In his address to the nation on 25 March 2020, the Russian President requested the government to implement measures ensuring the adequate taxation of Russian-sourced dividend and interest payments to "offshore" jurisdictions. These measures are aimed at supporting expenditures to be undertaken by the state in connection with COVID-19. Below we discuss the proposal and its impact.
The President's proposal is focused on Russian sourced dividends and interest income that are "channelled" to "offshore" jurisdictions by taking inappropriate advantages of Russia's tax treaties. The Russian government was requested to renegotiate tax treaties with so called "transit" countries (i.e., countries through which Russian-sourced income and investments are transferred through the most).1
On 28 March 2020, this proposal was formalized into a direction ("porucheniye") to the government (a) to put together a list of Russia's relevant double tax treaties; and (b) to take steps either (i) to amend these treaties by introducing a 15% standard rate for withholding income tax ("WHT") on dividends and interest at Russian source; or (ii) to terminate them. The government is to report on the implementation of these measures by 25 December 2020.2
On 13 April 2020 the Russian Ministry of Finance announced that it has already approached the competent authorities of Cyprus, Luxembourg and Malta and proposed to amend the relevant treaties by introducing a 15% standard tax rate at source for dividends and interest income.3 At the same time, the Ministry of Finance stated that "amendments will not affect interest income paid on Eurobonds connected loans, on Russian companies' bonds and on loans obtained from foreign banks" and that "taxation of such interest income will be regulated by Russian domestic tax laws".
A copy of the Russian Ministry of Finance's letter dated 31 March 2020 and addressed to the Ministry of Finance of Cyprus is available on various websites. According to the letter, the Ministry of Finance proposed to amend articles 10 ("Dividends") and 11 ("Interest") of the Russia Cyprus tax treaty, by introducing a 15% standard rate to limit Russian WHT on dividends and interest. The letter also stated that Russia reserved the right, in the case of a disagreement with regard to the proposed amendments, to unilaterally terminate the Russia-Cyprus tax treaty.
As a general rule, amendments to a treaty require an amending protocol to be signed and ratified in each treaty country (in Russia - in the form of adopting a ratification law), followed by exchange of ratification notes. Unilateral termination of a tax treaty requires a termination notice (as well as in Russia - adoption of a termination law). Therefore, it is realistic that the tax treaties in question (such as the Russia-Cyprus tax treaty) will be either amended or terminated by 1 January 2021.
Impact of treaty amendments
Which tax treaties are affected?
There is no published list of the tax treaties that are short-listed for renegotiation. The three countries that have been already approached by the Russian Ministry of Finance could be seen as logical "candidates" (being known more as locations for international group's holding or finance companies rather than for their domestic ultimate investors into Russia). It is yet to be seen whether the list will be extended further.
What benefits will remain after the tax treaty is amended?
Dividends. If amended as proposed, the relevant tax treaty would no longer reduce Russian WHT of 15%. (Compare: currently, under tax treaties with each of Cyprus, Luxembourg and Malta, reduction down to 5% WHT is possible under certain conditions.)
For multinational enterprises (MNEs) and other international groups affected, now could be a good time to rethink their corporate and tax planning as well as their organizational structures. In particular, the following steps may be considered in developing a strategy in light of the new circumstances: eliminating intermediate corporate layers in the countries affected by the proposed amendments; utilizing "look-through" taxation rules; changing tax residence to Russia; redomiciling to Russia (by registering an "international company" in one of the Special Administration Regions); streamlining public offering structures by direct listing of Russian shares (including through depositary recipients).
Interest on intragroup loans. If amended as proposed, the relevant tax treaty would allow the reduction of a Russian WHT of 20% down to only 15%. (Compare: currently, under the tax treaties with Cyprus and Luxembourg, full exemption is possible under certain conditions.)
Thin capitalization rules (intragroup loans). If amended as proposed, Russian WHT would be the same for all interest on a controlled loan (including any part of the interest recharacterized as a dividend).
Interest on loans borrowed from foreign banks. It is yet to be seen as to how interest income payable to foreign banks would be safeguarded from the proposed treaty amendments (as explained by the Ministry of Finance; see above). Note that no special rules are apparently proposed for Cyprus banks. In any event, any safeguarding would likely benefit only a direct debt owed by a Russian ultimate borrower to a foreign banks (i.e., no interim on lending).
Interest on Eurobond connected loans. As noted by the Ministry of Finance, Eurobonds connected loans should not be affected by the proposed amendments.
Indeed, the Russian Tax Code exempts a Russian borrower from an obligation to withhold Russian WHT from interest on Eurobonds-connected loans, provided that (i) the Eurobonds are "traded" (Eurobonds are listed on a designated stock exchange/online trading system and/or rights to them are recorded in a designated depositary-clearing institution); and (ii) the issuer is tax-resident in a country that has a tax treaty with Russia. Hence, amendments to the relevant tax treaty should not affect Eurobonds-connected loans, but the tax treaty must remain in place.
Thus, for issuers of Eurobonds established in the countries affected by the proposed amendments, it would be important to closely watch further developments with regard to the proposed treaty amendments and to consider in a timely manner whether any structural adjustments are warranted in the event that the relevant tax treaty is terminated.
Interest on Russian companies' bonds. As noted by the Ministry of Finance, interest paid by Russian corporates on their bonds should not be affected by the proposed amendments. However, this needs to be monitored further.
Under the Russian Tax Code, WHT rules vary depending on the type of bonds issued by a Russian corporates: (i) foreign law governed bonds – a Russian issuer is exempt from the obligation to withhold WHT provided that the bonds are "traded" (within the same meaning that applies to Eurobonds connected loans); (ii) RUB nominated listed bonds (issued between 1 January 2017 and 31 December 2021) and mortgage bonds – 15% WHT (or 20% WHT due to some ambiguities in the Tax Code); (iii) other bonds – 20% WHT. Notably, none of these instruments are safeguarded from thin capitalization rules (unlike Eurobond connected loans). It is our view that for these instruments to be properly safeguarded from the proposed amendments and to be fully exempt from Russian WHT, the exemption from thin capitalization rules would be helpful.
Click here to download 'Amendments to Russian Tax Treaties' PDF in Russian.
1 President's address to the Russian nation dated 25 March 2020 (http://kremlin.ru/events/president/news/63061).
2 President's directions to the government dated 28 March 2020 (http://kremlin.ru/events/president/news/63080).
3 See the official website of the Ministry of Finance: https://www.minfin.ru/ru/press-center/?id_4=37027-minfin_rossii_napravil_pisma_ob_izmenenii_soglashenii_ob_izbezhanii_dvoinogo_nalogooblozheniya_s_lyuksemburgom_i_maltoi.
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