Explanations of the Russian Federal Tax Service regarding the application of the concept of a beneficial owner of income
Pepeliaev Group advises that the Russian Federal Tax Service (the ‘Federal Tax Service’) has disseminated among tax authorities written explanations regarding the issues of using the concept of ‘a person that enjoys the beneficial ownership of income’ (a beneficial owner of income) when international double taxation treaties are applied.[1]
The letter summarises the court practice that has been established in favour of the tax authorities. The letter also contains cases that are still being considered by courts of different levels. However, the Federal Tax Service probably believes that the courts’ positions in these cases will be affirmed.
Some approaches are widely known already and to a large extent coincide with those expressed in a similar letter from 2017. [2] However, there are also new guidelines to be used in practice.
The letter points out that international tax treaties must be applied taking account of their purposes and tasks relating to the raising of foreign capital, and cannot be applied solely for favourable tax conditions to be created. There must be business purposes other than reducing the tax burden for foreign persons to be involved in the operational structure. Tax benefits cannot be applied in particular when a foreign element is introduced into the operational structure artificially or when a foreign person is a nominee and acts on behalf of a third party which cannot itself use such benefits. Foreign persons must have permanent offices in the country with which an international treaty is concluded and must independently dispose of the income obtained from Russian persons.
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The above approaches (testing whether the operations are real, determining the principal purpose and the ‘priority of substance over form’) are known from the concept of an unjustified tax benefit provided for by Resolution No. 53 of the Plenum of the Russian State Commercial (‘Arbitration’) Court dated 12 October 2006 and from article 54.1 of the Russian Tax Code (the ‘Tax Code’). Taken as a whole, they do not constitute a new approach. Only the application of such approaches to specific types of situations described in the Federal Tax Service’s letter can be treated as a new development. |
The letter confirms the tax authorities’ approach, supported by the courts, that it is the tax agent that makes payments to a foreign person that are subject to the withholding tax, that bears the burden of proof of the beneficial ownership of income. When the tax authority refutes the argument that a foreign person obtaining income enjoys beneficial ownership of the income, it is not obliged to independently determine what other person is entitled to beneficial ownership of the income.
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The tax benefits provided for by international treaties cannot be granted based on formal compliance with the necessary conditions without the real economic grounds being established. The state has grounds to expect that tax agents will take into account not only the interests of their counterparties, but also the fiscal interests of the state.
However, the distinguishing feature of the Russian approach to the application of the concept of a beneficial owner of income is that it is the tax agent that is obliged to prove that the tax benefits provided for by an international treaty are applied lawfully. This is the case even when the parties are not related and it may be difficult for the tax agent to collect the relevant evidence.
As the practice of the application of the new requirements develops, the approaches are expected to become more balanced with stricter requirements applied to payments to related parties, and less strict requirements applied to payments to independent persons. |
If the tax agent states that a third party is entitled to the beneficial ownership of income, such statement, according to the Federal Tax Service, must be confirmed unambiguously. The Russian tax agent must check whether such person paid taxes on its income and obtain the relevant confirmation.
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The letter proposes a rather strict standard of proving that the beneficial owner of income is a third party (a ‘pass-through approach’, a ‘look through’): a simple statement of the third party, let alone the tax agent, is not enough. Special attention should be paid to this clarification within the framework of the current checks, where the status of a beneficial owner of income is likely to be challenged. The necessary justification of the status of the third party must be prepared in advance.
Draft law No. 442400-7 has passed its first reading in the State Duma. This draft law significantly simplifies the application of the ‘pass-through approach’ for individuals as well as for foreign companies whose stock is traded on the stock exchange or in which an interest of over 50% is owned by the Russian or a foreign state, if they are the actual owners of income. |
As a new guideline in the Federal Tax Service’s letter an approach can be stated according to which ‘activity that is performed only in the form of making investments and financing the companies of a group (a holding structure) or related <parties> does not testify to the performance of independent entrepreneurial activity’. Moreover, the Federal Tax Service has made a new conclusion that ‘companies which serve only the interests of their own group and its affiliates’ cannot enjoy the benefits provided for by international tax treaties if the receipt of income by such companies is not economically justified.
Income is recognised to be insignificant in terms of the actual activity if such income is obtained from the provision of information and consultancy services, if such income is in the form of positive exchange differences from the sale and purchase of foreign currency, or in the form of a ‘high interest rate under deposits’.
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Russian legislation treats the performance of the functions of a holding structure or intra-group financing as entrepreneurial activity, and the above requirement of the Federal Tax Service does not have any direct legislative ground. However, such approach is known from international taxation practice. Actually, the Federal Tax Service’s letter introduces into Russian practice the strictest approach to imposing withholding tax - the American approach of the ‘limitation of benefits’. Within the framework of such approach, ‘entrepreneurial activity’ does not include an imitation of activity (the creation of formal document flow); neither does it include the actual activity of a holding structure and treasury companies if such activity is performed under the conditions of beneficial tax treatment. A similar approach is carried through in the latest double taxation treaties Russia has entered into with foreign states. |
What to think about and what to do
We recommend checking how the existing structures of cross-border obligations relate to the Federal Tax Service’s approaches, and taking measures to reduce the risks that emerge.
Help from your adviser
Pepeliaev Group lawyers have unique methodological experience with regard to international taxation issues and are ready to provide any legal support with respect to issues relating to international taxation and the application of the concept of the beneficial owner of income. This includes the optimization of the existing structures, and the provision of support during audits and in court disputes with tax authorities.
[1] Letter No. SA-4-9/8285@ of the Federal Tax Service dated 28 April 2018.
[2] Letter No. SA-4-7/9270@ of the Federal Tax Service dated 17 May 2017. See also: R.I. Ahmetshin and A.E. Aidinyan. A beneficial owner of income under the Federal Tax Service’s letter dated 17 May 2017: one year on // Nalogoved. 2018. No. 5.