Moscow Throws Oligarchs Lifeline in Form of ‘Offshore’ Zones in Kaliningrad and Vladivostok

On April 9, Prime Minister Dmitry Medvedev asked his Cabinet for specific measures to alleviate the consequences of the economic sanctions the United States passed (on April 6—see EDM, April 9) against Russian companies and individuals, with metallurgy, the energy sector and the defense industry being priority areas (Vedomosti, April 10). The next day, the Ministry of Finance proposed establishing two offshore economic zones, in Kaliningrad (October Island) and Vladivostok (Russky Island), that could be used to blunt the effect of the US sanctions (Kgd.ru, February 2).

The idea to turn Kaliningrad into an “offshore tax haven” dates back at least 15 years. Yet, serious policy discussions on the matter started only in 2014. Notably, the director of the Institute of Problems of Globalization, Mikhail Delyagin, suggested then that the creation of a financial offshore zone in Kaliningrad could benefit not only members of the Moscow-led Eurasian Economic Union (EEU), but even some European businessmen/entrepreneurs (especially from France, Germany and Poland) given the decreasing number of tax heavens in the European Union. Of course, such an initiative would have effectively put an end to long-running speculation about the possibility of developing heavy domestic industry and manufacturing in the exclave oblast—a questionable economic development scheme from the start considering Kaliningrad’s physical detachment from mainland Russia (Rosbalt, July 9, 2014). In 2017, during that year’s Eastern Economic Forum, Russia’s First Deputy Prime Minister (2012–2018) Igor Shuvalov similarly endorsed the idea of creating an offshore zone in Kaliningrad. Subsequently, the oblast’s authorities also expressed confidence in such a decision: “[Turning] Kaliningrad into an international financial center, which could attract not only Russian but foreign financial resources,” would be extremely beneficial both for the oblast and sanctions-hit businesses, the local argument went (Kgd.ru, September 6, 2017).

The current proposal on the offshore zones states, “[T]hose interested in returning their money back to Russia could do so promptly and without imposition of any form of taxation on externally acquired assets,” if they fully reinvest this wealth in the planned Kaliningrad or Vladivostok offshore areas (Rugrad.eu, April 10). On the surface, this seems like a promising policy initiative. The policy text was reportedly prepared jointly by a group of lawyers from the Skolkovo high-tech park outside Moscow, experts from the International and Comparative Law Research Center and specialists from the Moscow Higher School of Economics (HSE), with the participation of specialists from the Ministry of Economic Development. Interestingly, the main purpose reflected in the proposal is concerned “not with repatriation of financial capital for companies hit by economic sanction,” but with “the replacement of standard offshores used by Russian and international business” with Kaliningrad and Vladivostok (Pregel.info, accessed May 26).

Additionally, the proposed legislation outlines the following key ideas (Kommersant, April 12):

– Creation of a “maritime shipping offshore” (including potentially removing restrictions on hiring foreign personnel and contractors at Russian merchant shipping firms operating there), also with the possibility of registering aviation transport companies in a similar manner;

– The possibility to carry out medical and educational activities in the offshore zones without licensing;

– A simplified system for changing legal jurisdiction (while preserving the firm’s existing corporate and legal structure), quickly (within 24 hours) and without additional legal procedures;

– Facilitated economic transactions with non-residents for local businesses (while remaining under Russian legal jurisdiction) in foreign currencies via designated banks.

The Russian side has, thus, purposefully presented a broad catalog of possibilities/options in order to be able to reach out to both foreign and domestic companies with this proposed scheme to optimize their tax burdens. Indeed, the list of expected participants is an interesting subject in its own right. Moscow believes that its offshore schemes can attract firms from countries such as Switzerland, Austria, Belgium, China (Hong Kong), Hungary, Ireland, Israel, Latvia, Lichtenstein, Luxemburg, Portugal (Madeira Islands), the United Arab Emirates (primarily Dubai), Singapore, the US (the state of Delaware), Belize, Bermuda Islands, the British Virgin Islands (BVI), the Cayman Islands and Cyprus. However, the list conspicuously excludes the United Kingdom, which has traditionally been one of the main recipients of outflowing Russian financial capital (Kommersant, April 12).

News of the possibility of opening offshore zones in Kaliningrad and Vladivostok triggered intense discussions in the Russian mass media and expert community. But despite the noticeable splash of optimism, particularly in the Russian conservative media and among Kremlin-connected experts (Regnum, April 14), the dominant reception to the idea has been rather pessimistic. For instance, the managing partner of the International Tax Associates, Rustam Vakhitov, stated the dual offshore projects are unlikely to succeed. Primarily, he points to the fact that this initiative will run contrary to the practices adopted by the EU, whereby artificial support for the maritime and air transportation sectors is strictly prohibited. According to Vakhitov, if Russia pushes ahead with this initiative, it could result in the blacklisting of these transit firms by EU financial regulators. In turn, those measures would likely result in Moscow passing its own package of counter-measures, which would deal a detrimental blow to the nascent offshore economic zones (Fingazeta.ru, May 17).

Likewise, a partner at the Paragon Advice Group, Alexander Zakharov, explicitly called the government’s proposed initiative “unrealistic.” He pointed to the fact that “granting any entity a tax regime separate from the rest of the country (thereby elevating one group of taxpayers over others) will violate the basic principle of the Russian constitution.” More importantly, the expert pointed to the example of Crimea, where an established Special Economic Zone (SEZ) has already demonstrated its weakness and inability to attract large businesses (Kommersant, April 12). And it is worth mentioning that all previous attempts to attract foreign investors to Kaliningrad through similar schemes also brought few practical results over the years (see EDM, September 27, 2016; January 10, 2018).

Even if Kaliningrad and Vladivostok become offshore zones in the coming months or years, substantial foreign interest is unlikely to materialize. Economic sanctions as well as the lack of stability and predictability in the Russian economy will probably ward off potential investors. That said, Moscow’s interest in this project points to a specific conclusion: Despite buoyant rhetoric, the US-imposed economic sanctions are apparently having a serious impact on Russian oligarchs and financial tycoons, who have now intensified their search for a way out of the current situation.