Changes in the tax landscape for IT market participants: what new benefits will appear and which ones will go away?
From January 1, 2021, legislative changes regarding the taxation for IT companies’ activities will come into force. The main criterion for applying new VAT exemptions is the inclusion of software and databases, the subject of the transaction, in the unified register of Russian programs for electronic computers and databases.
At the same time, if using license agreements, there is already a VAT exemption for software and database sales. The IT exemptions don’t just apply to VAT—from 2021, IT companies meeting the criteria specified in the law are eligible for reduced profit tax and social contribution rates. Read more about the opportunities for IT companies to reduce their tax burden, as well as the negative impact of changes on other market participants, in the articles in Russian (links below).
In December 2016, Russian President Vladimir Putin, in his message to the Federal Assembly, proposed launching a program for economic development towards its transition to digitalization. The industry has shown positive dynamics in recent years, and a significant part of B2G transactions were digitized by the Federal Tax Service of Russia. It is not planned to stop there, but we still cannot claim any radical changes in the structure of the Russian economy.
The temporary suspension and difficulty of regular business activities during the pandemic naturally affected the performance of all companies, including IT companies. At the same time, in 2020, the state authorities again started talking about the need to develop the IT sector. The idea arose to carry out a “tax maneuver” – a set of fiscal measures to provide additional incentives to a certain category of taxpayers.
A NEW FEDERAL LAW
Considering the consequences of changes in VAT, it is worth taking into account the role of the company in the transaction, taxation specifics, and to consider whether the company applies the general taxation system, enjoys special tax treatments, or is a resident of special tax zones and territories.
It is equally important to understand which software and databases can be included in the Software and Database Registry, as well as how to do it. For example, according to the Decree of the RF Government of 16.11.2015 No. 1236 “On the establishment of a ban on the admission of software originating from foreign countries for the purpose of procurement to meet state and municipal needs”, the Software and Database Registry includes information about programs, the exclusive rights to which belong to Russian commercial companies with a total direct or indirect share of RF citizens greater than 50%, worldwide for the entire duration of the exclusive rights. This condition significantly narrows the circle of entities which can include their developments in the Software and Database Registry and claim VAT exemption without any additional efforts, which, from the point of view of the FTS (Federal Tax Service of Russia), can be considered as operations aimed at obtaining unjustified tax benefits. In particular, we are talking about foreign subsidiaries, which are 50% or more owned by foreign citizens or legal entities.
Transactions involving software and databases that are not included in the Software and Database Registry will have the following consequences:
- for buyers, if they are VAT payers, the amount of VAT deductible will increase by 20% of the cost of the software and database they purchase
- for buyers who enjoy special tax treatments, implying that the company is not a VAT payer, the costs will increase by 20% of the cost of the software and databases they purchase
- for individual buyers, the final cost of software and databases may increase by 20%
- the seller has the opportunity to deduct the input VAT, if he pays it
Thus, the tax burden on VAT is largely shifted to those who purchase programs that are not in the Software and Database Registry, including cost increases, as well as additional burdens associated with the need to fulfill the duties of a tax agent in foreign trade transactions (for example, when programs are purchased from foreign IT giants or developers of specialized programs that have no competitive counterparts in the Russian market).
Regarding the programs included in the Software and Database Registry, more favorable conditions arise when software and databases are sold for export, as this generally meets the main goal of the tax maneuver—to support and stimulate domestic IT companies with the possibility of VAT reimbursement.
In the new version of this norm, there is no mention of a license agreement, which removes some of the questions. During the world IT industry development, various models of software and database sales and options for providing access to them have been developed which do not always imply sales or provision under a license. In a direct reading, the new wording does not restrict the use of “software-as-a-service”.
A special procedure is provided for the transfer of rights to use software and databases that allow you to distribute advertising on the Internet or get access to it, post offers in the Internet for the purchase or sale of goods, works, services and property rights, look for information about potential buyers and sellers, or conduct transactions. They will not be exempt in any case, unless the company applies special tax regimes. Online marketplaces are a good example of this. Nevertheless, the broad wording makes it doubtful. Platforms for the exchange of trade and labor offers and offers for the provision of services by the self-employed and small entrepreneurs do not exist in isolation. Such solutions may also require additional programs and information systems, which indirectly also allow distributing advertising and performing other tasks. Moreover, such service applications and information systems can be used simultaneously in other software and databases that are created to solve problems which are subject for such exemptions. This is not about the fact that the legislator purposefully left space for additional taxation of a wider range of developers and software owners that provide data exchange on the Web. The risk is seen in the arbitrary interpretation of this point by representatives of local tax authorities, since during the period of economic recovery, Russian regions have been deprived of part of their tax revenues from IT companies.
For the period including the end of 2019 and 2020, purely practical questions arise. For example, it is unclear how to apply VAT on the implementation of prepaid software and databases, which have all the prerequisites for inclusion into the Software and Database Registry, or are already registered there and will be used in 2021. The opposite situation can also occur, when payment for a program that was used in 2020 takes place. It is important to understand how such transactions will be perceived by the tax authorities, which are attentive to the activation of economic entities in anticipation of changes in the tax system that will aggravate the position of taxpayers in the future. It would be logical to assume that you need to focus on the day of shipment. Nevertheless, it is quite possible that the tax authorities will look at this issue differently, defending the interests of the budget.
PROFIT TAX AND SOCIAL CONTRIBUTIONS
The tax maneuver in the IT industry has affected not only VAT. From 2021, companies that meet the criteria listed below are eligible for reduced profit tax and social contribution rates.
Companies applying for these benefits must:
- be accredited as an IT organization
- strictly monitor the ratio of income from different types of activities, since for the application of benefits, the share of income from IT operations at the end of the reporting and tax period is at least 90% of the total income
- employ not less than seven full-time employees.
The following OKVED codes confirming the implementation of activities in the field of IT for the purposes of state accreditation are:
- 62.01 – Computer programming activities
- 63.11.1 – Activities related to the creation and use of databases and information resources
Also, the following OKVED codes can indicate the implementation of activities in the IT field:
- 62.02 – Computer consultancy activities
- 62.02.1 – Computer system planning and design activities
- 62.02.4 – Activities on preparation of computer systems for operation
- 62.03.13 – Activities for support of computer systems
- 62.09 – Activities related to the use of computers and information technology
The composition of income accounted for as income from IT activities includes activities related to software and databases developed by the company, income from which can be accounted as income in the field of information technology:
- sales of software and database samples
- transfer of exclusive rights on software and databases
- granting the rights to use software and databases under license agreements, in particular by providing remote access, including updates and additional functionalities, via the Internet
- services or work on installation, testing and maintenance of software and databases
In relation to software and databases, including those of third parties, in the composition of income there can be incomes from the provision of services or performance of work on:
- adaptation, that is, introducing changes made solely for the purpose of the software and database functioning on specific technical means of the user or under the control of specific user programs
- modifications, where the reworking means any changes, with the exception of software and database adaptation
Companies that meet all the requirements get the opportunity to pay a profit tax of 3% to the federal budget instead of 20%,. In fact, such companies will stop paying profit tax to the regional budget, which may affect the thoroughness of control by territorial tax inspectorates.
As for social contributions, instead of the currently possible aggregate rate of 14% for IT companies, companies that meet all the criteria will be able to pay 7.6%, including:
- 6.0% for compulsory pension insurance
- 1.5% for compulsory social insurance in case of temporary disability and in connection with motherhood
- 0.1% for compulsory health insurance
SPECIAL PROCEDURE FOR APPLICATION OF TAX BENEFITS BY SKOLKOVO RESIDENT COMPANIES
Firstly, Skolkovo resident companies can use the benefits provided for Skolkovo project participants, which are valid for 10 years after obtaining such a status. To use them, the total profit should not exceed RUB 300 million, and the annual revenue should not exceed RUB 1 billion. An IT company has the right to take advantage of VAT exemptions, profit tax exemptions, and pay social contributions at the reduced rate of 14%. Secondly, they can take advantage of the benefits foreseen within the frame of the IT maneuver.
There is also a third option. In accordance with the clarifications provided in the letter of the RF Ministry of Finance dated 28.09.2020 № 03-03-10/84983, which was sent through the tax authorities by the letter of the Federal Tax Service of Russia dated 29.10.2020 № СД-4-3/17736@, Skolkovo project participants can combine the benefits provided by the Skolkovo project and the tax maneuver in the IT industry. For example, simultaneously taking advantage of the exemption from profit tax and VAT under the rules for the Skolkovo project participants and reduced tariffs on social contributions, which will be in effect from 2021. Despite this, the attractiveness of special economic zones may decrease.
IT MANEUVER IN GROUPS OF COMPANIES
In general, the changes affect only one business entity and, with the exception of innovations in terms of VAT, they cannot have a significant impact on software and database consumers. Nevertheless, these changes create the basis for new disputes about the legitimacy of some options for structuring business activities.
So, if we talk about international groups of companies, then quite often there are situations when certain functions, consisting in providing the main activity, are separated into different legal entities specializing in the provision of intragroup services. At the same time, the groups in which such specialization of subsidiaries takes place may belong to any industry. For example, in the automotive industry, where recently there has been an interest in computer technology due to the fact that modern cars are gradually becoming part of the Internet of things. There are other examples of industries where it makes sense to create a special IT competency center serving the entire group and sometimes external users.
It is quite logical, from the point of view of an entrepreneur, to take advantage of the opportunity provided by the law. There may be an increase in the number of newly created companies that are set up specifically to get tax savings. Nevertheless, the practice of recent years suggests that this is associated with very specific risks. This preferential tax regime does not differ much in its content from other special tax regimes that create more favorable conditions. By motivating the setup of a new legal entity and the allocation of such activities only by the right to use tax benefits, entrepreneurs run the risk of facing accusations of splitting up the business and receiving unjustified tax benefits. Such transformations should be determined by a certain business goal and to a certain extent be isolated from the activities of the rest of the group, which may not always be possible in the case of international groups of companies, when the goal is precisely to increase the internal efficiency of support and development of the activities of other companies of the groups, and not to make a profit in general.
The number of applications to be accredited as IT companies has been increasing. It is associated by many with the growth of trust in the state. Some claim that this is due precisely to the intention of businesses to take advantage of the tax maneuver, or at least insure themselves and provide access to support measures, given the rather formal approach that tax officials followed during the peak of the pandemic last summer.
Still, it should be considered that to avoid claims, it is necessary not only to follow the formal requirements of the law, but also to be ready to justify the business purpose in particular. Otherwise, there is the risk of a significant tax burden increase as a result of tax base recalculation to the level of the general taxation system.
Thus, considering the above, we can agree with the statements of many representatives of IT companies that this package of tax measures violates their stability, and also creates negative consequences for consumers of software products, which does not correspond to the goal of stimulating the IT industry. Nevertheless, the initiative is generally positive for those companies that work for export, as the ability to deduct the input VAT should increase their financial stability. At the same time, the tax maneuver does not create opportunities for an increase in demand for exported software. This makes the change generally neutral for these companies.
Setting up new companies and meeting all the requirements for applying the benefits of profit tax and social contributions can be burdensome for businesses, which effectively prevents them from using them.
Major changes for IT companies:
- VAT exemption will apply only to software and databases included in the Software and Database Registry
- The profit tax rate is reduced from 20 to 3% for accredited IT companies
- Social contributions for accredited IT companies are reduced to 7.6%
- IT companies will not be able to write off expenses for the acquisition of electronic computing equipment lump-sum.