Double taxation treaties with unfriendly jurisdictions

On 15 March 2023 the Russian Ministry of Finance and the Ministry of Foreign Affairs published a proposal to suspend double taxation treaties (“DTTs”) with all countries that have imposed unilateral economic restrictive measures against Russia. We believe that the countries in question here would be those that, in accordance with Government Decree No 430-r dated 5 March 2022, are recognised as unfriendly.

If this initiative is ultimately supported and the President issues such a decree, the consequence will be, inter alia, the application of the default tax rates under the Tax Code on Russia-sourced income, specifically:

• 10% – withholding tax on income from international transportation (as defined in the Tax Code of the Russian Federation), the lease or sublease of ships, aircraft, rolling stock, containers used in international transportation (there is an exemption under a number of agreements);
• 15% – withholding tax on dividends (and other income treated as dividends) paid to a foreign company that is a resident of an unfriendly jurisdiction (instead of 5 or 10% as established by various treaties);
• 20% – withholding tax on interest, royalties, lease of property located in Russia (other than those taxed at 10%), fines and penalties for a breach of contractual obligations and other similar income.

This measure would reinforce a 20% Russian capital gain tax on income from the sale of (i) immovable property located in Russia; (ii) shares/participation interests in property-rich companies (having directly or indirectly more than 50% of assets consisting of immovable property located in the Russia); or (iii) derivative financial instruments from such shares/participation interests.

Practical comments

Given that the legislative construct of this initiative is announced as the unilateral suspension and not the termination of DDTs, the whole process can be carried out rather quickly.

Russia recognises that there is no mechanism for suspending DDTs prescribed in the OECD Model Tax Convention on Income and on Capital or the UN Model Double Taxation Convention between Developed and Developing Countries, which were taken as the basis for drafting the current Russian DDTs with a number of unfriendly jurisdictions.

As a result, Russia does not plan on following the special procedure provided for in the relevant article of the DDT (in particular, notifying the other party of the denunciation at least six months before the end of any calendar year).

In practice, DDTs with unfriendly jurisdictions can be suspended immediately on the date of signing a presidential decree. Given this “simplified procedure,” this could happen as early as the next few weeks of 2023 (and not from 1 January of the following year, as in the case of denunciation, eg with the Netherlands).

The Ministry of Finance and the Ministry of Foreign Affairs proposed suspending DDTs with unfriendly jurisdictions from the moment the relevant decree is issued for an indefinite term until the infringed rights of Russia are restored.

Given that this measure was initiated not by specific public individuals but by the relevant ministries, there are all grounds to believe that this measure may be implemented without delay.

Foreign multinationals that are residents of unfriendly jurisdictions with Russian subsidiaries expecting to rely on DTTs should review available planning opportunities to protect income, which can still be distributed out of Russia (such as royalties or dividends within the RUB10 million monthly caps), from excessive taxation by the Russian withholding tax triggered by this legislative change.