Insight

Changes in the Legal Regulation of Foreign Investment in Russia

Introducing significant changes in the legal regulation of foreign investment in the Russian Federation.

Foreign Investment Russia
AL

Artem Zhavoronkov and Oleg Lovtsov

September 5, 2017 12:24 PM

In July 2017, President Putin signed two federal laws, No. 155-FZ and No. 165-FZ, introducing significant changes in the legal regulation of foreign investment in the Russian Federation, aiming to implement the policy of “de-offshorization” of the national economy and strengthening state control over transactions with respect to Russian “strategic” companies.

• Law No. 155-FZ introduces amendments to federal law “on privatization of state and municipal property” and federal law “on procedures for foreign investment in business entities of strategic significance for national defense and state security” (the Strategic Investment Law).

First, the amendments stipulate that offshore companies incorporated in a state that is on the “list of states and territories providing preferential tax treatment and/or not requiring disclosure of information when conducting financial transactions” (the list) can no longer purchase state or municipal property that is being privatized in Russia. The list is approved by the Russian Ministry of Finance and currently includes, inter alia, such states and territories as Andorra, the Bahamas, the British Virgin Islands, the Cayman Islands, Gibraltar, Guernsey, Hong Kong, Jersey, Liechtenstein, Macau, the Isle of Man, Monaco, the United Arab Emirates, Panama, San Marino, and some other jurisdictions.

Importantly, the ban on the privatization of the Russian state and municipal property applies not only to offshore companies incorporated in the jurisdictions on the list, but also extends to any legal entities that are controlled by such offshore companies or by groups that include such offshore companies.

Second, according to the amendments, neither offshore companies nor companies under their control (including those incorporated in Russia) can make transactions or take other actions resulting in their establishment of control over so-called Russian “strategic business entities”1 and/or acquisition of fixed production assets of strategic business entities constituting 25 percent or more of the book value of their assets. Moreover, offshore companies and the entities under their control shall now obtain prior approval by the special Russian Government Commission for Control over Foreign Investment (the commission) for their transactions to acquire the right to exercise, directly or indirectly, more than 25 percent of the total number of voting shares of strategic business entities or the right to block decisions of their governing management bodies. And for the strategic business entities engaged in geological study and/or exploration and mining of mineral deposits of federal significance in Russia, this threshold is even less (5 percent).

Given that the term “control” is defined rather broadly in applicable Russian legislation, the amendments introduced by Law No. 155-FZ will apparently lead to the ban on a number of investment transactions in Russia involving not only offshore companies themselves, but also onshore companies under their control. The ban may also be interpreted as applicable to cases where offshore companies are just links in the chain of ownership within the group structure.

• Law No. 165-FZ introduces amendments to federal law “on foreign investment in the Russian Federation” and the Strategic Investment Law.

One of the most important changes is that the chairman of the commission will now have the right to determine and decide at his discretion that the transactions performed by foreign investors in respect of practically any Russian companies, not only in respect of strategic business entities, require prior governmental approval to ensure national defense and state security. This will apparently give the government the ability to interfere into any “high-profile” transactions involving foreign investors. Moreover, Russian citizens holding other citizenship(s) and Russian organizations controlled by foreign investors will now be considered foreign investors for the purpose of state control over investment and acquisition transactions. The commission will also have the right to determine practically any obligations to be imposed on a foreign investor as a condition for prior approval of the transaction.

It is worth mentioning that the amendments made by Law No. 165-FZ also introduce a new kind of liability for foreign investors’ failure to report their holding or acquisition of 5 percent or more of shares in strategic business entities as required by the Strategic Investment Law. In addition to the already existing fines, such a violation will result in the prohibition of a foreign investor to exercise their right to vote at a general meeting of shareholders of the strategic business entity though a court until the foreign investor duly fulfills the reporting requirement.

In light of the above-mentioned legislative changes, it becomes important to more carefully prepare and structure acquisition and investment transactions in Russia—especially if there are links to offshore companies.

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1 As per the Strategic Investment Law, a “strategic business entity” is a company engaged, or permitted to be engaged, in one or several activities that are deemed strategic sectors of economy in Russia. The list of such activities is quite extensive (more than 40 items) and includes, inter alia, subsoil use, mining exploration, nuclear energy, space and aviation, data encryption, TV broadcasting, etc.

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