The COVID-19 pandemic has affected the business environment in Russia considerably, similar to worldwide tendencies. On the one hand, many of the companies in Russia in various industries have been negatively affected and faced a decrease in revenue and, as a result, do not have enough internal resources for further project financing or for financing current operating costs. On the other hand, the new business circumstances have given way to the development of other companies, including various innovative start-up projects with growth potential that also requires financing at the initial stages of launching the business. In such a situation, foreign companies having Russian subsidiaries, as well as foreign companies interested in investing in start-up projects in Russia, may consider different financing options.
Historically, the form of financing mostly depends on whether such financing is planned to be repaid or if it is predictable from the beginning that the investment will not be returned.
In the case of non-repayable investments, such options as a contribution to the charter capital of the company or contribution to the company’s assets are available to shareholders. Contributing to the charter capital is a more burdensome procedure than contributions to the company’s assets, as it implies an increase of the charter capital of the company, the preparation of the necessary corporate documents, and requires the participation of a notary public and subsequent state registration of the changes with the Russian state registration authority. It should also be noted that the net asset value of the Russian company should not be less than the amount of its charter capital. If there is a breach of this rule for two consequent years, the Russian company is obliged to reduce its charter capital.
Providing repayable financing loans to subsidiaries or other companies, on the one hand, may be attractive to the shareholders since the latter is entitled to receive loan amounts back, as well as the relevant interest, and the Russian company may deduct such interest amounts, decreasing its profit tax obligations subject to certain conditions, including thin capitalization requirements. In practice, it is not always predictable whether the borrower would have enough resources to be able to return the provided monetary funds and interest. In the case of further failure to pay any interest and return the loan amount, there may be some disputes with the Russian tax authorities related to the requalification of such a loan into a non-repayable investment that may result in negative tax implications (i.e., contesting deductibility of the interest and currency difference expenses). In practice, in situations of a lack of funds for loan repayments, Russian subsidiaries and their foreign shareholders opt to apply a set-off mechanism, i.e., the obligation to contribute to the charter capital against obligations to return the loan and relevant interest.
A new mechanism – the convertible loan – was introduced in Russian legislation in the middle of 2021. With a convertible loan, the lender is entitled to claim the shares of the borrower instead of the return of the loan/part of loan and interest subject to conditions precedent set in the relevant agreement. The conclusion of a convertible loan agreement requires preliminary corporate approval for an increase of the charter capital, notary certification, and specification of the main information on the convertible loan in the publicly-available registrar of legal entities. The convertible loan agreement needs to contain the following essential terms: (1) conditions precedent (such as terms or other conditions, i.e., the borrower meets certain financial indicators, etc.) entitling the lender to claim a loan conversion and (2) the amount of increase of the nominal value of shares, acquired by the lender or the relevant calculation mechanism.
If the conditions specified in the loan agreement occur, the lender is entitled to claim a conversion of the loan into the charter capital if such an option is suitable for the lender instead of receipt of the funds back. The latter submits the relevant claim together with supportive documents to the notary and, if the borrower has no objections, the notary proceeds with the state registration of changes to the registrar of legal entities and the charter of the borrower connected with the loan conversion and relevant transfer of shares to the lender. In case of an objection from the borrower, the relevant conversion may be performed via a court decision.
We believe that the option discussed here may be attractive for investors as it provides a flexible mechanism for corporate financing. It has a variety of particular tools available for the lender to cover various developments in a future so unpredictable at present.
By Vlad Rudnitskiy, Partner, and Anna Zaitseva, Tax Advisor, Peterka & Partners Moscow
This Article was originally published in Issue 8.11 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.