Frequent Legal Issues for Contractors on
Sakhalin Oil and Gas Projects
(Appearing soon in the Russian Energy Law Journal)

VII. Secondment Contracts, Direct Employment and Body Shops

Presented by Natalia Prisekina, senior associate attorney and Director of the Vladivostok branch office of Russin & Vecchi.

Companies with expatriate workforces in Russia must consider the most appropriate manner for structuring such employment. Expatriates may be seconded, which entails continued employment by an offshore entity with the subsequent provision of the expat under a secondment agreement to the entity with operations in Russia. In the alternative, expats may be directly employed by a Russian legal entity or a foreign legal entity with a representative office in Russia. Which approach to take depends on an evaluation of the taxation and human resource issues involved.

A seconding company’s only responsibility is to provide staff to the receiving company. The seconding company is not involved in a secondee’s work and is not responsible for its quality. The secondment fee paid by the receiving company may cover a secondee’s salary and certain additional expenses, such as accommodation and business trips. Not all expenses may be covered by the fee. The receiving company does not pay for services provided, but rather for the time of the seconded staff. Secondment fee payments and other amounts paid in accordance with secondment agreements should be accompanied by an act issued by the receiving company stating that the staff was provided by the seconding company, not that the payment is for the provision of services.

Russian tax laws contain specific rules for secondment, in accordance with which secondment is not deemed to form a permanent taxable presence for the sending entity and the costs of secondment are deductible for the receiving company. Income received by the seconding company pursuant to a secondment agreement is treated as passive income and is subject to tax exemption. The seconding company is not required to pay payroll taxes on amounts received by the expat as pay, in accordance with an agreement with the Russian entity. The receiving company must pay value added tax on the secondment fee.

These benefits, however, apply only to corporate profit taxes. There is no tax relief with respect to the payment of personal income tax and social taxes, however, in a secondment arrangement, taxes may be collected through tax returns and self-assessment. There are no personal income tax withholding obligations. Beginning in 2004, expatriate employees seconded to Russian companies who spend more than 183 days in Russia and are therefore Russian tax residents, must not only file returns with the Russian tax authorities, but also pay their own personal income tax to the Russian Government from their own Russian bank account.

There are also human resource benefits with regard to secondment of foreign personnel. For instance, secondment is beneficial when contemplating confidentiality of labor relations, retaining home country benefits, continuity of service and maintaining an employee’s seniority with the seconding company. In addition, local human resource documentation is not required. Noteworthy, however, is that Russian labor law is applicable in substance to secondment arrangements. According to Russian labor law, a Russian receiving company utilizing the seconded employee will be treated as the employer and a full employment relationship under Russian laws will follow. Payments to seconded employees may be continued in hard currency. The entity with operations in Russia using seconded personnel is responsible for obtaining visas and work permits for its foreign seconded employees.

Direct employment of expatriates by the company with operations in Russia allows for salary to be fully deductible from profits tax, if the employment agreement is properly structured. An added expense to the employer is the requirement to pay the unified social tax and other payroll taxes, however, in direct employment, VAT is not applied. A direct employer is obligated to withhold personal income tax.

From a human resource perspective, confidentiality issues are greater with direct employment, and the employee may sacrifice certain home country benefits, continuity of service and seniority. Direct employers must maintain local human resource documentation and Russian labor law applies to direct employment in both form and substance. Payments in rubles may be required, with potential practical difficulty in repatriating earnings.

Body Shops

Russian job-contracting firms, known as "body shops" are companies that lease personnel, and may be used to recruit local professionals and contract them out to foreign companies. Foreign companies may use body shops in order to meet Russian content requirements for man-hours under the Production Sharing Agreement regimes. As a general rule, the foreign company makes payments to a local Russian company employing local professionals. An employment agreement is concluded between the employee and the local Russian company; therefore, the Russian company withholds all taxes. Russian employees perform work at the instruction of the foreign companies.