Vyasheslav Surkov and Vladimir Putin
Putin (right, with businessman Vyasheslav Surkov) needs to come up with an answer to Russia\'s capital drain Reuters

President Putin coined a new word in his state of the nation address at the end of 2012, when he called for new measures for the "deoffshorisation of our economy".

This was to become a major addition, not just to the Russian vocabulary but to business life in general. It marked the start of a wide-ranging campaign, led by President Putin himself, to bring Russian capital and tax revenues out of offshore jurisdictions and back home.

Over the past year the initiative has been picking up pace rapidly, with a new deoffshorisation law passed in late 2014. The campaign has become something of a political project for the Government, keen to stem capital flight out of the country. The problem is certainly pressing – net outflows from Russia have more than doubled to $151.5 billion (£96.5bn).

It would hardly be an exaggeration to say that all large Russian companies and many high net-worth individuals looking for asset protection, corporate law flexibility and fair dispute resolution have offshore and other non-Russian business structures of some kind, along with most mid-sized businesses and many small ones.

All of these people – and their advisers – may become affected by the 2015 regulations, and the new deoffshorisation law has major ramifications for them.

However, the immediate effect of the reform is far from what the authorities probably expected.

Regulations still under construction

Russia's new deoffshorisation law came into force on 1 January 2015, bringing new reporting and tax obligations for all Russian tax-resident companies and individuals with offshore and other foreign interests.

These companies and individuals are now required to disclose by 15 June 2015 any participation in all offshore and other non-Russian companies and structures, including trusts.

From 2017, the undistributed profits of controlled foreign companies (CFCs) and structures will be subject to annual taxes on profits generated since the start of this year.

To combat aggressive treaty shopping and offshore structuring practices, "beneficial ownership" and "corporate tax residency" concepts have been introduced to Russian tax law.

However, it is not surprising that the reform was off to a rough start. To meet the president's deadline and make legislation effective from 2015, the authorities were forced to rush it through Parliament.

Effectively, Russian regulators had only one year to put together a piece of legislation on controlled foreign company (CFC) rules and other international tax matters. Other countries have taken years, if not decades, to arrive at a functioning legal framework for this, and the Russian law is, of course, still "under construction".

Moreover, in their rush to get the law through Parliament in time, the authorities appear to have forgotten that the new law still requires multiple forms and subordinate procedures to be developed to make the new mechanisms truly effective.

In particular, the final form for mandatory disclosure of foreign companies and trusts that is due to be filed by the 15 June this year was only published on 24 April. The 15 June deadline had already been moved forward from the 1 April 2015 by last-minute amendments, due to the failure of the Federal Tax Service to produce the form in time.

Other mandatory forms and procedures are yet to be finalised. Those who want to bring their corporate structures "onshore" to Russia for tax purposes by voluntarily claiming them as Russian tax resident companies can only expect further delays.

Voluntary disclosure programme unlikely to succeed without further reforms

The deoffshorisation regulations are clearly a "stick" for business, but a hotly-sought after "carrot" is also anticipated. As announced by the president, Russia has also published a draft of the "capital amnesty" or voluntary disclosure programme.

The amnesty is intended to provide assurance to those concerned about general anti-avoidance charges relating to previous years. A voluntary disclosure programme, it offers individuals the opportunity to disclose (until the end of 2015) their CFCs, foreign bank accounts, real estate and other holdings – with no extra charges – by the end of the year.

In return, it will provide the guarantees that a participant will not be subject to criminal, administrative or tax liability for certain crimes and other violations in connection with assets they have disclosed.

However, at the moment, the draft law looks more like a vague manifesto rather than a solid legal document that reaches the goals set by the president. To make the amnesty truly effective, additional detailed amendments are required – again, these have yet to be developed.

In particular, Russia must relax its excessively harsh exchange control rules in order for Russian residents to use personal foreign accounts instead of accounts opened in the names of companies and structures.

The existing currency control regulations have their roots back in the Soviet era when, by law, the ultimate punishment for foreign currency speculation could be the death penalty and confiscation of all assets.

Whilst the regime has been liberalised significantly, it provides nowhere near the expected level of leniency. Perfectly ordinary transactions, such as selling overseas property or securities and receiving sale proceeds in foreign accounts, are still not permitted, with a fine of up to 100% of sale proceeds.

Although the amnesty grants a "clean bill of health" for disclosed foreign accounts and past transactions, with no change in currency control regulations going forward, Russian residents could be fined for new violations using the information about disclosed accounts.

All these currency controls only apply to transactions made via personal accounts, rather than accounts opened in the name of offshore business structures, providing a clear and legitimate incentive to use those.

Most importantly, despite all the guarantees, with current enforcement practices in Russia it is not excluded that information voluntarily disclosed under the programme could be indirectly used to initiate criminal charges against participating individuals or to otherwise pressure them.

In particular, there is widespread concern that the participants could be accused of crimes that are not directly covered by the amnesty, such as fraud, the definition of which is very broad under Russian criminal law.

Will it work – or backfire?

Russia's tax environment for business has changed significantly during the last few years.

On the one hand, it is clear that we are slowly entering a new era of global tax transparency. Long-term compliance and sustainable structuring, as opposed to risky short-term gains, should be the key priorities for all Russian businesses and individuals.

The problem is that Russia tries to push through these changes at a time of macroeconomic downturn, as well as falling public and corporate revenues when anti-avoidance international tax rules are being used to raise large arbitrary claims against leading compliant western multinationals working in Russia. The practice of using criminal charges in business disputes still remains widespread, and some examples are well-publicised.

In this environment, the negative effect of the reform can already be seen. Still in its early days, the deoffshorisation campaign has already led to a significant number of businessmen and even companies, particularly in the IT space, relocating outside Russia in search of stable regulation and business-friendly authorities. In the long-term, the current reform could lead to a lower taxpayer population and lower tax revenues – rather than the increase the Government hopes for.

In order to prevent such a mass exodus, the proposed rules need substantial additional work. This should not just be confined to the deoffshorisation law or "amnesty" law itself, but also include additional reforms and strengthening of the rule of law, to restore the trust of the business community and its faith in positive changes in the future.

The Russian authorities still have a long way to go to make the deoffshorisation campaign a success. Unless urgent action is taken, the campaign could actually backfire. The objectives of the deoffshorisation campaign may be laudable and in line with the international tax transparency drive but, if not handled correctly, the new anti-avoidance legislation could create instability, dent business confidence and actually increase the already growing capital flight rather reduce it.