Localization as a form of investment: latest news from the Russian market
The decision to localize a production plant in Russia, or any other country, is always a decision about investment.
Most companies decide to invest in Russia because they have customers in the local market and the conditions for realizing the project are favorable. These conditions are usually understood as: local infrastructure, costs of labor and land, availability of raw resources and components, and additional benefits such as subsidies. Nowadays, subsidies for foreign companies have become a beneficial instrument for both enterprises and the government.
For enterprises, Russia’s so-called “long-cheap money” is usually necessary for the project’s starting budget and can be invested directly, for example in infrastructure development or equipment. The Russian government uses subsidies as a support instrument for investors in order to boost the budget of projects and help itself by developing a future manufacturer that will pay tax, create employment, develop new technologies and, of course, produce goods.
Statistics, figures, industries and benefits
In 2020 foreign companies invested in 107 industrial projects in Russia, which now holds 11th place in the investment climate rating among European countries. However, it is difficult to analyze these numbers because of the crises raised by the coronavirus in 2020. Already in the first half of 2021, investment grew by 30% compared to 2020. In 2020 the main investment sectors were mining and quarrying (24%), manufacturing (21%) and wholesale and retail trade (including repair of motor vehicles) at 15,7%. The fact that the manufacturing industry took second place as one of the most invested-in sectors of the Russian economy should indicate two important messages to foreign businesses:
- It is a good time to invest in the Russian manufacturing sector
- The Russian manufacturing industry is in high need of technological innovation
Looking into the details, from approximately $10 billion of foreign investment, $3,5 billion was invested in the automotive industry, $1,15 billion in the food sector and $0,8 billion each in wood processing and the production of rubber and plastic products.
Russian government support: flexibility and accommodating business requirements
In recent years, the Russian government has continued to actively expand the list of tools available to support investors, balancing its own interests and the interests of business. Improving the investment climate in the country is an important task.
Since 2015, it has been possible to observe new approaches to stimulating investments in the production sector using SPIC 1.0 (Special Investment Contract, under which the investor undertakes to implement an investment project that meets certain criteria, and the state provides various incentives for implementation and tax benefits). An evolving SPIC 2.0 version introduced in 2019 focuses on technology as a driver of economic growth (a mandatory condition is the introduction of modern technology that makes it possible to produce products that are globally competitive).
SPIC 2.0 has a number of significant differences. An emphasis is placed on innovation, competitive selection is introduced, the period is increased from 10 to 15 years (and under a number of conditions up to 20 years), and it can be used both for the introduction of new technology from scratch and for the localization of foreign developments. The predecessor SPIC 1.0 had a high minimum entry threshold for investments - from 750 million rubles and a period of up to 10 years. Now the minimum threshold has been eliminated, making the SPIC 2.0 instrument open to a wider range of investors. The automotive industry, chemicals sector, pharmaceuticals, and most of all engineering use special investment contracts.
Investment protection and promotion agreement (IPPA) will increase the attractiveness and predictability of the economy for investors
In November 2019, the Government of the Russian Federation submitted to the State Duma a package of draft laws on the IPPA (Investment Protection and Promotion Agreement), called SZPK in Russia. The draft legislation was discussed for a long time both within the government and with businesses, and as a result underwent very significant changes. On April 1, 2020, Federal Law No. 69-FZ "On the Protection and Promotion of Investment in the Russian Federation" was issued. In October 2020, two Decrees of the Government of the Russian Federation (No. 1577 dated October 1, 2020 and No. 1599 dated October 3, 2020) governing the rules for concluding the IPPA and the procedure for granting subsidies were added from the federal budget. Accordingly, from October 2020 it became possible to conclude the IPPA/SZPK.
What is IPPA?
IPPA is an agreement between a business and the state, in accordance with which the business undertakes to implement an investment project on the territory of the Russian Federation and the state undertakes to ensure the stability of conditions for investment activity and its stimulation.
Unlike SPIC, which can only be used by manufacturing sectors, IPPA makes it possible to implement an investment project in any sector of the economy, including IT, except for the gambling industry, trade, and the construction of administrative and business centers, shopping centers, and residential buildings. At the conclusion of the IPPA, a tender is not required. The procedure for concluding the agreement is declarative.
For many projects, co-financing of infrastructure will also be an advantage. The agreement guarantees the provision of subsidies and other measures of state support, including the creation of infrastructure. A special guarantee is provided for the construction of transport infrastructure.
It’s possible to include a condition in the agreement stipulating that a public law entity will not implement a public investment project for the construction of transport infrastructure if it could negatively affect the financial performance of a similar project implemented within the IPPA.
One of the important points is also the presence of a stabilization clause with a differentiated approach, which confirms that acts or decisions that negatively affect conditions for conducting activities related to the implementation of this project, determined at the time of the conclusion of the IPPA, will not be applied to an organization implementing an investment project.
What does the stabilization clause mean in practice?
In practice, we often encounter, for example, the emergence of acts and decisions that increase the time required for the implementation of the project, establish additional prohibitions or requirements, increase the amount of payments, change the procedure for granting land plots, etc.
Thus, the stabilization clause makes the economics of the project more predictable and stable for the investor. The term of application of the stabilization clause is determined by the volume of investment in the project, excluding funds received from the budgetary system of the Russian Federation. For amounts less than 5 billion rubles, the term of the stabilization clause is 6 years. For investments from 5 to 10 billion, the term of the stabilization clause will be 15 years, but if the volume of capital investments is greater than or equal to 10 billion, the project will receive a maximum stabilization clause term of 20 years.
The IPPA also provides for the possibility of recovering losses from a public-law entity of the Russian Federation in case of violation of its terms.
The IPPA may include the terms of a related contract. In this case, if a public-law entity violates the terms or volumes of subsidies or changes the parameters for calculating prices (tariffs) of natural monopolies, then it will be obliged to provide compensation.
Guarantees and infrastructure
Unlike classic investment agreements, IPPA provides for a guarantee of compensation for real damage if the subsidy is not provided on time or in the wrong amount, or is not provided at all.
In addition to guarantees in relation to related contracts, the organization implementing the project can also be allocated other measures of state support in the form of reimbursable costs, such as: for the construction or reconstruction of supporting or related infrastructure, which may be in public ownership, and for the payment of interest on loans and coupon income on bonds raised for the creation and reconstruction of infrastructure.
The maximum volume of reimbursable costs is not more than 50% of the actual costs incurred for the supporting infrastructure (transport, energy, utilities, digital and social infrastructure used exclusively for the purposes of the project) with a maximum reimbursement period of 5 years and 100% of the actual costs incurred for related infrastructure (such infrastructure can be used not just for the purposes of the project and can be transferred to the ownership of a public-law entity of the Russian Federation) with a maximum compensation period of 10 years.
The maximum amount of reimbursable costs and reimbursable real damage, if there are grounds, may not exceed the amount of taxes and mandatory payments paid within the framework of the project.
As the mechanism is used in practice, proposals for its improvement and refinement naturally arise. Thus, already in 2021, a number of changes have been made. The most interesting of these are related to the expanded list of economic spheres for which the IPPA is applicable, as well as the possibility of implementing a project and concluding a private initiative of the IPPA by several organizations that can conclude an agreement with each other on the delineation of responsibilities and the allocation of costs for the creation, modernization and reconstruction of the supporting and related infrastructure necessary for the implementation of several investment projects.
Also, under consideration are possible changes related to the taxation of IPPA participants. One of these provides for the introduction of a tax deduction mechanism for a number of taxes for IPPA participants as an alternative way to reimburse the costs incurred in the framework of the investment project.
The transformation of the business climate in Russia makes it possible to conduct a productive dialogue between businesses and the federal and regional levels of the Russian Federation. Depending on the needs of the project, it is possible to achieve substantial support and additional individual conditions for the implementation of an investment project using various mechanisms.
As an example, we can cite a company engaged in the production of building materials, already present in the Russian Federation, but planning to build the third and largest site in the Russian Federation. Two main points are important for the company - the availability of a railway and cheap electricity. The specific nature of manufacturing the product is such that the transportation of components is 80% by rail, and a significant part of the cost of production is occupied by electricity. Thus, the company is considering the possibility of reconstructing the existing unused railway for its own needs to deliver components directly to the production site, as well as building an electrical substation, which, within the framework of a dialogue with the state, will allow the project to receive cheap electricity.
The state and the regions are willing to negotiate, and reliable providers are able to help you choose the most suitable region that meets your requirements, then calculate and help to obtain maximum support.
It is important to have detailed information on terms and conditions. When preparing the IPPA, for example, it is also important to be especially careful about the choice of measures that will be included in the stabilization clause, since the grounds for changing the IPPA are limited.
Forecast for 2022
Today we can say that localization processes in Russia in the last 5 years have changed for the better for both sides: business and government. Even more importantly, cooperation between these two parties has become a constant dialog. It is also clear that this positive dynamic will become more established and develop new instruments and structures in order to make the investment climate more favorable.
Moreover, in the coming years governmental institutes will elaborate new instruments for the development of already localized companies in order to make it possible to expand their businesses. Already today we see that foreign localized companies are opening new production plants in Russia. Such a new approach – to work on the investment climate for companies new to the Russian market and develop producers already operating in Russia – will provide stable growth in the Russian production industry.
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