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Toni Schönfelder
A lifetime of innovation

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Toni Schönfelder
A lifetime of innovation

Russia New legislation for real estate & tax rules  
Renewed interest in real estate investment in Russia and new legislation governing town planning is seeing the market – and the country’s dilapidated residential housing – receive a facelift.  
By Andrei Soukhomlinov  
It is not news that Russia is still topping the polls as the most attractive destination for real estate investment funds in Europe. Real estate investment in Russia increased by more than 1,000 per cent last year, according to real estate management company Jones Lang LaSalle.  
All sectors are doing very well, particularly warehousing and retail. Cushman & Wakefield reported in November 2006 that a record 13.8 million square metres of new shopping centre schemes are due to open across Europe this year and that Russia is top of the table for shopping centre developments.  
Infrastructure is also benefiting from investor interest, but bearing in mind the poor quality of Russian infrastructure, there are still plenty of opportunities for investors prepared to take a long view and carry the risk, as those involved in the new highway planned between Moscow and St Petersburg using a PPP structure are doing.  
What is new is that changes in Russian law aim to stimulate foreign investment in the most difficult section for foreign investors, and the most opaque – residential property.  
The new federal law on the amendment of the Russian Town Planning Code of the Russian Federation of 18 December 2006 (Law 232) ushers in a raft of changes in the biggest recent shake-up of residential property law.  
Land registration  
Unlike common law legal systems, in Russia there is only residential and non-residential property. Therefore warehouses, retail, infrastructure and other uses of property fall under the non-residential laws and regulations, which differ from those under the residential real estate system.  
There is also little privately owned land in Russia. The state or municipal bodies (in many instances it is not clear which) own almost all the land in Russia. Traditionally state or municipal authorities do not register their title to land even when it is clear which state authority is entitled to the land. Although the 1998 registration law stated that all transactions involving titles of land and property have to be registered, pending registration of title local authorities have been able to dispose of land via granting leaseholds.  
Furthermore, land and buildings located on such land are treated separately and the ownership of the land usually follows the ownership of the associated buildings on it.  
The need for legislative change to fuel investment in residential property had become urgent by last year for a very practical reason. A construction boom in the 1960s in Russia created many swathes of five-storey housing estates that have not stood the test of time. They urgently need to be replaced with housing befitting the 21st century. There is also a great need for investment in older, dilapidated residential housing, which is often located in prime city sites. Making residential housing more attractive for investors is the reason for these new laws.  
Extensive regeneration  
The new regime introduces a new concept of comprehensive development of existing residential areas. This type of development may include renovation of existing houses and, most significantly, new construction. This is exactly what is required for investors.  
In particular, the new law provides that districts may now be developed pursuant to a contract concluded between the investor and the local authorities following an open, transparent tender. The essential terms and conditions of such contracts are set out in the Town Planning Code.  
The contracts will require the investor to prepare at its own expense a draft plan demarcation of the territory and its zoning; to transfer into state or municipal ownership residential premises for the relocation of residents of existing houses rented from the authorities and to buy out the existing owners of privatised flats and apartments.  
Investors interested in participating in such projects still need to be willing to bear significant costs and expenses, some of which should not necessarily be borne by a private investor.  
This should not put investors off, though. The local authorities’ obligation to grant to an investor lease rights over publicly owned land, within the territory to be developed and without a tender, may give developers some comfort. This means that only one tender will be held. The winner will be given the right to enter into a contract for the comprehensive development of a territory, which may in fact consist of several land parcels. Previously separate development of these parcels would involve separate tenders.  
Tackling illegal development  
Another change will be a crackdown on corruption. Quite often developers have obtained the rights to develop residential sites without a transparent and legally clear tender and the sector had a reputation for being too opaque.  
Governmental agency the Federal Antimonopoly Service (FAS) is already showing it intends to fight corruption in this sector; there are already reports in the Russian press that it has issued a warning notice to a major local Moscow developer who is alleged to have obtained the right to develop a prime residential site in central Moscow without a transparent tender process.  
The construction permit process has been improved. A single state assessment of construction and design documentation will replace a bewildering array of separate expert assessments, including those previously carried out individually by public health, fire, environmental, historical monument conservation and other authorities.  
Local authorities frequently lack sufficient resources and staff to cope with the increased volume of documentation submitted for review, but unlike the previous regime the granting of a construction permit should certainly take less than a year.  
Mortgage rights  
The demand for residential property has been given a significant boost. The Mortgage Law 1998 is amended so that mortgages of land plots to which state freehold ownership is not determined and registered in the Consolidated State Register of Rights can be legally valid in the absence of such registration.  
The idea that you can have a mortgage on land that does not have a defined freeholder is not one that Western investors initially find comfortable. However, if you accept that the freehold is owned simply by a public body then it is easier to understand.  
The conditions under which the mortgage can be effected include the property being designated for housing construction or initial preparatory works for subsequent complex housing development or if the property is to be used as collateral to secure bank loan financing. This change will help raise financing for local as well as foreign investment in foreign housing development projects. Furthermore, if after three years no building or construction work has been commissioned, the landlord, the publicly owned body, can terminate the land lease.  
Four months have passed since the new laws were passed. However, developers are already proving happier to consider early stage development of residential property as a result of these changes. While good laws can be ruined at the implementation stage, currently it seems that these legal developments can only support and sustain the prominence of Russia as the most attractive European country for real estate investors.  
•Andrei Soukhomlinov is co-head of the Russian real estate group at Salans  
Tax relief  
Russias tax system is undergoing a raft of changes designed at improving both its procedures and fairness, but there is still more to be done.  
By Oleg Konnov  
The Russian Ministry of Finance has recently declared that the tax reform launched in 1998 is almost complete. The Tax Code of the Russian Federation, based on the Organisation for Economic Co-operation and Development (OECD) principles, sets out clear rules for taxation and defines the legal framework of the Russian tax system, including the rights and responsibilities of taxpayers, the powers and obligations of tax authorities, tax registration and filing procedures and tax audit and appeals procedures.  
Reducing the tax burden on individuals and corporations has been the cornerstone of the first phase of the reform and this task has been accomplished successfully. An exhaustive list of taxes has been established by the tax code, reducing the total number of taxes from more than 60 to 15.  
Regional and local authorities have been prohibited from introducing taxes not listed in the tax code or in violation of the general principles set out in the code. Most onerous taxes, such as turnover taxes, have been abolished and tax rates have been lowered substantially.  
Today the tax rates in Russia are among the lowest in Europe. For instance, the majority of Russians encounter a flat tax rate of 13 per cent. The lowest rate of social charges, which are assessed at a regressive scale, is only 2 per cent. Inheritance taxes have been completely abolished. Property tax rates are negligible compared with other countries.  
These legislative efforts have been backed up by the courts. In particular the Constitutional Court of the Russian Federation has issued several rulings declaring various pieces of tax legislation, such as excessive tax penalties, to be in conflict with the tax code.  
Tax constraints  
Notwithstanding this amazing progress achieved within a relatively short period of time, most investors do, however, continue to cite taxes as a major constraining factor to their operations in Russia. Tax law is no longer the problem - the issue is tax administration.  
A fundamental distortion between the role of the tax authorities and the mentality of the tax inspectors lies at the heart of this existing problem. In practice the main goal of the tax authorities remains the replenishment of the state treasury. As such, the more money collected by taxmen, the higher their performance is marked.  
Each year the government approves tax collection plans. Local tax authorities are instructed to procure the receipt of respective tax amounts, rather than to treat the taxpayers individually and lawfully. Any tax audit pursues the major objective of securing a maximum payment through the assessment of taxes, penalties and interest.  
VAT attracts the most acute form of abuse by taxmen. Tax authorities make a point of refusing a tax refund or offset on any artificial grounds. Although the targeted group was initially limited to exporters and other taxpayers in a refund position, the tax authorities have broadened the attack. In the view of taxmen, the input VAT amount should not exceed 70 per cent of the output VAT amount.  
Tax inspectorates have been accused of extending invitations to managers of businesses declaring excessive - as seen by taxmen - input VAT. During such meetings, they are said to push for a reduction in input VAT amounts under the threat of audits, freezing of accounts and other chastisements. It has also become virtually impossible to obtain a VAT refund without going to court. Even lengthy court proceedings do not guarantee the reimbursement of VAT, as tax authorities drag their feet over complying with court orders, using any bureaucratic loopholes available.  
Administration of VAT has become such a headache for taxpayers that the government has seriously considered substituting sales tax for VAT. Indeed, all shortcomings arising out of the difficulty to collect sales tax are considered to be a lesser evil than the administration of VAT.  
Further hurdles  
Taxpayers vulnerability is aggravated further by the irresponsibility of tax officials. Despite the fact that the legislation in force provides for administrative and even criminal responsibility to be placed on tax officials that fail to perform their duties, only a single instance is known where taxmen were held responsible for infringement of taxpayers rights and knowingly issuing unlawful orders.  
Although procedural legislation enables taxpayers to pass on their legal costs in successful cases, this rule does not work out in practice. In most cases courts award only nominal amounts to taxpayers. Companies are forced to allocate a budget for non-reimbursable tax consultancy fees and legal costs.  
Even where consistent case law exists, a tax authority is required by the government to exhaust all procedural steps to challenge a court order in favour of a taxpayer. Many headlines were captured by criminal proceedings initiated against two tax inspectorate lawyers who failed to file appeals in cases that were certain to fail. This approach has led to an excessive number of cases before the courts. For instance, in 2006 Russias courts reviewed 654,920 administrative (mostly tax) cases.  
Gradual change  
Although tax experts and businessmen have been calling for tax reform for years, little progress was made until President Putin identified improvement of tax administration as one of the priorities of the state policy in the Presidents Address 2005. This has urged tax practitioners and governmental officials to combine their efforts in developing the reform strategy.  
Time allocated for the conduct of audits has been substantially limited. The tax code also limited documents that the tax authorities may request from taxpayers in connection with a chamber audit. Tax authorities have become bound by the position of the Ministry of Finance.  
At the same time the Russian Ministry of Finance has adopted an internal document aimed at determining priorities of the tax service. The efficiency of a local tax inspectorate will now be determined pursuant to eight weighted criteria. Even though tax collection is among them, this should be balanced by other criteria, such as percentage of cases won by the tax inspectorate (based upon both number of cases and their total value), the percentage of cases settled out of court and percentage of taxpayers filing tax returns in electronic form. Thus the Ministry of Finance suggests that the performance of the tax authorities should not be assessed solely or predominantly on the basis of tax collections.  
Russian courts have also handed down several rulings aimed at improving tax administration. An information letter issued by the Presidium of the Russian Supreme Commercial (Arbitrazh) Court on 13 March 2007 related to the payment of the state duty. Contrary to the previous practice, when challenging court orders in cases won by taxpayers, tax authorities have now become liable for payment of the state duty.  
Such expenses must be reimbursed by the respective tax inspectorate and not by the treasury. In the view of the highest judicial authority, such a measure is expected to result in less pressure on the courts, since the tax authorities would think twice before filing the appeal.  
In order to attract investment, Russia needs, among other things, to create a tax system that is transparent, fair and easily administered. With the enactment of the tax code, Russia has made a significant step forward, but in order to achieve this goal it needs to continue to modernise and reform its tax administration system.  
Oleg Konnov is a partner in Moscow at Herbert Smith  

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