October 26, 2016

How do changes in Russian legislation impact doing business in Russia?


Introduction of new legislation – such as a new law on foreign media ownership that goes into effect in 2016 – can play an important role in changing how Western investors perceive the risk-reward trade-offs in Russia.

New laws that will come into effect in 2016 might change the way foreign investors perceive Russian business climate. Photo: AP

As Russia heads into 2016, a lack of access to Western financial markets and the general overhang of economic sanctions have forced the Russian government to take a closer look at the current investment climate. What can be done to convince Western investors that now is a good time to invest in Russia?

When it comes to Russia, fear of the unknown can have an outsized effect on incoming businesses. It does not help matters that the Russian legislator can work quite quickly. It is not only what is passed in the Russian Duma, but what could be passed, and, almost more importantly, how it would be enforced. These are extremely difficult questions for prospective market entrants to answer.

Admittedly, this is a subjective, but still highly influential, component. Some new laws have raised questions about the importance placed by the Russian legislator on the current investment climate. One example is the media law which will be put into effect in February 2016: the law will force foreign media companies to sell their assets to local Russian players until a maximum of only 20 percent remains under foreign control (this is down from the previous maximum of 50 percent). This law, which acts almost like a retrospective quasi-expropriation of assets, has been a source of concern for many new potential Russian investors. Fortunately, organizations and associations are currently working on certain amendments to the bill.

Besides uncertainty in the future, there is also uncertainty with regard to interpretation of the laws. The new personal data policy law concerns the processing of personal data using databases in Russia. Of course, while the concept is not unique to Russia (the EU also has their version), the question of enforcement and interpretation is still open (for instance, to interpret the law conservatively, one could say it prohibits storing the personal data of Russian citizens outside Russia in many cases).

Also, because it is a new law, there are few, if any, cases from which to draw examples, so lawyers are forced to be conservative in their consultations. It does not help that wording and definitions are vague in the legal text as well. The result is an overhanging fear that their company is infringing on a law which they do not (nor many others) really understand.

Because these events are not regular (nor frequent), it is extremely challenging to quantify them, meaning evaluating the risk objectively is almost impossible. The consequences for these “black swan” events are always grossly exaggerated. This indirectly may result in a company deciding not to enter the market for fear of a perceived sense of excessive instability and unfairness, even though the chances of something like that happening are almost zero.

Moving to something more concrete (and positive), taxes have been decreasing in general over the last decade or so. This trend began in 2001 with the introduction of a flat personal income tax rate of 13 percent, then to the abolition of sales tax of 5 percent in 2004, to the reduction of VAT and social insurance contributions in 2005, to a decrease of profit tax in 2009, among others.

On another note, the heavy hand of bureaucracy weighs heavily on Russian businesses. But, the authorities are aware of this and are taking steps to ease the burden. Discussions are in the pipeline for a standardized Business-to-Business (B2B) and Electronic Data Interchange (EDI) systems, which would make the transition of necessary accounting documents electronic and thereby much simpler. Currently, there are several different solutions on the market, which is not practical for manufacturers with more than one supplier. By standardizing this, they will be able to greatly streamline their accounting and administration departments.

Beyond taxes and efficiencies in business, a third way that legislation positively affects companies doing business here is by providing them with preferential conditions in the form of subsidies, support for export, preference for public procurement, special utility rates, etc. Federal Law No. 488-FZ, in combination with other resolutions, has come into effect at the beginning of this year and is designed to attract foreign manufacturers into Russia.

This legislation is relatively new, and the details and definitions are still currently being worked out. The whole project may take longer than expected since the authorities are trying to walk a very fine line: they want to attract foreign investors, but still protect local ones.

One solution for this is to require foreign investors to demonstrate that they are making products that are not “analogous” to Russian-made ones (or the noun form, “analog,” which is seen more in the legal text). Naturally, the details here can be technical, with layers of reviews and complications. However, once demonstrating that they have a unique product (and some others), foreign companies would be eligible for a “special investment contract,” which would be fairly customized for each applicant, offering a range of preferential conditions.

Recommended: "Cautious hopes for a Russian economic rebound in 2016"

Another way to affect businesses is via changes to business conditions or corporate law. The “Amendments to the Russian Civil Code” 42-FZ, which came into force on June 1, 2015, has introduced concepts that are prevalent in the West. A notable one includes article 381.1, which allows (and better regulates) security payments (financial collateral). This will make some types of agreements (e.g. lease agreements) less risky. For example, in a lease agreement, this collateral can secure the obligation of the lessee to pay the rent or pay the damages. Before this, a pledge of money was a more opaque and controversial issue under Russian law.

Perhaps more importantly, article 431.2 introduces representations and warranties for the first time in Russian law. The representing party now bears full liability for misrepresentations given to the other party under a contract. Essentially, this means that if Party A gives a representation in a contract (e.g. about its own good standing, or the quality of the premises in an agreement for sale of real estate; or absence of debts or claims from third parties to a target company that is selling its shares, etc.), then this statement can be regarded as true by Party B. If it is later evident that it is not true, then Party A has to compensate all the damages to Party B.

This subtle addition of inherent faith or trust into the document could improve the amount of integrity throughout the system. Integrity is regarded as an extremely important factor for businesses to operate efficiently and effectively. This is an important step towards making the business environment more credible, and thereby addressing a negative perception of Russian business held in the West.

Overall, legislation is a very important consideration for businesses at every stage – from perception to interpretation to enforcement. This also refers to the laws that could be passed in the future. Russia, like the vast majority of countries, is a country that wants to be attractive for investors, and recent legislative changes are in place  or being put in place  to advance this cause.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.

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