The Supreme Court’s position regarding the classification of income when double tax treaties are applied

The Ruling of the Supreme Court’s Judicial Panel for Economic Disputes (the “Panel”) dated 6 October 2020 in case No. А33-5439/201 (Coiltubing-Service LLC) addresses the specified issue.

This case is significant primarily for the Russian companies paying to their foreign contracting parties income that is not directly listed in the special provisions of the relevant Double Tax Treaties (DTTs).

In practice, both tax authorities and tax agents often classify such “unlisted” income as “Other income” in accordance with the article bearing the same title of the relevant DTT. By doing so the tax authorities justify the taxation in Russia of foreign entities’ income in the cases when an applicable DTT allows the taxation of “Other income” in Russia. On the other hand, the tax agents that pay income abroad justify the non-taxation in Russia of income that is thus classified if the relevant DTT does not provide for the taxation of “Other income” in Russia. 

The Panel’s Ruling may set a new direction for the case law involving administrative and judicial decisions, since the Ruling emphasises that “other” income only includes income that does not generate profit from a foreign company’s business activity and does not fall under any of the special categories of income that is directly mentioned in the relevant DTT. With regard to leasing payments this means that in the cases when the lessor does not have a permanent establishment in Russia the lessor’s remuneration may be subject to withholding tax in Russia only if the relevant payments may be classified as one of the categories of income set out in the special provisions of the relevant DTT (the DTT between Russia and Belarus in the case examined by the Supreme Court).

Of no less importance is the fact that the Panel’s Ruling points out that the special provisions of a DTT may be applied to a portion of a payment to a foreign company (usually a payment is treated in its entirety). Thus, with regard to leasing payments the Supreme Court has drawn the attention of the lower courts to the fact that the portion of the leasing payments that is the lessor’s income from providing financing may be subject to the special provisions of a DTT that are established for the taxation of interest. Within the framework of the DTT with Belarus this position provides that such portion of the payments should be subject to withholding tax even though such tax is to be imposed at a lower rate (of 10%) as compared with the rate set out in the Russian Tax Code.

What to think about and what to do

Russian companies that carry out cross-border payments of income should assess how the new approach affects the previously identified tax consequences of such payments. The Supreme Court’s approaches should be taken into account when such payments are made in the future.

The approaches set out in the Panel’s Ruling may cause the need for:

• reclassifying income that was paid to foreign entities and that was previously recognised as “other income” in accordance with the relevant DTT;
• determining the tax consequences of such reclassification;
• independently adjusting the withholding tax liabilities and assessing the prospects of a refund from the state budget of the excess tax amounts that were withheld from the foreign recipient.

Help from your adviser

In each specific case Pepeliaev Group’s lawyers are ready to assist with classifying any type of income correctly for withholding tax purposes, to assess the risks associated with the previous payments and to advise what to do if excess tax was imposed on a foreign contracting party.