Using an Agent or Distributor
Encompassing eleven time zones, Russia is the largest country in the world by landmass. Therefore, many businesses tend to approach the Russian market on a regional basis. Most new entrants start in Moscow and then move into the regions either through an existing distributor or by seeking new distributors in those locales. As both Moscow and St. Petersburg are major population and business centers, many Western firms have representatives there. Some companies have successfully entered the Russian market by starting distribution in other key regions first because of market features and industry sector concentrations (e.g. woodworking in northwest Russia, energy projects in Sakhalin and western Siberia) and then expanding elsewhere. Well-organized distribution channels are established in western Russia, especially in Moscow and St. Petersburg, and continue to develop rapidly in southern Russia, the Volga region, Urals, Siberia and Russian Far East. To succeed in Russia it is important to choose sales targets and distributors carefully.
U.S. companies have four basic options when choosing a distribution channel:
1) Agents It is not a common practice in Russia for foreign companies to rely solely upon the services of an agent. Distributors and representative offices, however, often employ agents in the Russian regions in order to promote their products.
2) Distributors The most common market entry strategy is to select a good distributor or several distributors (depending on the product). U.S. companies can consider a variety of national, regional and local distribution alternatives. In some product categories (e.g.,apparel, cosmetics, packaged foods, alcoholic beverages, consumer electronics, and household appliances), foreign suppliers can choose from a growing number of established distributors. A good distributor will typically sell and deliver foreign suppliers’ products to end-users and/or the retail market and provides a wide range of logistical support, i.e., customs clearance, warehousing, inventory management, etc. However, handling promotion and advertising campaigns exclusively through independent distributors can often result in disappointing results. Russian distributors normally handle products from multiple suppliers and are not typically dedicated to promoting a specific company’s product unless the supplier provides substantial support for promotion and advertising.
3) Representative/Branch Offices Some foreign manufacturers, in addition to using distributors, have established their own representative offices. The major advantage of opening a representative office is that foreign companies have more direct contact with their end-users and control over the promotion and distribution of their products. However, under the Russian Civil Code such offices cannot be directly involved in commercial activity. Instead, they typically oversee a network of distributors and/or agents that perform commercial functions. This approach affords greater control by the foreign supplier over the distribution process and helps to reduce risks. Representative offices are accredited for three years and must be registered with the State Registration Chamber, tax authorities and other state organizations.
As Representative Offices may not take part in commercial activities, Branch Offices have become increasingly more popular. According to a 1999 foreign investment law, foreign companies may engage in commercial activities through their legally established branches. Branches are accredited for five years and must be registered with tax authorities and other state organizations.
Both Representative and Branch Offices can be attractive to foreign businesses wishing to operate in the Russian market because there are fewer tax and other administrative burdens and currency control restrictions may not apply.
4) Foreign Subsidiaries Some foreign manufacturers, particularly in the cosmetics, pharmaceuticals, consumer appliances, durables and industrial products sectors, have registered their wholly owned subsidiaries in Russia. They then sell directly to their own companies registered in Russia who import for their own account. This approach affords full control of the supplier over distribution and helps to further reduce possible risks from false invoicing and other irregularities sometimes committed by independent importers and distributors. For more information on registering a company in Russia, please refer to the “Establishing an Office” section below.
U.S. exporters are advised to cultivate personal relationships with their Russian representatives and clients, to proceed gradually, and to ensure they have a contingency plan should problems arise. Since it is often difficult to find information on Russian companies, it is strongly recommended that U.S. firms consider using the International Company Profile Service to validate potential partners. The U.S. Commercial Service strongly advises against the risky practice of a company representative simply visiting Russia once or twice, selecting a representative, granting exclusive representation, and then moving quickly to consignment or credit sales without first establishing a payment and performance history. In addition, exporters are cautioned to take primary responsibility for registering their brand names in Russia and not to rely on a partner to do this. Finally, it is important to provide a Russian partner with Russian language product information and marketing materials. These can be prepared in the United States or done jointly with a Russian partner.
The U.S. Commercial Service provides assistance to U.S. companies in finding local partners through the Gold Key Service, International Partner Search, International Company Profile, Customized Market Research, Platinum Key and other products and services.
Establishing an Office
The U.S. Commercial Service can provide basic counseling on registration requirements and procedures. However, it is strongly recommended that interested U.S. companies seek legal advice on business registration. U.S. Commercial staff can provide contact information for U.S. and Russian consulting firms that offer professional legal advice in this area.
The following basic laws and government resolutions regulate business registration in Russia:
- The 1999 Federal Law “On Foreign Investment in the Russian Federation”
- The 1994 Part I of the Civil Code
- The 2001 Federal Law “On State Registration of Legal Entities”
- Russian Government Resolution No. 319 “On Authorized Federal Entity of the Executive Power, Providing State Registration of Legal Entities” of May 17, 2002, and a number of legal acts.
Conducting business without registration is illegal. Although the federal law governing the process is uniform throughout Russia, it is often subject to local interpretation.
Russian law offers several commonly used structures to conduct business:
- Representative or branch office of a foreign company
- Registration as an individual private entrepreneur
o Limited Liability Company (OOO)
o Privately held, closed joint stock company (ZAO)
o Publicly held, open joint stock company (OAO)
Branch offices and accredited representative offices are both legally distinct from Russian corporations, which may be established by foreign firms either as joint stock companies with partial Russian ownership, or as wholly owned subsidiaries of a foreign firm. Foreign ownership can be as high as 100%, with some exceptions. For example, foreign investment is limited in industries defined by the “Strategic Sectors Law” (discussed later).
Branches are not considered independent legal entities, though they may negotiate, market or provide other business support on behalf of firms based outside Russia. Setting up a branch may be worthwhile if a foreign company is starting to pursue business in Russia and is exploring opportunities. Many large U.S. firms began their Russian operations as locally established branches.
Branches of foreign firms must register with the State Registration Chamber, which is part of the Ministry of Justice of the Russian Federation. Branches will incur the following fees for accreditation: RR 60,000 (State duty) plus RR 15,000 for one year; RR 30,000 for two years; RR45,000 for three years; and RR 60,000 for five years.
Accredited Representative Offices
Like branches, accredited representative offices are not independent legal entities; they may not be involved in commercial activities. After accreditation is obtained, the office should register with the local or regional registration chambers, located in many Russian cities. Advantages of an accredited office include annual/quarter (rather than monthly) reporting requirements for some activities (including some tax payments), and the ability to issue invitations for U.S. partners to visit Russia on business visas. Up to five foreign employees may work with an accredited office of a foreign company. Offices are usually accredited for one to three year terms.
Accredited representative offices also must register with the State Registration Chamber in order to be included in the State Register of Accredited Representative Offices of Foreign Legal Entities in the Russian Federation. They are also advised to register with appropriate state organizations, depending on their industry. Such agencies include the Central Bank, Ministry of Economic Development Ministry of Finance, Ministry of Transportation, Ministry of Industry and Trade, Ministry of Energy and others. According to internal procedures accreditation of a representative office or branch should take 21 business days starting from the day the full set of required documents are provided. Representative offices will incur the following fees for accreditation: RR 30,000 for one year, RR 60,000 for two years and RR 75,000 for three years. An additional fee of RR 15,000 may be paid for expedited accreditation within seven days.
Companies and Taxation
Companies are required to register with the local Tax Inspectorate. Documents for state registration should be prepared and submitted to the local Tax Inspectorate in accordance with Chapter 12 of the August 8, 2001 Federal Law “On State Registration of Legal Entities.” An authorized legal entity, the Moscow Department of the Ministry of Finance of the Russian Federation (15, Tulskaya Street, Moscow) provides counseling to business people on registration procedures and registration documents.
Major revisions of Russia’s tax code took place from 1999 to 2003. The resulting tax legislation more closely matches the needs of a growing market economy, and many of the provisions of previous legislation that distorted the business environment and kept many businesses in the shadow economy have been removed.
The most fundamental changes were reflected in the new chapters of the Tax Code Part II and affected Value Added Tax, Excise Taxes, Individual Income Tax, Unified Social Tax and Profits Tax. Also affected was the Federal Law "On the Introduction of Amendments and Additions to Part II of the Russian Federation Tax Code and to Separate Russian Federation Legislative Acts." These changes aimed at improvement of Part II of the RF Tax Code were passed by the Duma and enacted into law in 2003. The ongoing tax reform has further improved procedural rules and reduced the overall tax burden in the country.
Implementing numerous changes in the Russian tax code inevitably results in varying levels of confusion. A general overview of Russian taxes follows, but companies operating in Russia should consult with a professional tax advisor to confirm details and stay abreast of developments.
The profits tax is levied on gross profits. Effective January 2009, the profit tax rate was reduced from 24% to 20% (18% of this amount is allocated to Regional authorities and 2% to Federal) to address the economic downturn. The regional authorities may, at their discretion, reduce their regional profits tax rate to as low as 13.5%. Thus, the overall tax rate can vary from 15.5% to 20%. Depreciation provisions were improved with the introduction of a 30% initial lump sum depreciation deduction and revision of non-linear depreciation rules. The tax rate was reduced in tandem with the introduction of more realistic interpretations of deductible expenses, the combined effect of which is to significantly reduce the profit tax burden and support Russian economy throughout the downturn period.
The provisions on profit taxation enable foreign companies operating in Russia to benefit from the reduced withholding tax rates and exemptions under Russia's dual taxation treaties (the U.S. and Russia have had a dual taxation treaty in place since 1992), which in certain cases could result in advantages to U.S. companies. For example, representative offices are permitted to deduct expenses incurred on their behalf by a parent company located abroad.
Value Added Tax (VAT) and Import Duties
VAT is designed as a tax to be borne ultimately by consumers, but is collected on a basis similar to the European Union model. VAT is calculated on the sales value and is applied at a uniform rate of 18%, except for certain foodstuffs, pharmaceuticals and children's clothes, which are taxed at 10%, and some products that are entirely exempt from VAT (certain financial services and medical equipment). As an attempt to increase R&D and investment in technology, as of January 1, 2008, non-tangible items such as inventions, software, industrial designs and production secrets are exempt from the VAT.
Imports are also subject to VAT, calculated based on the customs value of the item plus customs duties and fees. In addition, import duties are assessed at specified rates, ranging from 5% to 30%. They are assessed according to classification and are applied to the customs value of the imported goods, including shipping charges and insurance. Goods imported as in-kind contributions by foreign partners to the charter capital of a new enterprise may be exempt from import duties during a period specified in the charter documents and import VAT under certain conditions (e.g., the goods qualify as technological equipment which has no analogues manufactured in Russia). In general, goods manufactured or assembled in Russia, whether by a Russian or foreign company, and then exported, are not subject to VAT. If these goods are exported before payment is received, then no VAT should be collected. On the other hand, if payment is received before shipment, the exporter must pay the applicable VAT and then request a refund from the tax authorities.
Social Welfare Taxes
Effective since 2001, one Unified Social Tax (UST) replaced employers’ contributions to three separate social benefit funds (the Pension Fund, the Social Security Fund and Mandatory Medical Insurance Fund). A business is liable for the entire tax due and no amount is withheld from employees. The total liability for each employee is calculated based on monthly gross pay.
In accordance with the current Tax Code, all employers are obliged to pay UST on behalf of their employees. There is an annual descending scale for this tax – 26% on the first RR 280,000, RR 72,800 plus 10% of the amount in excess of RR 280,000 on earnings from RR 280,001 to RR 600,000, and 2% on all earnings over RR 600,001. Reduced UST rates apply to the following business categories: agricultural producers (20%), private entrepreneurs and farms (10%), and attorneys (8%).
Workplace accident insurance is paid by the employer in addition to the UST. Rates vary from 0.2% to 8.5% depending on the established class of professional risk.
Withholding on Dividends, Interest and Royalties
Foreign legal entities without a business presence in Russia are subject to a withholding tax of 6% on freight services rendered in Russia. Dividends are taxed at a rate of 15%, interest and royalties at a rate of 20%. These rates are often applied according to the relevant double taxation treaty. Lease payments and other income are subject to a 20% withholding rate.
Land, Property and Personal Income Taxes
Local authorities may levy a tax on land according to its type and location. The rate is higher in Moscow and St. Petersburg than in some other cities and rural areas. The personal income tax rate for Russian tax residents is a flat 13%, following tax reform over the last few years, which sharply reduced the former graduated rate (non-residents are taxed at 30% on the Russian-source income). When applied to expatriates, however, there may be some withholding requirements.
During the past 10 years, the franchising sector has developed in Russia mainly in consumer oriented segments such as fast food, retail, real estate services, education and training, fitness and health care, recreation and entertainment, travel and lodging, and automotive. Franchising in business-oriented services is also increasing. Examples of the business-to-business segments where franchise models are successfully used are: cleaning services and maintenance, transportation, logistics, express mail services, management training and consulting.
Franchising seems most visible in the fast food sector. Many local and international fast food franchise concepts successfully operate on the market, although it is far from saturated. Expansion of casual dining is expected over the next few years, as emerging local and new global players enter the market. Also, there is growing demand for cafes (coffee shops, tea rooms) as the culture of drinking coffee and tea in cafes is penetrating the Russian lifestyle. That demand is being partially met by the arrival of Starbucks into the Russian market in 2007, the emergence of smaller franchising concepts (Travelers Coffee) and augmenting traditional fast food services with additional services catering to coffee drinkers (McDonalds’ Café Mac).
Another large segment where franchise opportunities exist is retail trade. According to recent statistics published by Rosstat, Russian retail trade turnover for January -September 2008 amounted to RR 9.886 billion. During the same period in 2007, retail turnover was RR 7.598 billion. Industry experts agree that franchising development in such retail segments will continue to grow.
Currently, the share of the retail sector in franchising operations in Russia is 46%, and the fast food sector represents 22%.
Given the relatively underdeveloped state of some distribution channels in Russia, direct marketing has become a very effective and profitable alternative for customers, especially outside of Moscow and St. Petersburg. Telemarketing and fax marketing to business customers is common in Russian cities but not particularly effective. Other direct marketing channels (catalogs and e-commerce) are still in early stages of development.
By contrast, direct selling works exceedingly well and is cost effective for the distributor (e.g., health and beauty products) since it also develops an effective distribution network. For a large number of under-employed workers and pensioners in Russia, the option of supplementing their wages and pensions through working in direct sales is quite attractive. World Direct Selling Association statistics released in 2008 reveal that Direct Sales in Russia the previous year were worth US $ $2.78 billion and that almost 3.4 million salespeople engaged in direct selling. Major, well known direct selling companies such as Amway, Avon, Mary Kay and Tupperware are active in Russia. The Russian Direct Selling Association estimates that direct sales accounted for approximately 25% of the total cosmetics and toiletries in 2008. According to Russian law, companies may not use direct sales for such products as biologically active food additives and vitamins. At present, these products can only be sold through pharmacies, kiosks, and health stores.
Though not as common as in the past, U.S. companies may become strategic partners with Russian firms by taking an equity position in Russian joint stock companies and thus establishing joint ventures (JV). Establishing a JV in Russia demands meticulous planning and sustained commitment. In most cases, other forms of alliance, in which the U.S. partner retains managerial control, are preferable. JVs in which foreign partners hold minority stakes are dependent on the good intentions of their Russian majority owners. Experience shows that foreign minority shareholders face serious difficulty in protecting their interests in Russian courts.
One advantage of a JV is that it helps a U.S. firm gain a measure of Russian identity, which can be useful in a culture where many still view foreigners with suspicion. The May 2008 Strategic Sectors Law identified 42 industry sectors requiring the Russian government’s pre-approval of a foreign firm’s purchase of controlling interest. Additionally political pressure is mounting in Russia for domestic content mandates in key sectors or for large-scale procurements. For example, some foreign investments in the oil industry may be required to source 70% of their goods and services from Russian providers. Firms that creatively help oil producers meet these requirements will have an advantage in this industry.
Russian and U.S. partners often view JVs differently. U.S. companies, especially smaller ones, often view JVs as a means of securing a local partner with experience in the Russian market. On the other hand, many Russian managers view a foreign partner chiefly as a source of working capital and these managers may place a low priority on local market development. While there are many examples of successful JVs, a U.S. investor invites trouble when it cedes oversight of any aspect of a JV to a Russian partner which does not share the same objectives. Before making financial or legal commitments, U.S. firms should thoroughly explore whether a potential partner shares their priorities and expectations. Any firm that forms a JV in Russia should be ready to invest the constant personal attention of U.S. managerial staff to keep the business on course, both before and after the venture has achieved commercial success.
U.S. technology is sometimes licensed for Russian production outside the context of a joint venture. Major hurdles that must be overcome include quality levels attainable by Russian facilities in the absence of significant retooling, uncertain intellectual property protection and difficulty in receiving regular and prompt payments. In the opposite direction, Russian companies generally are eager to license their technologies to foreign companies in exchange for the cash infusion.
Selling to the Government
A law on federal procurement, adopted in May 1999, allows foreign firms to participate in public tenders if the product or service is not available from domestic producers, or if Russian production is not considered economical. Regional or local authorities are potential customers for U.S. suppliers. For example, the Federal Ministry of Health and Social Development and some of the regional administrations often buy supplies for distribution to hospitals and clinics. While local governments receive sharply reduced federal subsidies, they have the flexibility to make purchase decisions based on local factors and contacts. It should also be noted that there is pressure on many levels of government to purchase Russian goods and services. Since many federal and regional tenders are only available to local companies, U.S. manufacturers are advised to establish good working relations with local tender operators and seek appropriate local partners or distributors who will represent their products at the tenders.
Distribution and Sales Channels
Well-organized distribution channels have developed significantly over the last few years, particularly in the major population centers, such as Moscow and St. Petersburg, and have begun to expand to the regions. In the consumer sector, some large-scale retail stores have recently emerged in Moscow that are able to buy in bulk and negotiate relatively long-term commitments. Large shopping malls have opened up on the Ring Road circling the capital and are giving the Moscow retail environment more of the characteristics of other European cities. Shopping malls and big box stores are becoming common sights in St. Petersburg, Moscow and many other Russian cities.
By utilizing these increasingly professional domestic distribution organizations, the task of bringing goods to market in Russia has been greatly eased. However, their geographic coverage can be limited, and accessing markets in some of the regions can still be problematic. In these regions, U.S. firms may encounter erratic distribution, unpredictable (but tough) competition, and word-of-mouth marketing. Although Russia boasts increasing numbers of western-style stores in major cities, much distribution and retailing still takes place through such informal channels as kiosks and open markets. Those who succeed do so through a combination of improvisation and innovation, combined with a substantial investment of time and a tolerance for early mistakes. U.S. companies with a long-term market development strategy may find regional markets well worth exploring.
St. Petersburg remains the main port of entry for a variety of consumer and industrial products for European Russia (Russia west of the Urals). Vladivostok is the main port of entry for the Russian Far East. In general, the transportation infrastructure in this vast country is still underdeveloped and in need of major upgrades. The majority of cargo moves by rail and the road network need to be expanded. Major Western freight forwarders and express couriers are active in Russia.
As with any country, successfully marketing and selling goods and services in Russia requires adaptation to its commercial climate and business practices. Market research is required to identify opportunities and potential Russian business partners. The choice of a partner is key and should be done only after conducting sufficient due diligence to determine their reputation and reliability. The U.S. Commercial Service has services to assist with market research, identifying partners and conducting due diligence.
Both before and after launching operations, travel to Russia is strongly recommended to establish and maintain relationships with business partners and to understand market attributes. Marketing in Russia requires patience: exporters should maintain a long-term perspective and not expect immediate results. It can be helpful to network with companies already on the market, as well as business organizations, such as the American Chamber of Commerce in Russia and the U.S.-Russia Business Council.
Business planning should include advertising, market promotion and regular visits to Russia. When recruiting personnel or identifying business partners, local talent should be utilized, especially for government relations, which can be of critical importance, and professional services of all kinds, whether law, accounting or engineering, etc. Absentee management should be avoided; it is important to communicate regularly with Russian business partners to ensure common understanding of expectations. Partners can assist with required testing and certification, after-sales service, customs clearance, warehousing and preparation of Russian-language marketing and instruction materials.
Business should always be conducted in compliance with all Russian laws and regulations (taxes, customs, labor, etc.), as well as applicable U.S. laws and standard business practices, including corporate governance and accounting practices. Companies that undertake corporate social responsibility programs in the U.S. should consider developing a similar approach for the Russian market.
Exporters should avoid selling on open account until they have developed a well-established track record with buyers; letters of credit and other secure financing vehicles are available. Another option may be U.S. government or multilateral development bank financing, such as U.S. Export-Import Bank (Ex-Im Bank), U.S. Overseas Private Investment Corporation (OPIC) or the European Bank for Reconstruction and Development (EBRD). Exporters should be prepared to adjust prices according to currency fluctuations.
Russian purchasers are generally sophisticated and highly-educated. They are likely to be internet users and receptive to imported goods. Russian purchasers may be price sensitive, but are frequently willing to pay for quality, especially for recognized and reliable imported brands – another reason to invest in advertising.
E-commerce in Russia grew 30% in 2007, reaching $7.9 billion in sales. The business to-business e-commerce segment tripled in 2007 to $2.3 billion. The number of Internet users has increased dramatically over the past five years, reaching 40 million people or 28% of the population nationwide.
Over 30% of these users, however, are in Moscow and St. Petersburg. Future growth in Internet usage is expected to be significant, but e-commerce in general, business-to-consumer in particular, is constrained by the lack of online payment mechanisms. The number of online shops in the Russian market has reached 9,000, selling $1.7 billion worth of goods in 2007. Home appliances and electronics accounted for 39% of sales, while the fastest growing subsectors were cosmetics (at 1000%) and household goods (at 150%).
Although the number of consumers with credit and debit cards is increasing rapidly, many Internet businesses in Russia still do not accept online payments but rather use their websites as a front end for the buyer to select the goods and place an order to be delivered COD. Businesses offering goods or services that can be accessed immediately (electronic downloads, and service account top-ups, for instance) offer credit card payment options most frequently. E-currency payments are also an option. Additionally, the number of consumers with credit cards who are willing to use them online is very low and remains a key constraint to the growth of catalog orders and e-commerce. Many customers are reluctant to use credit cards online because of the risk of fraud. Nevertheless, sales through these channels are expected to grow rapidly in the coming years. The Russian government’s “E-Russia” program is intended to stimulate the growth of e-commerce throughout the country using federal and local E-government initiatives as a catalyst.
Trade Promotion and Advertising
Television, radio, print, and billboard media are ubiquitous in the Russian market. Most international advertising agencies are active in Russia, along with domestic agencies, and the quality of their services is world class.
Until the economic crisis of late 1998, and the subsequent devaluation of the ruble, foreign multinational consumer products companies provided most of the revenues for Russia’s budding advertising industry. These revenues collapsed after the crisis, as imported goods became prohibitively expensive for most Russians. However, strong economic growth since 2002, and increasing incomes have resulted in a resurgence of the advertising industry. Today, their clients include successful Russian manufacturers of consumer goods, particularly of processed foods and beverages. Federal Law #9 allows Russian regional authorities to require all companies distributing outdoor advertising to pay a 15% unified tax on imputed income.
Because of the economic crisis that began in Russia in October 2008, many companies have pruned their advertising budgets. Other firms, however, consider the reduction in the amount of advertising to be a perfect opportunity to increase their company’s recognition. In this context, most advertising agencies are reconsidering their approach to the communication mix and are increasing their share of non-standard communication methods such as “below the line” (BTL), trade programs, ambient media, and flashmobs (publicity stunts).
Russian consumers are attracted to bargains, but are increasingly willing to pay for quality merchandise. U.S. companies exporting to Russia should be prepared to offer competitive prices for their goods, knowing that in many areas they face inexpensive Russian and strong European and other third-country competition. With a few exceptions, all goods and services sold in Russia are subject to a value-added tax of 18%. As noted above, imports into Russia are subject to VAT, which is assessed on the CIF value of an imported shipment plus applicable duty. In addition, in many sectors with strong local and third-country competition, it will be necessary to spend money on advertising and brand promotion. All these costs should be figured into the U.S. exporter’s pricing structure and become part of a long-term marketing and sales program.