estate and construction; investment projects.
Recent transactions
T +7 495 287 4444
F +7 495 287 4445
E inna.firsova@gblplaw.com
W www.gblplaw.com
Qualified. Russia, 2004
Areas of practice. Real estate and construction.
Recent transactions
