Stability – What an Investor Needs
Law Journal (Moscow, Russia), 2001
Posted: 9 Feb 2014
Date Written: September 1, 2001
One of the factors of investment attractiveness of any country including Russia is the stability of legal conditions for investing. In the legal terms it is provided with two ways: the guarantee from the unfavourable change of legislation ("grandfather's" clause) and the change of an investment contract in connection with the change of legislation (stabilization or renegotiation clause).
WAY ONE. "GRANDFATHER’S" CLAUSE. The "grandfather's" clause creates a temporary immunity from implementing new laws that allows an investor to prepare and to adapt to less favourable conditions of his investment activity. In Russia such a clause is embodied in Article 15 of Federal Law No 39-FZ from February 25, 1999 "On Investing in the Form of Capital Investment" and Article 9 of Federal Law No 160-FZ of July 9, 1999 "On Foreign Investments in the Russian Federation". They state that the action of federal laws shall not be applied to an investor during a period of the recoupment of an investment project if these acts increase the tax burden or establish the restrictions of the rights of the investor.
Although these provisions are progressive in the Russian legislation, investment boom has not started in Russia yet. One of the reasons is a set of shortages, which are inhered to the "grandfather’s" clause. First, the implementation of the "grandfather's" clause spreads to federal acts whereas there are also regional and local legal acts in Russia.
Second, the implementation of the "grandfather's" clause only concerns priority investment projects – projects in which the investment is worth 1 billion roubles or the sum of the authorized capital stock of a company is not less 100 million roubles. All these projects should be included in a special list adopted by the Government of the Russian Federation, which has not been enacted yet. Moreover as it is well known, basic investments are fulfilled by usual, rather than "vip" investors.
Third, under the calculation of the tax burden of an investor some taxes are not taken into account. They are import customs duties applied in case of the protection of the economical interests of the Russian Federation; excises; value-added tax; fees into the Pension Fund of the Russian Federation; federal fees; regional and local taxes and fees. As it indicates that list of taxes is unfairly long. Especially, it concerns excises, value-added tax, and fees into the Pension Fund of the Russian Federation because they are the most part in the tax payments of an investor.
Fourth, there is some uncertainty concerning the situation when the Federal Assembly of the Russian Federation decides to decrease tax rates. Having analyzed the provisions of the Federal Laws concerned, the author goes into conclusion that the new reduced tax rates should not apply to an investor according to the "grandfather's" clause.
Fifth, the implementation of the "grandfather’s" clause does not spread to partners of an investor who are also involved in performing an investment project. It may result in decreasing the expected profits of the investor. That is why many tax privileges are now granted not only investors, but also their contractors in accordance with Federal Law No 225-FZ from December 30, 1995 "On Production Sharing Contracts".
Sixth, the "grandfather’s" clause does not stipulate the legal mechanism of its implementation in the tax sphere. The matter is that there is no such provision in the Tax Code of the Russian Federation.
Seventh, according to federal law concerned the "grandfather's" clause does not apply if new federal laws are adopted for the purposes of the safety of conducting works, protection of subsurface, environment, and the people’s health, public and state safety. It is unclear if a particular federal law is enacted for these purposes or not. The matter is that there is a presumption that if a federal law restrains the rights of legal entities, it is always adopted for the purpose of the safety of the people’s health or public safety.
Eighth, having analyzed the definition of the term of the recoupment of an investment project, it is concluded that time and inflation factors are not taken into consideration. The cumulative sum of net income with depreciation charges should be revised by the effective rate of interest for the purpose of discounting by a proper moment (e.g. the moment of starting financing the project).
Ninth, the duration of the "grandfather's" clause should not be restricted by a seven-year-term. The matter is that the period of the recoupment of most investment projects exceeds such a term. It is deemed that the stability for an investor should be provided until the moment of the recoupment of a particular investment project rather than for a fixed time. The "grandfather's" clause starts acting no earlier than the date of coming the Federal Laws concerned into effect. If an investment project commences fulfilling before this date, the clause will apply for more long term than it is required for the recoupment that is considered to be wrong.
Finally, the "grandfather's" clause is also stipulated in Federal Law No 225-FZ of December 30, 1995 "On Production Sharing Contracts". However it concerns the action of only federal sublegislative legal acts. For example, Article 18 (2) of this Federal Law states that the action of the normative legal acts of the federal bodies of the executive authority as well as the regional laws and other normative legal acts of the subjects of the Russian Federation and bodies of local governments not be applied to an investor, if these acts establish the restrictions of the rights of the investor except for the instructions of the appropriate bodies of supervision which are given out according to the Russian Law for the purposes of the safety of conducting works, protection of subsurface, environment, and the people’s health, public and state safety. Thus there is some legal vagueness concerning which federal law (Federal Law No 39-FZ from February 25, 1999 "On Investing in the Form of Capital Investment" or Federal Law No 225-FZ of December 30, 1995 "On Production Sharing Contracts") must be implemented in case of production sharing contracts.
WAY TWO. STABILIZATION CLAUSE. A possibility to amend an investment contract on the ground of changing the Russian federal legislation is set in Article 17 (2) of Federal Law No 225-FZ of December 30, 1995 "On Production Sharing Contracts". It means that if during the period of the validity of a production sharing contract there will be accepted norms and rules which make worse the legal status of an investor, the conditions of the contract shall be changed in order to compensate his losses and damages caused by the norms and rules concerned. The order of alteration ought to be written in the contract. This provision is not applicable if the norms and rules belong to the standards on the safety of conducting works, protection of subsurface, environment, and the people’s health (including, but not limited to, for the purpose of corresponding them with the similar standards accepted in the international practice).
"The rule of Article 17 (2) [of Federal Law No 225-FZ of December 30, 1995 "On Production Sharing Contracts"] has an advantage that the stabilization clause is not restricted by time limits and allows estimating the influence of changing national law individually". The disadvantage is the uncertainty of the definition of such terms as "commercial results" and "changes effecting commercial results". For example, commercial results can be esteemed through internal rate of return (IRR), return on capital employed (ROCE), return on stock equity (ROSE), net present value (NPV), etc. Other disadvantage is that the stabilization clause is not implemented to contractors of an investor who are involved in performing an investment project.
Article 13 (1) of Federal Law No 225-FZ of December 30, 1995 "On Production Sharing Contracts" also provides an investor the guarantee of stability from collecting regional and local taxes under the fulfillment of a production sharing contract if regional and local tax laws do not stipulate the exemption of the investor. In this case the investor’s share of profitable products is supposed to increase by the sum of paid regional and local taxes.
The unilateral change of a contract in the judicial order in case of the change of substantial circumstances is stipulated in Article 451 of Civil Code of the Russian Federation. It is unclear if the change of law could be considered as the change of substantial circumstances, that should be regulated by Civil Code of the Russian Federation. Moreover, sometimes investment contracts regulate both private-law and public-law relations. In the latter case the application of Civil Law of the Russian Federation is not permitted.
Thus there are some legal problems in the application of both "grandfather’s" and stabilization clauses. For the purpose of improvement of the Russian federal legislation it is proposed a set of recommendations to the federal legislators. In particular, it is necessary to expand the application of the "grandfather’s" clause, first, on regional and local laws, second, to any investment project, third, to the contractors of an investor who are directly involved in the fulfillment of his investment project. Fourth, to take into account VAT, excises, fees into the Pension Fund of the Russian Federation, regional and local taxes under the calculation of total tax burden. Fifth, to determine the order of the implementation of the "grandfather’s" clause in Taxation Code of the Russian Federation. Sixth, to establish the validity of the "grandfather’s" clause until the moment of the recoupment of an investment project (without any limitations and exceptions). Seventh, to take into consideration time and inflation factors under defining the term of the recoupment of an investment project through using "net present value". Finally, to determine the criteria of the negative change of conditions of the taxation and restrictions for foreign investors on the legislative level.
Keywords: Investment, Law
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