Development of Russian court practice on taxation of dividends distributed to a Russian branch of a foreign parent company

On 4th of October 2016 the Commercial Court of Tambov Region delivered a judgement in case No. А64-3695/2016 under the claim of “Uvarovsky Sugar Plant” Closed Joint Stock Company (the “Company”).
The case demonstrates that the courts are ready to support an application of reduced tax rates under double tax treaties in uncommon situations.
The court deemed that the Company had lawfully applied withholding tax at the tax rate of 5% with respect to dividends, which were distributed to the Russian branch of the Cypriot parent company. The branch had furtherly transferred the dividends to a third party as repayment under a loan agreement.
It should be noted that the Company hadn’t withheld the tax when distributing dividends (as the Russian tax law requires). But while the tax authority had been examining tax audit’s materials, the Company had paid the withholding tax at the tax rate of 5%.
The court took into account the following circumstances:

  • there was a certificate of tax residency of the Cypriot parent company in the case file;
  • the tax authority did not challenge the fact that the Cypriot parent company had invested more than €100,000 in the Company’s capital;
  • according to Article 10(4) of the Russian-Cypriot double tax treaty, preferential tax rates for dividends shall not apply if the beneficial owner of the dividends, being a resident of Cyprus, carries on business in Russia through a permanent establishment located in Russia, or performs independent personal services from a fixed base situated therein, and the dividends are effectively connected with such permanent establishment or fixed base;
  • the Cypriot parent company, being the shareholder that received dividends from shares, was entitled to dispose the entire amount of dividends at its own discretion, determining destination and timing for payment;
  • there was an evidence in the case file that the branch had followed the explicit instruction from the Cypriot parent company’s head office about where to pay the dividends;
  • the tax authority failed to prove that the disputed dividends were related to the branch’s activity and that the branch disposed those amounts at its own discretion.

In this case the tax authority focused on the formal circumstances of inability to apply the benefit under the Russian-Cypriot double tax treaty. In turn, the court took a rather brave stance and allowed the taxpayer to apply the reduced withholding tax paid within the tax audit.
Dentons’ Tax practice experts have an extensive experience in supporting tax audits of Russian companies paying income to foreign companies. Dentons’ tax practice experts would be happy to review your process of application of tax benefits under double tax treaties and if needed to support you in tax audits, considering the latest trends in the practice of applying the laws.

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Dzhangar Dzhalchinov

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Boris Bruk

Boris Bruk