Tax Breaks Planned for Innovation Investors

The government is planning to exempt investors from long-term capital gains taxes, but for now the rules would only apply to shares of companies not traded on exchanges, in hopes of stimulating private equity and venture capital investment.

A special focus was put on boosting innovation during a meeting chaired by Prime Minister Vladimir Putin last week on tax policy for the coming three years.

Putin agreed with a proposal to exempt the sale of not publicly traded shares from the 20 percent tax on capital gains, a move intended to increase long-term investment in innovative companies and entice investors to conduct their deals in Russia's legal jurisdiction, two officials with knowledge of the meeting told Vedomosti.

Putin's press secretary, Dmitry Peskov, declined to comment on the matter.

Under an Economic Development Ministry proposal that was forwarded to the Finance Ministry before the meeting, the tax break would apply to stakes of at least 10 percent held for at least five years. A copy of the proposal was obtained by Vedomosti.

Shares traded on the MICEX Market for Innovations and Investments or not traded on any organized exchange would be covered under the plan. MICEX's innovation market was opened in July 2009 and has five companies' shares trading.

Final proposals should be finished by April, said an official at a state body participating in the discussion of the Tax Code amendments. Canceling the capital gains tax for legal entities has essentially already been approved, but extending the benefit to private investors is still being discussed, the source said.

There are currently no discounts on the capital gains tax, although until 2007, investors holding securities for at least three years were exempt from it, said Dmitry Kostalgin, a partner at Taxadvisor.

The practice is, however, nearly universal in European Union countries, said Rustam Vakhitov, a senior lawyer at Pepeliaev Group. He said 10 percent ownership was a widespread condition for the tax breaks, though typically there are either no limitations on the period of ownership or the period is less than five years.

Vakhitov said he could not think of any countries with a tax break applying only to securities not traded on exchanges.

The goal is to stimulate an inflow of investment beyond blue chips and into startups and venture capital projects, Deputy Economic Development Minister Stanislav Voskresensky told Vedomosti.

Kirill Dmitriyev, president of Icon Private Equity, said he thought it was the right approach, since a disproportionate amount of investment in Russia goes to blue chips. Tax breaks on capital gains would make Russia more attractive for private equity investment, investors contacted for this article told Vedomosti. But there was no consensus on how significant the measures would be for the market.

Investors will start to look more closely at a business' fundamentals and not just its stock price, said Alexei Panferov, managing partner at New Russia Growth Capital Advisers. For venture capitalists and private equity investors, the changes are very positive, agreed Finam general director Arsen Aivazov, but portfolio investors — who tend to prefer liquid assets — are unlikely to change their priorities.

The investors surveyed for this story said they generally approved of the ownership requirements for the discount. For venture investors, five years is the upper limit for staying in an asset — three to four years is more common — but they could come to terms with the longer time for the tax break, Aivazov said.

Rusnano managing director Dionis Gordin said the proposals were a positive indication about changes in the system as a whole but the time limits and the size of the stake were a bit harsh for venture capitalists. They're more used to frequent purchases and sales with a timeline of three to five years, he said.

The Economic Development Ministry's proposals are also intended to encourage investors to conduct their business in Russia, Voskresensky told Vedomosti.

Capital gains taxes are a major argument in favor of selling shares somewhere else, for example, in Cyprus, said Giedrius Pukas, a partner at private equity fund Quadro Capital Partners.

But taxes aren't the only reason, said Konstantin Demchenko, a managing director at Everest Asset Management. Foreign jurisdictions are favored also because of problems with Russian law enforcement and courts. Another reason for offshore transactions is reluctance to disclose end beneficiaries, said Finam's Aivazov.

Additionally, from 2011, tax exemptions will be simplified for dividends being paid into Russia from abroad, said Alexander Zakharov, a partner at Center USB. The minimum investment of 500 million rubles ($17.1 million) will be lifted, and the discount will apply to owners of stakes of 50 percent for more than a year, excluding countries in the Finance Ministry's list of tax havens, he said.