In August 2016, the Russian Ministry of Finance issued additional explanations on the taxation of Eurobond transactions.
Previously, from 2011-2015, Russian tax authorities had tax claims on banks’ Eurobond transactions, especially if these bonds were purchased from non-residents of Russia. The tax authorities considered the accumulated coupon yields to be equal to loan interest. Therefore, applying by analogy the rules of double taxation agreements (DTA), the tax authorities requested the disclosure of the ultimate beneficiaries of the accumulated coupon yields from the banks. Banks refusing to disclose beneficiaries were considered to be the actual income receivers and charged with a 20% income tax on the accumulated coupon yield. Two major Russian banks – Gazprombank and Khanty-Mansyiskiy Bank Otkritie – suffered from decisions of the tax authorities. Subsequently, the courts supported the position of the tax authorities.
The situation with both banks was quite similar: A Russian bank purchased Eurobonds from a foreign broker. Upon further inspection, the tax authorities identified an accumulated coupon yield accrued in respect of all bonds. In fact, it was the sellers of the bonds who were responsible for paying the taxes from these amounts; however, since the banks provided no information on the counterparties’ residency, they were charged instead.
According to the new explanations recently issued by the Russian Ministry of Finance, only the interest income from Russian borrowers is taxable under this scheme. In both cases mentioned above, the borrowers were foreign SPVs, i.e., the bonds were issued by foreign issuers. Hence, such coupon yields are not taxable in Russia. The same rule applies to the accumulated coupon yields arising from the acquisition of Eurobonds from foreign companies on secondary markets.
In principle, foreign securities should not be taxable in Russia. Subject to the amendments to the Tax Code implemented in 2012, Russian companies were exempt from taxes arising from foreign Eurobond issues made through SPVs. However, Russian tax authorities often concluded that SPVs should not be regarded as separate legal entities, considering them instead as conduit companies concealing bond emissions of the Russian borrower. The tax authorities used to suggest that since there are Russian companies behind the SPVs, then the interest income should be taxable as it was for Russian taxpayers as well. The main problem is that the Tax Code has no direct definition of the term “funds source.” On the one hand, the accumulated coupon yield appeared outside of Russia in this case. On the other hand, it is payable by a Russian bank. This lack of formal determination still exists and has yet to be amended.
Additionally, it is still unclear whether the common DTA rules for loan interest taxation apply to the accumulated coupon yields as well. Russian courts tend to hold the opinion that the accumulated coupon yield is the Eurobond interest; hence, subject to OECD guidance, the ultimate beneficiary must be disclosed. If the person formally receiving the interest is not the actual owner of the profits, then that person is not subject to any incentives and preferences provided by the DTAs. The courts came to such conclusions in cases involving the quite large MDM Bank and the Capital company. The position of the courts is not logically perfect; since the interest shall formally be accrued with respect to the issuer’s debt towards the bond holder only, the issuer shall not take any part in the resale of the bonds on the secondary market. Therefore, the bank as a buyer of the bond on the secondary market is not always capable of identifying the actual receiver of the income, since it is buying a bond, but not lending any money.
New explanations from the Ministry of Finance should decrease the risks of extra tax charges for bond buyers – however, they will not eliminate them completely until the Tax Code is amended accordingly.