* Levy plans on bonds issued by Jan. 1, 2013 scrapped
* Bonds placed after 2013 taxed only on interest to SPVs in offshore jurisdictions
* Initial plans to collect levy caused furore among issuers (Adds analyst and investor comments, market reaction)
By Jason Bush and Lidia Kelly
MOSCOW, Feb 21 Russia is scrapping plans to collect tax on corporate Eurobonds placed before Jan. 1, 2013, following a storm of protest from major Russian companies and banks who warned that the move threatened seriously to dent fragile investor confidence.
Russia's finance ministry said late on Monday that it is dropping the idea and may apply only a partial levy to papers issued from next January onward.
The ministry's statement provides reassurance to international bondholders of Russian companies, who faced the prospect of significant losses if issuers had redeemed their bonds at par in response to the ministry's earlier proposal to withhold 20 percent profit tax on interest payments at source.
"The ministry of finance is treating investors in the right way - it's an investor-friendly decision - and in this respect it's a positive outcome," said Elena Kolchina, fund manager of the Renaissance Russian Debt Fund in Moscow.
"The immediate source of investor concern appears to have been removed," said Mikhail Galkin, a fixed income analyst at VTB Capital.
"From an investor standpoint that was the only risk: There was no risk of suffering from the tax - there was a risk of high cash price bonds being redeemed early at par."
Some of Russia's biggest corporate borrowers, including top gas producer Gazprom and its second largest state bank VTB, had been facing large bills in relation to existing bond programmes.
Oil pipeline monopoly Transneft had threatened to redeem over $4 billion bonds at par in response to the proposals outlined by officials in recent months.
"First, as regards interest income paid on Eurobonds issued prior to Jan. 1, 2013, we propose to fully release Russian borrowers from any obligations to withhold tax, i.e. from obligations to act as tax agents (including interest income that has already been paid to investors)," the ministry said in a statement.
Corporate Eurobonds issued after Jan. 1 of next year will be taxed only on interest income received by an intermediary located in an offshore jurisdiction which has no double-tax treaty with Russia, the ministry said.
Russian corporate Eurobonds saw only a small positive reaction after the finance ministry's announcement, with the yield on 2018 bonds of Gazprom, the largest corporate issuer, tightening by just 3 basis points on Monday and Tuesday.
Analysts said that the reaction was muted because of previous indications that the ministry was retreating from its original position, following the strongly negative reaction from issuers and investors.
"When these rumours first appeared people were a bit scared, but then everyone calmed down. It's just official confirmation that nothing bad will happen," said Kolchina.
The yield on Gazprom's 2018 bond has tightened by around 45 basis points since peaking on Feb. 8, having previously risen by around 50 basis points in the two weeks after the finance ministry's initial proposal was publicised in late January.
Deputy Finance Minister Sergei Shatalov had recommended, in a letter to tax officials at the end of last year, that by Russian law companies issuing Eurobonds were obliged to pay 20 percent profits tax on interest at source.
The finance ministry had also insisted that payments to foreign debt holders through offshore units called special purpose vehicles (SPV) are taxable under the existing Russian law, but this tax has not been collected in the past.
Russian corporates, which have over $100 billion in Eurobonds outstanding, could face a back-tax bill for $600 million, Shatalov said earlier this month.
While the finance ministry has ditched its previous plan to impose the tax retroactively, the introduction of withholding tax from next year may potentially raise the cost of issuing Eurobonds in future.
"Higher borrowing costs could keep Russian borrowers from frequent Eurobond issuance starting in 2013, and it would likely push issuers to use alternative sources of funding, including the local bond market," VTB Capital said in a research note on Tuesday.
However, analysts said that the impact of the tax should in practice be limited because of further changes to the finance ministry's position, which would enable the majority of issuers to avoid paying the tax.
"The issuers will be able to prove easily to the tax authorities that they don't need to pay the tax," said Dmitry Dolgin, a fixed income analyst at Alfa Bank.
"There is one condition for issuers to be exempt, which is that they provide the identification not of final bondholders, as was the case under the previous proposal - which is impossible - but only first-tier bondholders, who are tax residents of countries with which Russia has double taxation agreements."
Such first-tier bondholders are usually easily identifiable structures such as depositories, located in countries with double tax treaties with Russia, he said.
Despite the resolution of the Eurobond taxation issue, analysts said that the spat has been negative for Russia's investment climate, as it comes as a reminder of the pitfalls in Russia's often complex laws, and of the often poor co-ordination among policymakers.
"We never know where other taxation traps may be hidden in the legislation," Dolgin said. (Writing by Jason Bush and Lidia Kelly; editing by Stephen Nisbet)