# ANALYSIS OF RUSSIA’S NEW FOREIGN INVESTMENT LAW

 

By David M. Wack

 

On July 9, 1999, PresidentYeltsin signed into law the new Russian Foreign Investment Law (FIL). The newFIL replaces the previous FIL, which had been in effect since 1991. In general,the new FIL offers many of the same protections provided by the previous law,with a few notable additions, including a new tax stabilization clause andgreater detail on the use of branch offices in Russia. Although the new FILoffers protection to all forms of foreign investment, a number of itsprovisions are expressly designed to promote “direct” foreign investment, whichis defined as (1) the acquisition of a more than 10 percent stake in a Russiancommercial entity, (2) investment in a branch of a Russian legal entity, or (3)leasing of certain electric and transportation equipment (including aircraft).In response to the financial crisis of August 1998, Russia is encouraging suchforms of direct investment as preferable to portfolio investment.

 

TaxStabilization Protection

The tax stabilizationprotection of the new FIL is its principal innovation. Although the protectionis fairly strong, its efficacy is still somewhat uncertain, particularly in theabsence of implementing regulations and the presence of ambiguities in the law.Under the new FIL, the enactment of any new laws or regulations that change theamount of certain federal taxes, customs, and other mandatory payments, oramendments to existing laws and regulations that increase the total tax burdenon or otherwise limit foreign direct investment, is not applicable until    recovery of investment (asdetermined by implementing regulations to be enacted by the RussianGovernment). Protection under this clause appears to be available only toRussian commercial entities engaged in “priority investment projects,” whichare defined as projects in which total foreign investment is at least $40million, or foreign equity investment is at least $4 million, in industrysectors specified by the Russian Government. However, the language of otherprovisions in the new FIL suggests that tax stabilization is intended to applyto all direct foreign investment projects in which foreign investors hold a 25percent equity stake, regardless of size or industry. This ambiguity will needto be addressed in implementing regulations or through amendments to the newFIL.

 

Although the stabilizationprotection covers the majority of applicable federal taxes, a few significanttaxestax (VAT) ondomestically produced goods and Pension Fund contributions. In addition, itshould be noted that the stabilization protection does not apply to regional orlocal taxes. However, regional and local governments have considerableauthority to grant tax incentives for these taxes.

 

The new FIL calls for the Russian Government to enact aseries of regulations implementing the tax stabilization protections, includingregulations governing the procedures for: determining whether a change in lawhas an adverse or limiting impact; registering priority investment projects;and oversight of foreign investors’ compliance with investment commitments.

 

Other Relevant Provisions of the New FIL

1.               *Application and Definitions.*Thedefinition of foreign investor in the new FIL includes legal entities, noncorporateentities, and individuals, as well as international organizations acting underinternational agreements and foreign governments. Investment is defined broadlyto include cash, securities, property, property rights, intellectual property,services, and information. Specifically excluded from the definition areinvestments in banks and other credit organizations, insurance companies, andnonprofit organizations for the purpose of socially desirable objectives, whichare to be governed by separate laws. The protections of the new FIL also applyto branches of foreign investors and commercial entities in which foreigninvestors participate, but not to subsidiaries or affiliated companies of thelatter.

 

2.               *National Treatment.* Under the new FIL,foreign investors are guaranteed the same legal rights and privileges availableto Russian residents, subject to limitations or benefits that may beestablished by Russian law. 

 

3.               *Expropriation and Compensation of Losses.*****Like the previous law, the new FILprotects foreign investors against expropriation and nationalization of theirproperty. However, unlike the previous law, it does not enshrine the principleof “prompt, adequate and effective compensation,” which is widely regarded asthe international standard; rather it merely requires that the investor becompensated for the value of its property without indicating the timing, methodof determining value, or currency of compensation. 

 

4.               *Repatriation of Profits.*****Under the new FIL, a foreign investoris guaranteed unrestricted use of its after-tax income, both within Russia andabroad. 

 

5.               *Preferential Treatment.*****Except for tax stabilizationprotection, the new FIL does not grant any tax or customs concessions toforeign investors. Priority investment projects are eligible to receive tax andcustoms benefits in accordance with Russian tax and customs law. Currently,however, Russian tax and customs laws do not contemplate any special taxconcessions for large-scale investments. The new FIL underscores the ability ofregional and local governments to offer tax and other incentives to foreigninvestors.

 

6.    *Foreign Personnel.*****Unlike the 1991 law, the new FIL does not explicitly address theissue of employment of foreign personnel, but implies that such employment ispermitted by stating in the preamble that one of its purposes is attractingforeign managerial experience. Moreover, unlike the previous law, the new FILdoes not guarantee import customs duties exemptions for personal effects ofexpatriate employees.

 

7.    *Dispute Resolution*. The new FIL providesthat a foreign investor is guaranteed the right to settle disputes arising outof its investment or business activities in Russian courts or througharbitration in Russia or abroad. Unlike the previous law, the new FIL does notdifferentiate between disputes with private entities and the RussianGovernment. 

 

8.               *Registration and Accreditation*. The newFIL removes the separate national registration requirement of the previous lawfor Russian companies with foreign investment. It now appears that suchcompanies are to be registered with the local registration bodies in the samemanner as purely Russian companies. In addition, the new FIL spells out ingreater detail the procedures for accreditation, operation, and liquidation ofbranch offices of foreign companies, an area that previously lacked anymeaningful legal guidance.

 

On the whole, the new FIL reiterates in a more succinctfashion many of the protections that have been available to foreign investorsin Russia for over 8 years and eliminates a number of provisions of theprevious law that became inconsistent with subsequent Russian laws. The newFIL’s principal innovation—the tax stabilization provision, although notwithout its flaws, is a positive step toward mitigating one of the greatestuncertainties related to investment in Russia. 

 

***David Wack is a member of the CIS Practice Group of****Squire, Sanders & Dempsey LLP**in Washington, DC.***

 

***For a lengthier analysis of the new Russian FIL, visit****BISNIS Online**at www.bisnis.doc.gov/bisnis/isa/isa.htm#Kisa.***