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Moscow Times
March 15, 2006
Foreign Pay Pitfalls Loom Large at Tax Time
By Kathrina Szymborski
Special to The Moscow Times

Navigating the Russian tax system can seem like tricky business, especially for expatriates or new tax residents. With the deadline for individual tax filing fast approaching, one question looms large for foreigners living in Russia: what about income received from abroad?

Anyone who spent more than 182 days in Russia last year is considered a tax resident, and is expected to declare worldwide income here by April 30, 2006. While Russian companies generally withhold their employees' taxes directly from income, foreign companies have no such obligation. As a result, the responsibility of declaring these earnings for tax purposes falls on individuals' shoulders.

"If you happen to be receiving payment from an individual or company which is not required under Russian law to exercise withholding, the mechanism for paying any tax you owe is by filing a personal tax return," said Peter Reinhardt, a partner at Ernst & Young Tax Services.

The standard declaration forms can be obtained from the offices of the Moscow Tax Inspectorate or downloaded from the inspectorate's web site. Foreign nationals should include a photocopy of all pages of their passports with their tax returns in order to verify tax resident status and a separate form, called the 2-NDFL, indicating income paid from within Russia. Legally, there is no need to provide proof of payments received from abroad.

"You're not obliged at the time of filing your tax return to give any documents confirming income received outside Russia," Reinhardt said. "The basic underlying premise in the Russian tax code, just like in many other countries, is that it's on the honors system, so you are supposed to be believed as telling the truth unless you are selected for audit."

Although the law does not stipulate the need for documentation confirming foreign-source payments, Dinar Akhmetov, a tax consultant at ExpatCPA, warned that procedure does not always follow policy.

"Local tax bodies like to elaborate local regulations and instructions and demand that they must be observed, even if they are not officially published," he said. If you are asked to confirm income received abroad, a simple statement issued by your foreign employer summarizing your foreign earnings, translated, signed and stamped, should suffice, he added.

Svetlana Meyer, director of tax and legal services at Deloitte, agreed. "Tax authorities generally request documents confirming income," she said. "They may request a statement of earnings from the employer, pay slips, employment contracts. In most cases, a statement of earnings from the employer is sufficient."

If an audit is initiated and the requested documents are not presented by the taxpayer, tax authorities might attempt to impose a fine, Meyer said.

"The fine depends on the quantity of nonsubmitted documents, and it will be a difficult task to establish how many of them should be submitted," she said. "In practice, it is better to have supporting documents to save time and avoid unpleasant communications with the tax authorities."

Akhmetov cautioned foreigners who are Russian tax residents to check that the tax rate used for them by their Russian employers is, in fact, 13 percent, not the 30 percent rate used for non-tax residents who are taxed here only on their Russian-source income.

"Sometimes employers forget to change expatriates' tax rate from 30 percent to 13 percent when the number of 'Russian days' exceeds 182," he said. "Some expatriate employees do not pay attention to the tax rate and take their 30 percent rate for granted."

Such issues have become pertinent to an increasing number of foreigners, as Russia's low 13 percent rate, introduced in 2001, has made it an attractive place to declare worldwide income.

"What we're seeing is tax planning revolving around not trying to avoid Russian tax, not trying to defer income for tax purposes," Reinhardt said. "It's just the opposite. People are trying to spend at least 183 days here so they can pay the 13 percent rate, receiving their income now rather than later, because if they defer income for two or three more years under various tax planning structures, they don't know what rate will be applicable at that time. If it'll change, it'll probably change upwards."

Although the low rate is undoubtedly alluring, the Russian tax system as a whole can prove thorny for those unfamiliar with its structure.

"The system can be deceptive," Reinhardt said. "The forms you have to fill in, the whole process of filing and, in particular, the process of making payments is not simple at all."

The simple structure of the laws themselves can make for complicated tax filing, especially when confronted with an issue that is not specifically addressed in the tax code.

"Russia has a relatively simple set of tax laws," Reinhardt said. "Sometimes that's a good thing, but sometimes that's a bad thing, when you have to find the answer to an unusual question. There are many gaps and gray areas."

In such situations, "you have to rely on the general principles on taxation that are in there and try to find an analogous situation," he said.

Thus, anyone declaring worldwide income in Russia this year is advised to contact a professional.

"Use a tax consultant," Akhmetov said. "It will save you money and make your life easier."