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Russian Currency Control Aspects of Cross-Border Leasing Transactions



04.07.2002Debevoise & Plimpton LLC
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This article is one in a series of reports on leasing in Russia, written by Dmitry K. Gladkov, associate of Debevoise & Plimpton LLC, Moscow, with assistance of Edita V. Luchits. Debevoise & Plimpton LLC may be contacted in Moscow by telephone at (7 095) – 956-3858 and by fax at (7 095) – 956-3868, e-mail: dkgladkov@debevoise.com

A foreign company (a “Lessor”) having no presence in the Russian Federation (“RF”) which is considering international leasing operations with a Russian lessee, should be aware of certain currency control requirements under Russian legislation that may significantly complicate the execution of such transactions.

The purpose of this article is to describe the relevant currency control requirements and to evaluate potential compliance issues.

Hard Currency Rental Payments as “Capital Operations” under Currency Control Law; Leasing Law Exemption

Under Article 1.10(e) of the RF Law on Currency Regulation and Currency Control (“Currency Control Law”), all payments by a Russian lessee in foreign currency under an international leasing agreement are deemed operations connected with the movement of capital (“capital operations (This is mostly because the leasing transaction does not qualify the "current currency operations" and thus, falls within the sweeping provision of Article 1.10(e) of the Currency Control Law which defines "capital operations" as "all other currency operations which are not current currency operations.") ”). In order to conduct capital operations, a Russian lessee must obtain prior permission of the RF Central Bank (“CBR Permission”), unless otherwise determined by the Central Bank (“CBR (Article 6.2 of the Currency Control Law.) ”). Without CBR Permission, none of the banks operating in Russia would permit the transfer of rental payments in foreign currency to a lessor located abroad. If a bank did permit such operations, currency control sanctions could be imposed upon a lessee at any time. Although the procedure for obtaining CBR Permission is not overly complicated, it is very time- and labor-intensive, sometimes taking several months.

The Law of the Russian Federation on Leasing (“Leasing Law”), adopted on October 29, 1998, created an exemption (“Exemption”) from the CBR Permission requirement for some capital operations that are carried on within the scope of international leasing transactions (Article 34 of the Leasing Law.) . Thus, under the Leasing Law, no prior permission of the CBR is required to conduct the following operations:

A lessor resident in Russia is entitled to procure funds from financial entities which are not residents of the RF for the purchase of the object to be leased. The time period for which such funds are procured is limited only by the terms of the leasing contract (Article 34.1 of the Leasing Law. Under the rule established by the Currency Control Law procurement of financing in hard currency for period exceeding 90 days falls into the category of capital operations.) .

A lessor resident in Russia is entitled to pay interest on deferred payments to sellers of objects to be leased by such a lessor.

A lessee resident in Russia is entitled to pay the full amount of rental payments, irrespective of the term of a lease, provided that the first rental payment under the lease is made no later than six months following the putting into operation of the object to be leased (Article 34.3 of the Leasing Law. Article 34 seems to neglect exemption of the leasing transactions providing for the purchase of leased assets by a foreign Lessor in the RF from the CBR Permission requirement.).

The Exemption, along with many other provisions of the Leasing Law, has given rise to many questions. First, some officials of the CBR hastened to declare that the Exemption provision contravened the provisions of the Currency Control Law, according to which only the CBR is entitled to establish the procedure for carrying on capital operations. They also asserted that the CBR did not agree to the Exemption introduced by the Leasing Law. Technically, the Exemption set forth in the Leasing Law is effective and valid since it was introduced by a later legislative act of a special nature. Thus, the CBR officials will have to comply with the provisions of the Leasing Law. However, one cannot but agree with the CBR representatives who argue that the Exemption creates a huge breach in the current currency control regulations which are designed to curb capital flight. As a result, the CBR will have to find ways to seal off this opening.

Second, in the opinion of a number of Russian banks which act as agents of currency control under the Currency Control Law, the Exemption may not be enjoyed unless (i) the Lessor has a Russian leasing license, and (ii) the leasing agreement meets all the requirements established by the Leasing Law. The bankers assert that the Exemption was established by the Leasing Law for leasing transactions which are defined in and which meet the requirements of the Leasing Law. Therefore, a leasing agreement must comply with all the established requirements of the Leasing Law. Otherwise, by operation of Article 16 of that Law, a transaction may not qualify as a leasing agreement under the Leasing Law, and the Exemption will not apply. Admittedly, this is a persuasive argument in support of the bankers’ position.

However, there are weaknesses in the bankers’ arguments. Article 7.1 of the Leasing Law provides that in the case where the title to the object to be leased is held by a non-resident of Russia, an international leasing transaction is regulated by the federal laws for external economic activity. This provision may be used as an argument that general leasing transaction definition and the requirements governing leasing agreements may not be applicable to the international leasing transactions. On the other hand, certain provisions of the Leasing Law specifically apply to international leasing operations (See, e.g., Articles 34.3 and 8.5.), one in particular sets forth the Exemption. The conclusion may be that pursuant to Article 6.1 of the Leasing Law, not all the provisions may apply to the international leasing transactions, unless explicitly spelled by the terms of the provision in question. For example, Article 34.3, which introduces the Exemption, is defined to be applicable to the international leasing.

The leasing licensing requirement, which in the bankers’ opinion is an indispensable condition for the qualification of a transaction as a leasing operation, is based on ambiguous provisions of the Leasing Law. More attentive reading of Article 6 of the Leasing Law suggests that a license is required for leasing activity, while the Exemption from the CBR Permission under Article 34.3 of the Leasing Law can be granted to an international leasing agreement. In addition, Article 34.3 grants the Exemption to lessees, rather than to Lessors, which makes the license requirements absolutely inapplicable.

Even if they accept the above arguments, Russian banks, especially those with an interest in state participation, prefer to take a conservative position to avoid any possible risk of imposition of currency and export control sanctions by the Federal Service of Russia for Currency and Export Control. Therefore, as long as the confusion on this issue exists, one way to prevent complications is to inquire at the lessee’s bank as to the bank’s position on this issue. In the event that the bank takes an overly conservative approach, a lessee may:

apply to the CBR for permission to conduct capital operations, which might mean waiting for several months;

bring a leasing agreement into compliance with provisions of the Leasing Law, and oblige the Lessor to receive a leasing license, thereby exposing the Lessor to the risks associated with formation of a “permanent establishment” for tax purposes;

open a bank account for the leasing transaction with a bank which takes a less conservative view as to the impact of the Currency Control Law; or

make payments to a Lessor in Russian rubles to the Lessor’s ruble account opened with a Russian bank. Current Russian legislation allows foreign companies having no presence in the RF to open accounts with Russian banks and deposit revenues from the sale of goods and services into such accounts (see discussion below (See Instruction No. 16 of the CBR on the Procedure for Opening and Maintaining Non-Residents' Accounts in Currency of the Russian Federation by Authorized Banks of July 16, 1993.) ).

Recent CBR Requirement for Obtaining Approval for Purchase

of Hard Currency to Make Rent Payments in Hard Currency

On December 30, 1999, the CBR took action to help close the opening created by the Leasing Law. The CBR adopted Directive No. 721-U on Purchase by Resident Legal Entities of Foreign Currency for Making Payments for Performance of Work, Provision of Services or Transfer of Results of Intellectual Activity (“Directive No. 721-U”). Pursuant to Directive No. 721-U, in order to pay in foreign currency under a leasing transaction, a lessee must submit a prior application to the Federal Service of Russia for Currency and Export Control (“CEC”). The CEC will then grant approval (“CEC Approval”) for the purchase of hard currency to pay for services rendered by a foreign company in an amount exceeding $10,000. This measure is intended to set up an additional barrier to flight of capital from Russia. Pursuant to the February 10, 2000 Instruction of CEC and CBR, No.03-26/493 and No. 88-I (the “Instruction”), the CEC Approval must be issued within a month following the date of submission of appropriate documents.

Approval Requirement Limited to Finance Leases as Distinct from Operating Leases.

Directive No. 721-U defines “Financial Leasing Services” as a type of service, the payment for which requires the CEC Approval. At the same time, no specific provisions are devoted to operating leasing. These facts may lead a number of Russian banks, those responsible for compliance with Directive No. 721-U, to believe that a CEC Approval is not required in the event that a lessee is going to buy hard currency for making payments under an operating leasing agreement. In our view, such a narrow interpretation of Directive No. 721-U is unfounded because “Rental Services” (arenda) have also been included on the list, and an operating leasing is a transaction that is very similar in most aspects to the Russian “arenda”. The difference in the terminology cannot be sufficient grounds for non-application of Directive No. 721-U to operating leasing.

There are no precedents involving application of Directive No. 721-U and the Instruction, but mere reading of these documents raises many issues. First, it is not clear whether the Approval might serve as a sort of substitution for the CBR Permission for conducting capital operations in the event that payment for services constitutes a capital operation. Both Directive No. 721-U and the Instruction are silent on this issue, although some provisions indicate that Directive No. 721-U might be used for this purpose. For example, Paragraph 5 of Annex 4 of the Instruction mentions using the CBR Permission as a simplified application procedure for obtaining the Approval. However, it does not exempt altogether the Approval requirement.

An applicant may also apply for the Approval without the CBR Permission (as defined above) but the procedure will not be simplified. In this case, the list of required documents does not include the CBR Permission. Many Russian banks accept this interpretation of the Instruction as indication of legal superiority of the Approval over the CBR Permission. In our view such a position is not well-grounded. Approval to acquire hard currency issued by one governmental agency does not necessarily permit transfer of the acquired currency outside Russia. Discretion to permit the latter transaction belongs to a different governmental agency.

Pursuant to the Instruction, the list of documents required for application to the CEC includes a customs declaration (See Paragraph 2.6.6 of the Instruction.). Therefore, in the case of leasing, a lessee evidently will not be able to receive the Approval before the assets have been imported into the RF. This fact creates uncertainty as to the ability of the parties to the transaction to make payments thereunder in hard currency.

Questions arise as to the recourse parties have if the Approval was not issued to a lessee, especially in the event that the assets have been imported into the RF and all applicable taxes and duties have been paid. Among other things, the Instruction provides for appeal of a decision of the CEC to higher offices of currency and export control, and thereafter, to the courts in accordance with current Russian legislation.

Option of Paying Rent in Rubles

An alternative method for foreign Lessors to receive payment on a leasing transaction is to open a ruble account with a Russian bank. Article IV.1.1 of the CBR Instruction No. 16 on the Procedure for Opening and Maintaining Accounts of Non-Residents in the Currency of the Russian Federation by Authorized Banks, dated July 16, 1993 (“Instruction No. 16”) provides that “[p]roceeds from residents for goods supplied to the Russian Federation, as well as for work performed by a non-resident owner of the account (rendered services) may be credited to ruble accounts of type ‘T’ [“current accounts”] and to ruble correspondent accounts of non-resident banks….”. On June 30, 1999, Instruction No. 16 was amended by CBR Directive of June 30, 1999 No. 595-U (“Directive No. 595-U”) to give a right to foreign enterprises, institutions and organizations having the status of a non-resident to open current and investment accounts with Russian banks without opening a representative office or branch in the territory of Russia. Before the enactment of Directive No. 595-U, non-resident companies having no business presence in Russia were not entitled to open current hard currency accounts. Instruction No. 16 allows a non-resident company to convert ruble proceeds from services into foreign currency and to transfer the proceeds abroad.

As a currency control matter, making leasing payments in rubles to the Russian bank account of a Lessor seems to be more convenient and practical than effecting payments in hard currency because no CBR Permission or CEC Approval is required if payments are made in domestic currency. However, tax complications may still arise for a Lessor from active use of a ruble account. For instance, to open an account, a non-resident company must obtain approval from the tax authorities. In addition, the current level of banking technology in Russia makes managing bank accounts from abroad difficult. Therefore, to convert rubles into hard currency and to transfer leasing payments (Pursuant to Instruction No. 16, in order to convert ruble proceedings into hard currency an owner of an account should first transfer funds from a ruble account of type "T" to a ruble account of type "I" and only then rubles can be converted and proceeding can be transferred abroad.) abroad, a Lessor must have a representative in the RF, who would be able to execute payment instructions to the bank and manage the accounts. Pursuant to current tax regulations, the presence of an agent of a foreign legal entity in the RF during a term exceeding one month may, in certain circumstances, be considered a formation by such legal entity of a “permanent establishment…. in the Russian Federation for taxation purposes (Article 1.4 of Instruction of the State Tax Service of the RF of June 16, 1995 on Taxation of Profit and Income of Foreign Legal Entities (as amended on December 29, 1995 and December 31, 1997).).” In view of the uncertainty of Russian legislation as to the status of foreign lessors in the RF (See Articles Does a Foreign Lessor need a Russia's Leasing License? and Tax Aspects of Cross-Border Leasing in Russia, http://www.lawfirm.ru.), receipt of leasing payments through a ruble account may entail undesirable tax consequences for a Lessor. Our practice shows that registration of an account with a tax inspection office and receipt by a Lessor of a leasing license, combined with other factors, serve as a sufficient ground for the Russian tax authorities to assert that a “permanent establishment” has been created and require a Lessor to submit tax returns and pay taxes as if it were a Russian taxpayer.

It seems that the option providing for the use of a ruble payment scheme may be efficiently used by the parties to a cross-border leasing transaction in the event that frequency of payments does not require the continued presence of a Lessor’s representative in the RF. This option is especially advisable because the CBR and the Customs Committee are now considering tightening the regime for payments in rubles between resident and non-resident companies, since payment for services in rubles has become the principal channel for outflow of capital from the RF. The current plan of the CBR and the Customs Committee would tighten the regime for ruble payments only with respect to export-import transactions, but it is likely that similar restrictions may be imposed on leasing transactions as well.

Passport of Transaction

A passport of export/import transaction is an instrument of currency control over transfers of foreign currency in connection with export-import transactions. Using the passport, authorized Russian banks and the customs authorities are obliged to confirm that the value of imported/exported goods fully agrees with the amount of paid/received currency. In the case of a cross-border leasing transaction the import/export of an object of leasing also takes place. It would be senseless to enforce accordance between the value of the object of leasing and the amount of total leasing payments by means of the passport because a total amount of leasing payments will always be greater than the customs value of leasing assets due to additional payments payable to a Lessor. Under the existing currency control legislation, a lessee should apply for the CBR Permission in such cases. However, existing regulations do not address the situation where a transaction qualifies for the Exemption and the CBR Permission requirements are not applicable.

In addition, a question exists as to whether a passport is required for operating leasing. A joint letter of the CBR and the State Customs Committee of May 28, 1996 No. 285, 01-42/9482 provided that a passport of transaction is not required for cross-border financial leasing transactions. Given that no specific exemption is contemplated for operating leasing, the regulations remain unclear.

It is not difficult to obtain a passport of transaction. However, a conflict may arise if a bank permits leasing payments in foreign currency under an operating leasing agreement and if the amount of such payments considerably exceeds the value of an imported object of leasing because Instruction of the CBR and of the State Customs Committee No. 30 requires that they be equivalent.

The practice of leasing transactions has not yet formed a clear approach of the customs authorities to passport issues relating to leasing transactions. In some cases lessees were unable to effect customs clearance of imported objects of leasing without opening a passport of transaction even under a financial leasing transaction. In other cases customs agencies did not require the passport even in the event of operating leasing. This situation could be explained only by the fact that cross-border leasing operations have not become mass phenomena for the customs agencies and currency control authorities. As a result, they have not yet felt the need to develop clear and uniform rules for the import of objects of leasing and for the determination of validity of leasing payments.

It is possible that Directive No. 721-U has been adopted to establish control over the validity of payments under cross-border leasing arrangements, but ambiguity exists. Certain provisions of Directive 721-U allow banks to interpret the Directive as inapplicable to operating leasing transactions, while a passport of transaction, which may be necessary for operating leasing operations, prohibits payments in excess of the cost of imported assets. This ambiguity suits only companies seeking to evade the law, which use leasing as a channel for outflow of capital, and has a deterrent effect on companies seeking to comply with the law.

Of the two principal types of cross-border leasing, financial leasing and operating leasing, the greatest certainty in Russian currency legislation exists with respect to cross-border financial leasing, even though financial leasing faces a number of bureaucratic barriers. Many foreign investors, after having faced customs, tax, licensing and currency control problems associated with leasing, prefer to structure their transactions as purchase-sale contracts with deferred payments.

 


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