Russia reviews double tax treaties

As we have already informed, on March 25, 2020, President of Russia Vladimir Putin instructed the Russian Government to arrange for updates to Russia’s double tax treaties (DTTs) with “certain” countries to change how dividends and interest are taxed.

The Russian Government didn’t take long to respond.

On March 31, 2020, Russia’s Ministry of Finance sent a letter to the Ministry of Finance of the Republic of Cyprus proposing to sign a new Protocol to the Russia-Cyprus DTT.

Below we make more detailed predictions as to what may happen next.

Considering that Russia’s Ministry of Finance quickly started taking the steps articulated by the president, there is reason to believe that similar proposals to amend treaties will also be made to other countries.

It is already clear from the Cyprus example that the proposals will be not only to have the Protocols to the DTTs set the minimum rate of tax on dividends at 15%, but also to set a minimum withholding tax of 15% on interest (this rate will be subject to prove of the beneficial ownership for interest).

The key issues as of today are the following:

  • Which countries will receive a similar proposal (will the number of such countries be huge)?
  • How will it all end?

Russia’s Ministry of Finance stated the following in its letter to the Ministry of Finance of the Republic of Cyprus: “Despite international efforts aimed at addressed the issues of base erosion and profit shifting, multinational enterprises are continuing to employ structures and arrangements leading to profit shifting from the Russian Federation to jurisdictions where they are subject to non-taxation or reduced taxation. That causes unfair tax competition for domestic bona-fide taxpayers. To address this issue the Ministry of Finance of the Russian Federation is offering to amend the Agreement with respect to the taxation of the dividend and interest income and increase tax rate for such type of income to 15%.”

So, as we had supposed, Russia has decided to take radical steps to “close the issue once and forever” with transit countries instead of continuing to develop and use mechanisms and concepts to combat abuses (which could ensure not affecting the interests of real business).

Cyprus is of course more widely used in tax planning than other countries. However, considering the current situation, the measure articulated by the president will hardly be used with such surgical precision. Proposals will also most likely be made to Luxembourg and the Netherlands, and possibly Singapore, Switzerland, Malta and other jurisdictions.

In its letter Russia’s Ministry of Finance asked the Cyprus Finance Ministry to respond “by June 15, 2020.” That indicates how quickly the situation could develop.

Given this, sometime we expect that in June there could be either official negotiations or Russia could start to take unilateral action to withdraw from the DTT.

If the countries agree to sign a new Protocol with Russia:

  • The rate of tax on dividends payable to companies from jurisdictions with which a Protocol is signed will be fixed at 15% at source in Russia.
  • The rate of tax on interest payable to companies from jurisdictions with which a Protocol is signed will be not below 15% at source in Russia; however, if the recipient is not the beneficial owner of income, then the general 20% rate will apply at source in Russia.
  • The number of possible tax authority claims and cases of requalification of intragroup payments (royalties, fees for intragroup services) into dividends could go up.
  • If taxpayers keep foreign companies in their structures and, for example, apply the look-through approach to taxation of dividends and interest at source in Russia, the number of rejections in application of this approach could grow.

If the countries refuse to sign a new Protocol and Russia withdraws from the treaties:

  • There will be no mechanisms for avoiding double taxation with those countries.
  • Not only will the rate of tax on dividends and interest at source in Russia be 15% and 20%, respectively, when payments are made to companies from those countries, but the tax on other types of income taxable at source in Russia will be charged, according to the local rules, at the 20% rate.
  • Information exchange with those countries could end.
  • Other problems will also arise because there is no DTT (for example, for Russian borrowers who use funds from bonded loans abroad).

We recommend monitoring these events and assessing in advance whether the actions described above could adversely impact your business. It is clear that these changes will require a review of both ownership structures and financing models.

Dentons’ Tax practice has extensive experience advising on international tax matters and supporting tax disputes with the tax authorities in this sphere and is prepared to provide practical assistance in resolving these issues.

Dzhangar Dzhalchinov

About Dzhangar Dzhalchinov

Lidia Charikova

Lidia Charikova