Clause 3 of the Decree instructs the Government to prepare and submit to the State Duma a draft federal law on the suspension of the tax treaties mentioned in the Decree.
From what moment are the DTTs suspended?
The provisions of the affected DTTs do not apply from the date of the publication of the Decree, ie from 8 August this year.The treaties, as far as the relevant provisions are concerned, are suspended but not denounced. The Decree presumes that Russia does not have to follow the special procedure provided for in the relevant article of the DTT, in particular, notifying the other party of denunciation at least six months before the end of the year.
Therefore, from a tax perspective the relevant Russia-sourced payments made already after 8 August will be taxed in Russia at the rates stipulated by the Tax Code of the Russian Federation (“RTC”), rather than the relevant DTT. These tax consequences will be fully applicable despite the fact that the corporate, contractual or other documents formalising such payments were executed before 8 August 2023 and the payment itself is made after that date. According to the legal position declared by the Russian Ministry of Finance and the Federal Tax Service, when paying income from Russian sources to foreign recipients, the Russian party (being a tax agent) should apply the withholding tax rate as at the date of such payment.
The legal basis for the suspension of the DTTs
Clause 4 of article 37 of Federal Law No. 101-FZ “On International Treaties of the Russian Federation” dated 15 July 1995 (“Federal Law on International Treaties”) sets out that the legal effect of an international treaty signed by Russia, where the decision on consent for such to be binding on Russia was adopted in the form of a federal law, may be suspended by the President. This is possible in cases requiring urgent measures to be taken, with the obligatory immediate informing of the Council of Federation and the State Duma and submission to the State Duma of the draft of the relevant federal law.In accordance with article 39 of the Federal Law on International Treaties, the suspension of an international treaty, unless the treaty provides otherwise or there is another agreement with its other parties, releases Russia from the obligation to perform during the period of suspension the treaty in its relations with those of its parties with whom the treaty is suspended, and does not otherwise affect the legal relations of Russia with its other parties established by the treaty.
Article 60 of the Vienna Convention on the Law of International Treaties (“Vienna Convention”) provides that a material breach of a bilateral treaty by one of its parties entitles the other party to invoke this breach as a ground for the termination of the treaty or its suspension in whole or in part. Meanwhile, under the Vienna Convention, a material breach of a multilateral treaty by one of its parties entitles the other parties, under a unanimous agreement, to suspend the treaty as a whole or in part or to terminate it. In other words, the suspension of an international treaty by mutual agreement is envisaged.
However, in various cases in international practice there is a possibility of the unilateral suspension of a treaty, firstly, in cases expressly provided for by the treaty itself, and secondly, under domestic legislation establishing the procedure for the ratification and denunciation of international treaties.
The absence of provisions in the DTT on the procedure for its suspension is not an unconditional ground for considering the unilateral suspension to be unlawful. Based on the principle of in plus stat minus (the greater includes the lesser, i.e. when the greater is permitted, the lesser is deemed permitted), if a party had the right to terminate a treaty, it certainly had the right to suspend the treaty.
Under article 39 of the Federal Law on International Treaties suspension of the DTT for Russia effectively means that the Russian Federation has no obligation to perform the treaty in part of the suspended provisions. In other words, during the suspension period, the suspended provisions of the DTT under article 7 of the RTC cannot prevail over the provisions of the RTC and cannot be applied in tax relationships.
What particular provisions have been suspended?
The Decree suspends the provisions establishing the rules for the taxation of:- capital gains,
- all passive income (dividends, interest, royalties),
- income from international carriage,
- income from employment, directors’ fees, pensions and other similar types of income.
- 10% — on income from international carriage, leasing or subleasing of sea and air vessels, mobile vehicles, containers used in international carriage (previously these types of income were exempt under a number of DTTs);
- 15% — on dividends (and other income qualifying as dividends) paid to a resident of an unfriendly jurisdiction (instead of 5 or 10%);
- 20% — on interest, royalties, rents on property located in Russia (except for those taxed at the rate of 10%) and other similar income.
Tax will also be calculated at the rate of 20% on capital gain received upon the sale of (i) immovable property located in Russia; (ii) shares/participation interest in property-rich companies (more than 50% of assets of such company directly or indirectly consist of immovable property located in Russia); or (iii) derivative financial instruments derived from such shares/participation interest.
- permanent establishment;
- non-discrimination;
- entitlement to benefits (for certain DTTs);
- assistance in the collection of taxes (similar to the point above, but only for certain DTTs that provided for this form of assistance).
- Russia was “backlisted” — included in the EU list of non-cooperative jurisdictions for tax purposes adopted by the Council of the European Union;
- in turn, unfriendly countries were included by the Russian Ministry of Finance in the updated List of states and territories providing preferential tax treatment and/or not providing for the disclosure and provision of information in financial transactions (Order of the Ministry of Finance of the Russian Federation No. 86n dated 5 June 2023), as well as
- a number of states have unilaterally stopped or intend to stop exchanging financial information with Russian tax authorities in the near future (including, for example, the USA, the UK, Canada, Germany, Austria, etc).
Which DTTs are suspended?
This measure applies to DTTs with all unfriendly states with which such treaties were concluded. A total of 38 treaties have been suspended with the following countries:- USA, Poland, South Korea, Bulgaria, Sweden, Luxembourg, Romania, UK, Hungary, Ireland, Slovakia, Albania, Belgium, Slovenia, Croatia, Canada, Montenegro, Switzerland, Czech Republic, Denmark, Norway, Italy, Finland, Germany, France, Macedonia, Cyprus, Spain, Lithuania, Iceland, Austria, Portugal, Greece, New Zealand, Australia, Singapore, Malta and Japan.
For what period are the DTTs suspended?
As stated in the Decree itself, the provisions of the DTTs are suspended until “foreign states eliminate their violations of legitimate economic and other interests of the Russian Federation, the rights of its citizens and legal entities, or until the complete denunciation of such treaties.” This effectively means that at the moment the abovementioned DTTs are suspended for an indefinite term.This form of “mothballing” the DTTs was not chosen by chance, since if the other party is ready to resume the DTT, it will be possible to restart the treaty in a short period of time without the need to re-sign and ratify it. Nevertheless, it can be expected that not all states will continue to be able to unblock the DTT in a simplified manner. In particular, as of today, the Ministry of Finance has already received an official notification from Denmark on the denunciation of the DTT. The treaty between Russia and Denmark will cease to be in force on 1 January 2024.
What next?
- First of all, it is still unclear what reaction the other parties to the DTT will have to Russia’s suspension of the tax treaties. It is not excluded that, guided by the principle of “reciprocity”, the competent authorities of some unfriendly states will follow the example of Denmark and take actions aimed at the complete denunciation of the treaties. A number of jurisdictions, acting pragmatically, may take a wait-and-see attitude, analyse the possible benefits for themselves and will not take any action for the time being.
- It is not clear now how, or whether, Russia will interact with unfriendly states within the framework of the following international treaties:
- Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, MLI;
- Convention on Mutual Administrative Assistance in Tax Matters.
According to information on the website of the Organisation for Economic Co-operation and Development (OECD), both Conventions are in force and apply to the Russian Federation. The Decree did not suspend these agreements with respect to unfriendly states, and the official procedure provided for by article 37 of the MLI and article 31 of the Convention on Mutual Administrative Assistance in Tax Matters was not launched.
Therefore, formally, although these Conventions will continue to be in force, however, the general expectations are such that it is unlikely that it will be possible to use in practice their provisions for Russia. - A separate issue concerns the possibility of crediting or deducting the amount of foreign tax paid / withheld in another contracting state.
We believe that it will be still possible for Russian taxpayers to apply the foreign tax credit (“FTC”) for the amount of tax paid / withheld in an unfriendly state (if the requirements of articles 232 and 311 of the RTC to the list of documents, their execution and application are met). This is because the Decree effectively parked the mechanism of eliminating double taxation from the scope of suspension, and the relevant DTT norms formally continue to be in force.
Therefore, despite certain technical issues in the legal construct of article 232 of the RTC and the DTT, we believe that the Russian tax authorities (quite possibly, taking into account additional clarifications of the Ministry of Finance) should allow to apply these rules and preserve the right of individuals — Russian tax residents for the FTC.
Nevertheless, regardless of whether the FTC is provided for by the domestic legislation of a foreign state or not, foreign parties to cross-border transactions and international structures will likely face difficulties in applying the FTC for taxes paid (withheld by tax agents) in Russia: - foreign tax authorities may refuse to apply the FTC for the full amount of the tax paid in Russia as an “excessively paid tax”, ie paid not in accordance with the rules of the DTT, or;
- the FTC will be available only in part of the tax paid in Russia and only to the extent that the taxpayer would have been required to pay under the terms of the DTT.
- The suspension of the DTTs will lead to problems in determining and resolving in disputed situations tax statuses, in particular, the presence or absence of a permanent establishment.
- As long as the treaties remain to formally exist, it is assumed that the Russian tax authorities should not impose additional scrutiny over Russian controlling persons in terms of controlled foreign companies (“CFCs”) regime, in particular:
- for preparing financial statements of a CFC and confirming its profit (subclause 1 of clause 1 and subclause 1 of clause 1.1 of article 309.1 of the RTC);
- to allow tax exemption of the profit of a CFC according to a number of specific criteria, in particular, based on the effective tax rate test (clause 7 of article 25.13-1 of the RTC).
- It is also not very clear how the general logic of preserving the effect of the articles of the DTTs on co-operation in respect of the exchange of information and mutual agreement procedures relates to the extension of the Decree to the provisions of the DTTs that provide for assistance in the collection of taxes. In particular, the issue relates to the DTTs with Norway, Cyprus, Austria and Japan, which will not receive such assistance due to the suspension of the treaty.
- Scenarios where the ultimate beneficiary of Russia-sourced income is a resident of a “friendly” country, but an intermediary of channelling such income is made through a company — resident of an unfriendly jurisdiction will require separate consideration. Taxpayers will have to solve practical problems of applying the DTT with the country of the ultimate beneficiary, providing all necessary confirmations on the beneficial ownership, economic substance, etc.
- Similarly, practical difficulties may also arise when applying the DTT to income paid to companies — residents of unfriendly jurisdictions but controlled by Russian beneficiaries (taking into account the special procedure provided for in clause 12 of the Presidential Decree No. 95 dated 5 March 2022).
- Such suspension may aggravate the situation that has already arisen; “black-listing” Russia by the EU — tax authorities of unfriendly states may start applying more onerous taxation to payments made to Russian shareholders/income recipients even under a “look-through approach.”
In particular, situations arise in practice when Cypriot companies impose the Special Defense Contribution on dividend payments to Russian shareholders, whereas claiming the FTC for this contribution is not obvious in Russia.
The Decree instructs the Russian Government to ensure that measures are taken to reduce the impact on the Russian economy of the consequences of the suspension of the DTTs. It cannot be ruled out that solutions may be developed to mitigate certain negative consequences of such a suspension of the DTT provisions (for example, in terms of licence fees to prevent Russian organisations from reducing their access to foreign intangible assets). Time will tell to what extent these expectations are justified.
The Denuo team is ready to provide tax and legal support in assessing the implications and risks of how these changes will affect your structure, as well as in developing potential opportunities and solutions for restructuring and fine-tuning international structures.
