Moscow Musings: The Future of Offshore
Nicholas Davies, Partner, Hong Kong, reflects on a recent trip to Russia.
I've recently returned to Hong Kong after an excellent trip to Moscow. Below I've set out some thoughts on the future role for well-regulated offshore financial centres, in particular BVI, Bermuda, Cayman and the Crown Dependencies - in international business involving Russian companies.
After a week meeting old and new contacts across the legal, banking and business sectors in Moscow, i found that talk was generally of 'cautious optimism' and an embrace by the Russian business community of the 'new normal'; very different sentiment from my last business visit a year ago. Clearly the EU and US sanctions have taken their toll, both on the sanctioned entities themselves that are unable to raise international funds, or, in the energy space, where they seek international partners or investment to develop key technology or exploit certain resources, and also, indirectly, on the Russian economy more generally.
However, the indirect effect of the sanctions that effectively deterred international banks or investors from dealing with Russian business generally appears now to have lessened. Indeed, Russian debt capital markets have been the success story of the year, with investors hungry for emerging markets yield and certain Russian corporates and (non-sanctioned) banks having an increasingly attractive financial story to sell. There are even signs of activity in the equity space.
The economic backdrop, while clearly still far from good and nowhere near the levels seen pre-2014, and impacted by the low oil price as much as the sanctions-effect, is not without its positives. Perceived cheap valuations are attracting international investment, while on the flip-side, cash-rich businesses that earn in dollars and have the bulk of their costs in the roubles - and many such companies have taken advantage of economic circumstances to de-leverage - are now looking to put their resources into play. Although much depleted, the Russian government still has significant strategic reserves at its disposal, that continue to be put to use in stimulating economic activity.
A consequence of the effect of sanctions, and the need for continued international investment and support, has been the increasing realization of the 'Asia pivot'. There has been a great deal of talk of this, at both political and commercial levels, over the last few years. However, there now seem to be increased, and sustained, levels of investment and financing activity not only between Russian and Chinese businesses and banks, but throughout the Asian region. Certain Russian businesses are looking again at tapping Asian liquidity, especially through debt or equity offerings in the region and Chinese and other Asian banks are playing an increasingly important role in financing Russian businesses (commonly alongside some or all of the big three Russian financial institutions, which now dominate the Russian finance market).
As everywhere, 'Fintech' is a buzz-word in Moscow corporate and finance circles. We had lots of conversations around crypto-currencies, ICOs and financial innovation. This will be an exciting area to watch in this market in the coming years.
'De-offshorization' is still a hot topic, though less so than in previous years as businesses adjust to the CFC rules and their related reporting requirements, having largely rationalized existing international asset holding and financing structures. It is absolutely appropriate for the Russian government to seek to understand the international holdings of its corporate and individual tax residents and, where 'mind and management' is in-fact in Russia, to tax those accordingly. This is nothing new in the international context, and it seems to me that there is now more confidence in the reporting regime and - notwithstanding wider concerns in some quarters as to providing the authorities with sensitive business information - a willingness to declare international structures and have them taxed as Russian resident where appropriate.
What does this mean for offshore?
Clearly there isn't the volume of international business generally, or the use of offshore vehicles, that there was in the 2000 - 2014 period. I very much doubt those days will ever return. However, in the new normal, well-regulated and increasingly transparent international finance centres continue to have a key role to play in facilitating international transactions and fundraising involving Russian businesses. Why? Tax neutrality helps - and by 'neutral' I mean that no additional taxes are imposed at the offshore level; offshore structures are not intended to facilitate the avoidance of taxes that are legitimately due in home jurisdictions, and where control is exercised in Russia or by Russian tax residents they will be reportable and taxable. Of more importance in my view, and especially in the Russia context, is the range and flexibility of products on offer (and the evolving and often innovative statutory framework that facilitates them), legal certainty, familiarity, and, importantly, the provision of a neutral playing field that both Russian businesses and their international counterparts or investors are comfortable with. The strength of the offshore product shines through particularly where business is being done with Chinese or other Asian counterparts, where the use of offshore jurisdictions to facilitate cross-border business or international fundraisings is commonplace.
Of course, this is not to say that all is good and we in the offshore world can afford to be complacent as regards Russian business. As ever, doing business in Russia can be difficult and requires enhanced due diligence - including on the part of offshore service providers - and advisers with deep knowledge of the Russian market. The Russian economy remains in difficult waters, and, notwithstanding the generally-bullish sentiment, the effect of the anticipated new wave of US sanctions - and the geopolitical situation more generally - remains to be seen.
We also shouldn't kid ourselves that offshore jurisdictions haven't suffered reputational damage which, even where unfair, needs to be countered by having experts visiting Russia regularly and outlining the continued benefits that offshore centres bring to international transactions. This extends to explaining the very considerable steps that have been taken to ensure that leading offshore jurisdictions are at the forefront of international efforts to increase transparency and governmental information exchange, with the recent introduction of beneficial ownership information regimes in both BVI and Cayman being testament to this. The world has changed and, as elsewhere, legitimate Russian business will welcome these advancements.
On a related note, all of the key offshore jurisdictions remain on the Russian Ministry of Finance 'blacklist', a list of around 40 countries which extends to each of the key offshore jurisdictions, as well as certain 'midshores' such as Hong Kong. The list is maintained in connection with the Russian dividends taxation regime (with dividends received in Russia from entities established in such jurisdictions ineligible for zero-rating), as well as restricting access to state budget funds. However, legislation amending the Russian privatization and strategic industry regimes that came into force this month refers to this list in determining jurisdictions that may not participate in certain transactions. This might change as the legislation involves, not least in light of what follows, and arguably does not preclude holding a minority, non-controlling stake through an offshore entity, but is an area of concern from the offshore perspective that needs careful navigation where relevant. On the plus side, Bermuda, BVI, the Cayman Islands and Mauritius have all been removed from a blacklist of over 100 countries maintained by the Russian Federal Tax Service that are deemed as not sharing sufficient tax information with the Russian authorities, and which is relevant in determining tax liabilities under the CFC regime.
We are very unlikely to see a return to the volumes of corporate business involving Russia seen by offshore finance centres in the past. In my view, this is not necessarily a bad thing. Where we will continue to see offshore jurisdictions used is in the facilitation of often complicated, bespoke, cross-border investment, joint venture activity and fund raising, a sweet spot for the likes of Bermuda, BVI, Cayman and the Crown Dependencies.