As announced by the Russian President on 25 March 2020, the Russian Ministry of Finance has sent an official request to the Ministry of Finance of Cyprus to modify the existing double taxation treaty (DTT) between the two countries.
Cyprus is expected to reply by 15 June 2020.
If Cypriot authorities refuse to negotiate the requested amendments to the DTT, Russia reserves the right to terminate the DTT unilaterally.
Contents of the requested amendments
As specifically mentioned in an official letter from the Russian Ministry of Finance (of which CMS Russia obtained a copy), despite the international efforts aimed at fighting tax-base erosion and profit shifting, multinational enterprises continue structuring their businesses in tax favourable jurisdictions in such a way that shifts profits from Russia. This gives rise to unfair tax competition, negatively affecting good-faith taxpayers in Russia.
Based on the text of the letter and a draft Protocol of DTT amendments attached to it, the following modifications have been proposed:
• The withholding taxation rate on dividends under Article 10 of the DTT will be increased to 15% (which is the equivalent of the withholding tax rate applicable to dividends under Russian domestic law).
Currently, applicable DTT rates vary from 5% to 10%, depending on fulfilment of investment criteria.
• Article 11 of the DTT will be amended to introduce withholding taxation of outbound interest payments at a 15% rate.
Currently, such cross-border interest payments are exempt from withholding taxation under the DTT.
As evident from the letter, Russian authorities have ultimately chosen the most straightforward approach to addressing the President’s announcement, immediately increasing withholding taxation rates both to outbound interest and dividends payments.
Previously, the business community expected that the initiative to increase withholding rates would be applied in a more limited manner, such as aiming it at structures that lack real economic substance and which were put in place solely for tax-avoidance purposes.
If the requested amendments are introduced to the DTT, it may be reasonably expected that newly increased withholding tax rates will not only apply to direct payments made to Cypriot entities, but also indirect ones made through other jurisdictions, provided that the ultimate beneficial owner of such income is located in Cyprus (based on recent court practice on beneficial ownership issues).
However, should Cyprus refuse to introduce the requested changes, the DTT will be terminated unilaterally, and outbound payments made from Russia will be subject to domestic law regulations leading to:
• the application of a 15% domestic withholding tax rate on dividends payments;
• the application of a 20% withholding tax rate on other outbound payments (e.g. interest, royalties, etc.) subject to withholding taxation in Russia under domestic rules; and
• the termination of tax information exchanges, potentially resulting in toughened tax rules for structures falling under specific transfer pricing requirements or rules applicable to controlled foreign corporations in Russia.
Also, in this context, it is highly probable that other jurisdictions will be approached for DTT modifications in the short run. These jurisdictions are likely to include the Netherlands, Switzerland and Luxembourg, which are frequently used as locations for transit-holding companies due to their attractive tax regimes.
If the requested amendments are introduced or even if DTTs with such jurisdictions are terminated, it will be necessary to reconsider existing corporate structures in particular to remove intermediary layers lacking real economic substance. As the respective changes to DTTs can be expected as early as 2021, companies should make internal analyses as soon as it is apparent what the concerned jurisdictions will be.
By Dominique Tissot, Partner, and Maria Kabanova, Senior Associate, CMS Russia