Most of the articles of double tax treaties with ‘hostile’ states have been suspended

Pepeliaev Group advises of the implications of the Russian President’s Decree [1], suspending most of the articles of double tax treaties with ‘hostile’ states.

The Decree was published and came into force on 8 August 2023.

I. Countries with which the tax treaties have been partially suspended

The President’s decree partially suspends international double tax treaties with the following countries:

II. Which principal articles of the tax treaties have been suspended

In fact, the President’s Decree suspended all principal articles of the treaties. That is, the above applies to those articles that drew a line between the tax claims of states with respect to the same income.

The suspended ‘tax’ arrangements were reflected in the following articles of the treaties:

III. Which principal articles of the tax treaties remain in force

The President’s Decree does not affect the general provisions of international treaties, specifically, articles on:

• Avoidance of double taxation

• Exchange of information

• Mutual agreement procedure

• Employees of diplomatic and consular establishments

IV. Tax consequences for companies that will receive income from sources in Russia

1. For foreign companies conducting business in Russia

Despite the suspension of treaties in parts, including the articles on Permanent Establishment and Profit from Commercial Activity, foreign companies conducting business in Russia and receiving ‘active’ income, in most cases, will not see any changes.

The provisions of the Tax Code contain rules that are similar to the rules established by these articles in most of the treaties.

Income of these companies is subject to profit tax in Russia only if their activity forms a permanent establishment and only insofar as it is connected with the permanent establishment.

The exceptions are companies conducting activities at a construction site: under the rules of the Tax Code, once they start regular operations their activities give rise to a permanent establishment. The preferential timeframes established by the treaties will not apply (12 months in most cases).

2. For foreign companies receiving passive types of income from Russia

The most radical changes apply to foreign companies receiving ‘passive’ types of income.

For instance, when they receive all types of income from Russia, they will have taxes charged at the rates that are provided for in the Tax Code:

• For dividends – the rate is 15% (the treaties may establish various options for reduced rates, for instance 10% or 5%);
• For royalties and interests – the rate is 20% (the treaties usually establish a full exemption from taxation for royalties and interest in the country of the source of payment).

3. Taxation of other types of income received by foreign persons from sources in Russia

Other individual types of foreign companies’ income are taxed as follows:

V. Nuances

1. The unilateral nature of the suspension of treaties

Most foreign companies and individuals receiving income from sources in Russia will pay additional amounts of taxes. This will happen owing to both the broadened list of the types of income and the values of tax rates (for types of income that were subject to reduced rates).

As the provisions of tax treaties were suspended unilaterally, the income of Russian companies and individuals will be taxed under the old rules. At least, this is true until other countries announce a symmetrical withdrawal from the treaties.

2. Avoidance of double taxation (the right to offset the taxes withheld)

Under the general rule that is stipulated in double tax treaties, double taxation is eliminated for Russian taxpayers by offsetting tax that is withheld against tax paid in the country where the taxpayer is located.

While the articles of double tax treaties continue in effect, Russian companies will be able to offset tax amounts withheld as they used to do in the past.

As for foreign companies receiving income from Russia, the situation looks a bit more complex.

Despite the articles of treaties establishing rules for eliminating double taxation having not been suspended, in terms of agreements they point to the fact that an offset applies only to an amount of tax that may be withheld in the other state under the treaty. The treaty with France may serve as an example of the above.

As Russia will charge a larger amount of tax than the amount established in the treaty, the question arises as to whether the foreign recipient may offset this amount of tax. The answer to this question is to be sought in the national tax legislation of the recipient of income.

There are other examples. The treaty with Poland, for instance, sets out rules for the offset of any tax withheld in Russia if the corresponding type of income is taxable in Russia under the treaty.

Some treaties provide for double taxation to be eliminated in foreign states in ways other than the offset. Instead they stipulate an exemption or different methods for different types of income. That said, the rules for different types of income may be quite complex (e.g. Austria, Germany). To understand how these rules will apply in the new situation, a thorough analysis has to be conducted in the specific country.

What to think about and what to do

Obviously, an analysis should be carried out of group, intra-group payments and income expected to be paid in order to determine their tax fate. A payment to a hostile jurisdiction does not always mean a complete denial of the DTT. The beneficial owner of income may not be found where expected.

It is also worth considering an intra-group restructuring of assets, liabilities and mutual settlements. However, one should not forget about the ‘business purpose test’, which is described in detail in the Commentaries on the OECD Model Tax Convention and the various forms of which are set out in our court practice relating to article 54.1 of the Russian Tax Code. Therefore, simply ‘tossing’ assets from a hostile person to a friendly person, assigning rights to claim with regard to income expected from Russia and similar measures may not work. In other words, a simple and quick solution is not always the most correct one.

International companies with Russian capital may consider a redomicilation of business to ‘friendly’ states or Special Administrative Districts (SARs) in Russia. The treatment of international holding companies that are residents of SARs entails considerable benefits such as reduced tax rates, an absence of currency control requirements and others.

Finally, actions in response by hostile counties should also be monitored. It is likely that they will suspend the performance of DTTs in some form. This may entail tax consequences for Russian companies that receive income from such states.

Help from your adviser

The lawyers of Pepeliaev Group have extensive experience of advising clients on all tax matters.

We will be happy to help you analyse the consequences of the suspension of the treaties and the development of measures to reduce tax risks within the international group. 

[1] The Russian President’s Decree No. 585 “On the Russian Federation suspending individual provisions of international tax treaties of the Russian Federation” dated 8 August 2023.