Exchange of tax information: what does it change for Russian clients?

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1 Exchange of tax information: what does it change for Russian clients? Exchange of fiscal information with Russia: What is the impact on Russian client s tax planning? Irina Dmitrieva Russia & CIS Private clients 6 March 2013, Zurich

2 Exchange of tax information Source of rules International treaties Double tax treaties with 88 treaties covering 89 countries All contain Exchange of Information clause 6 treaties amended in to bring Exchange of Information clause in line with the OECD-Model Amendments in force - in treaties with Cyprus, Czech Republic, Germany, Italy, Switzerland Amendments in force as of 2014 in treaty with Luxembourg Special TIEA with former USSR countries Mongolia (2001), Greece (2000), Romania (1999) TIEAs specify the procedure and types of information available for disclosure Domestic rules No procedural guidelines Once ratified, international treaties = a part of Russian laws with overriding effect Exchange of tax information: what does it change for Russian clients? White & Case 1

3 Exchange of tax information What does it change for Russian clients? Exchange of tax information - tool for Russian tax authorities to Control eligibility of non-russian tax residents to claim treaty relief Control compliance with domestic tax rules (in particular, thin cap rules and transfer pricing rules as well as future CFC rules) Enforce tax claims New reality for Russian clients need to make international tax structures Aligning with corresponding business structures and activities Justifiable from a business purpose and business substance perspective Defendable through compliance with domestic laws and tax treaties Exchange of tax information: what does it change for Russian clients? White & Case 2

4 Inward and outward FDI and tax treaty network CBR statistics (cumulative as of 1 Jan 2012) Inward FDI: $455bln Outward FDI: $362bln Equity Debt Equity Debt Tax havens 35.39% 6.21% 23.44% 15.73% Cyprus 29.11% 24.54% 33.68% 33.37% Netherlands 13.35% 12.04% 13.66% 24.14% Luxembourg 1.12% 18.94% 2.77% 4.87% Switzerland 1.23% 1.96% 3.36% 4.07% Ireland 0.00% 10.42% 0.07% 2.21% Subtotal 80.20% 74.11% 76.98% 84.38% Source: CBR Exchange of tax information: what does it change for Russian clients? White & Case 3

5 What does it change for Russian clients? Full compliance with domestic tax rules and tax treaty conditions needed In the country of income-recipient Tax residence Effective management & control Beneficial ownership Business purpose for existence (compliance with Limitations of Benefit clause) In Russia (country of source) No permanent establishment Domestic transfer pricing rules Domestic thin capitalization rules International arm s length principles Tax savings doctrine CFC rules (when enacted) Exchange of tax information: what does it change for Russian clients? White & Case 4

6 Tax residence in treaty country and no PE in Russia Tax residence in Russia Organizations by place of incorporation Individuals by duration of stay (183-day rule) Tax residence in the treaty country Place of incorporation or place of M&C Tie-breaker rules - place of effective management (MAP usually required) Place of effective management - where Key management and commercial decisions necessary for the conduct of the entity s business as a whole in substance are made Shareholders reserved matters Experienced executives Meetings of the board of directors are held Day-to-day management is carried out Senior executives usually work Accounting records are maintained and kept Other factors (office, personnel, etc.) PE is created if in Russia Fixed place of profit-generating business Dependent agent Provision of services that generate > 50% income, through individuals who spend in Russia > 183 days / 12-month period PE risk when Russia-based individuals appointed to corporate bodies (esp. to management board) actively involved in decision-making process (e.g., through advisory or investment committees) given broad PoA to negotiate and sign contracts, represent interests Exchange of tax information: what does it change for Russian clients? White & Case 5

7 Recent cases: tax residence and management PE Korus case (2009) Russian tax authority is not allowed to question the tax residence if it is confirmed by the relevant competent tax authority MinFin Letter (2009) Russia-based individuals on BoD do not create a PE for the foreign company as long as it has substantial business/presence outside of Russia So far no reported cases of dual tax residence resolved through MAP Exchange of tax information: what does it change for Russian clients? White & Case 6

8 Limitation of Benefits clause Domestic tax laws look-through concept in discussions Tax treaty overriding effect not applicable to foreign income-recipient that is owned/controlled by persons resident outside of the relevant treaty country Tax treaties - Limitation of Benefits Denial of treaty benefits (with MAP) - IF main purpose of creation and existence of the entity in the treaty country is to obtain benefits which are otherwise unavailable (MAP required) DTT with Cyprus for non-cyprus incorporated entities only DTT with Luxembourg (when Protocol becomes effective), Singapore dividend, interest and royalties paid as a part of conduit arrangement (i.e., the recipient pays the most part of income to a person that is not eligible to benefits) DTT with Switzerland companies owned/controlled by non-residents (look-through) - DTT with Brazil and Chile interest paid under back-to-back arrangements - DTT with Mexico income enjoys preferential taxation in home country DTT with Australia, Brazil, UK income not remitted to state of residence and on this basis avoids taxation - DTT with Singapore complex provisions requiring significant link to the state of residence - DTT with the USA Exchange of tax information: what does it change for Russian clients? White & Case 7

9 Unjustified tax savings concept "Tax savings" doctrine introduced by Supreme Commercial Court Resolution No. 53, dated 12 October 2006 Taxpayer s right to achieve tax savings is recognized presumption of good faith of taxpayers and economical justification of taxpayer s actions burden of proof lies with the tax authorities possibility of receiving the same economic results, but with lesser tax benefits is not a basis for finding tax benefits unjustified On the other hand: tax savings are unjustified if received with no connection to actual economic activities or as the only/main business goal if the form of transaction differs from the substance, taxpayer s rights and obligations should be determined based on the actual economic substance Can treaty benefits be questioned based on tax savings doctrine? Exchange of tax information: what does it change for Russian clients? White & Case 8

10 Beneficial ownership concept Development of the concept Prior to 2004: no distinction from legal title After 2004: beneficial ownership = 1) right to receive income; 2) right to determine the destiny of income ADR/GDR programs: BO - the ADR holder foreign-law trusts: BO - beneficiary of trust Sovereign bonds till 2010: BO depositary (that holds the global certificate) since 2010: BO bond holders, but the issuer (the Russian state) is not deemed to be tax agent Eurobonds (2011): BO holder of Eurobonds; no treaty relief entitlement for Issuer/Lender Tax Code amendment to accommodate sovereign bonds and Eurobonds (till 2014) No obligation for Borrower/source of income to withhold tax Criteria of beneficial ownership No tested set of criteria, but the following might be of relevance: adequate equity arm s length terms inclusion of income into financial statements and income tax base regular payment of taxes business link to jurisdiction of incorporation where possible keep all vehicles in one jurisdiction Exchange of tax information: what does it change for Russian clients? White & Case 9

11 Recent cases Beneficial ownership, arm s length rule Eastern Value Partners (2012) Tax authority s claims denial of Cyprus DTT exemption from WHT on interest, since: interest was paid at the direction of the Cypriot Lender directly from Russia to the BVI Lender Cypriot Lender is a shell company established to use the DTT and is not a beneficial owner of interest Eastern Value Partners, Cypriot and BVI Lenders are associated enterprises 20% fine and late payment interest for non-withholding of WHT Court s decision court of 1 st instance, positive decision court of appeal, positive decision main arguments: Article 11 ( Interest") applies regardless of whether interest is paid directly to or at the direction of the lender Article 11 ( Interest") (unlike many other treaties) does not require compliance with the beneficial ownership test beneficial ownership over interest income has not been actually investigated by the tax authority Article 9 ( Associated Enterprises") only applies to cases where special relations influence the amount of interest tax authority did not claim that "arm s length test is not satisfied Cypriot Lender has substance, actually pays taxes in Cyprus and reflects interest income in financial statements Exchange of tax information: what does it change for Russian clients? White & Case 10

12 Recent cases - Unjustified tax savings / arm s length terms Monetka case (2011) Denial of deductibility of trademark royalties paid to Cyp IPCo tax authority s arguments: assignment of TM rights from Russia to Cyprus and their subsequent licensing from Cyprus to Russia is of artificial nature and is aimed at minimizing tax transactions lack business purpose and are entered into for unjustified overstatement of expenses taxpayer aimed to shift profit away from Russian taxation to Cyprus using Russia-Cyprus DTT reference to "tax savings" doctrine Case decided in favor of taxpayer court s arguments: TM represents a recognizable brand and is used for increase of sales tax authority failed to prove how the affiliation of counterparties affected the terms of agreements and royalty amount Exchange of tax information: what does it change for Russian clients? White & Case 11

13 Thin capitalization rules Thin cap rules (D:E of 3:1) apply to borrowers with >20% foreign capital and if loans are obtained (or secured by) foreign parent or Russian affiliate wide-spread practice to structure intra-group loans via foreign sister FinCo Court practice before 2011 Literal interpretation of the Tax Code hence, thin cap rules do not apply to loans from sister FinCo Non-discrimination clause (that refer to nationality of shareholder) override Russian thin cap rules hence, thin cap do not apply even to loans from foreign parent Court practice after Severny Kuzbass case (2011) Article 9 Associated Enterprises is applicable to both the interest rate and the loan principal amount Article 9 overrides Article 24 (non-discrimination by reference to nationality of lender and nationality of shareholder) Sec 4 of Article 24 (non-discrimination by reference to nationality of shareholder) requires equal treatment of any Russian company with > 20% foreign capital, but not prohibits distinct treatment of Russian company with no foreign capital Exchange of tax information: what does it change for Russian clients? White & Case 12

14 Recent case thin cap rules Naryanmarneftegas (2012) Tax authority s claims Loan from foreign sister FinCo is subject to thin cap rules hence: denial of excessive interest deduction WHT on excessive interest - subject to withholding from future interest payments 20% fine and late payment interest for non-withholding of WHT Court s decision court of cassation, Moscow District, 27 Feb 2012 negative decision main arguments: debt financing is a part of a JVA (the JVA contains all substantial provisions for the debt financing) the JVA is executed by top holding companies which actually agreed to provide the JV with debt financing instead of making contributions to the charter capital the financing company is a mere conduit company controlled by the foreign parent and registered in offshore zone (Delaware, USA); the parent is the actual creditor or de facto guarantor non-discrimination clause does not override Russian thin cap rules Article 10 ("Dividends") allows Russia to reclassify excessive interest into dividends Exchange of tax information: what does it change for Russian clients? White & Case 13

15 Compliance with tax rules and tax treaty conditions Transfer pricing rules Controlled transactions with Russian related parties Value threshold = RUB 1bln (RUB 2bln) p.a. Foreign related parties No value threshold Offshore residents Value threshold = RUB 60mln p.a. Foreign residents with respect to exchangetraded commodities Value threshold = RUB 60mln p.a. Related parties concluded through unrelated reseller/service provider (that undertakes no risks/functions) No value threshold If chain of transactions aimed at avoidance of TP control upon court decision Notification and documentation Value threshold = RUB 80mln p.a. (only in 2013) No value threshold (from 2014) Adjustments and corresponding adjustments for profit tax and individual income tax for entrepreneurs Methods in line with OECD TP Guidelines Exchange of tax information: what does it change for Russian clients? White & Case 14

16 Transfer pricing rules - Related parties Parent-subsidiary relations Brother-Sister relations Other grounds participation > 25% direct or indirect > 50% direct chain authority to appoint 50% of BoD 50% of executive body sole executive body common participation > 25% ownership common authority to appoint 50% of BoD 50% of executive body sole executive body employment subordination close relatives upon court decision upon taxpayer s decision acting as sole executive body (or management company) common management bodies > 50% of BoD > 50% of executive body sole executive body (or management company) state ownership irrelevant Exchange of tax information: what does it change for Russian clients? White & Case 15

17 CFC rules proposed concept Aimed to restrict transactions with black-listed jurisdictions and encourage disclosure of beneficiaries of companies incorporated in black-listed jurisdictions ultimate beneficiary of a company a person who is, directly or indirectly (through participations or otherwise) a recipient of income and has the factual right to possess, use and dispose of income (i.e., to decide on the destiny of income) Contractual payments to black-listed jurisdictions are, by default, not deductible for Russian payor s profit tax purposes subject to 20% withholding tax unless all of the following conditions are met (and relevant information is disclosed) recipient is created for a business purpose and is factually resident in the country of incorporation neither Russian payor nor its affiliated persons are ultimate beneficiaries otherwise, Russian payor is subject to 9% tax on deemed dividends equaling the amount of contractual payments income paid out of Russian is subject to tax at 10% or more otherwise, Russian payor has to pay, to Russian budget, the difference from the 20% tax rate Exchange of tax information: what does it change for Russian clients? White & Case 16

18 What does it change for Russian clients? Due care in structuring Each foreign income recipient must have sufficient substance and M&C place in the country of the income-recipient no PE in Russia beneficial ownership clear "business purpose", cannot be "mere conduit mere conduit" test includes due diligence into the ultimate parents contractual arrangements, e.g., JV and shareholders' agreement, etc. Terms of loan should be arm s length interest rate under DTT and TP rules D : E ratio under DTT own commercial risk of DTT lender Terms of IP license should be arm s length royalty under DTT and TP rules assignment price under TP rules business purpose of assignment Exchange of tax information: what does it change for Russian clients? White & Case 17

19 Worldwide. For Our Clients. whitecase.com Russia Irina Dmitrieva Partner White & Case LLC Romanov per Moscow Telephone: Fax: idmitrieva@whitecase.com White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other In this presentation, White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, affiliated partnerships, companies and entities. The partners of our German offices are partners of the New York State registered limited liability partnership. According to the laws of the State of New York, the personal liability of the a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities. individual partners is limited. White # & Case

Russian international tax planning & transfer pricing developments

Russian international tax planning & transfer pricing developments Seminar at RedTheNetwork June 29, 2018 / Hertogenbosch MILOGOLOV NIKOLAI, candidate of sciences (econ.) Senior researcher, Tax Policy