Tax Messenger. The Federal Tax Service Issues Guidance on the Beneficial Ownership Rules. Tax Edition

Transcription

1 25 May 2017 Tax Messenger Tax Edition The Federal Tax Service Issues Guidance on the Beneficial Ownership Rules The beneficial ownership rules introduced by the deoffshorization amendments to tax law have been in effect in Russia since 1 January The rules prevent lower withholding tax rates provided for in Russia s tax treaties from being applied where a foreign company receiving income fails to meet certain criteria, and in particular where it is deemed to be an intermediate ( conduit ) entity. The letter is threaded through with implications and arguments to the effect that the concept in question extends to periods before The Federal Tax Service has issued Letter No. SA-4-7/9270@ of 17 May 2017, which is devoted to practice relating to disputes associated with the improper application of tax reliefs by tax agents in charging withholding tax on foreign companies. The letter is addressed to inspectorates for major taxpayers and interregional inspectorates for federal districts. The purpose of the letter is to help strengthen the defence position of tax authorities in arbitration court cases. The provisions of the letter will affect every Russian company which pays income to foreign companies. We advise taxpayers to re-evaluate their transactions and structures through the prism of this letter, assess potential risks and take steps to eliminate or reduce them, including for periods before 2015.

2 Guidance previously issued by the Ministry of Finance (such as in Letter No RZ/16236 of 9 April 2014) was not directly reliant on criteria referred to by courts in their rulings. It might even be said that the Tax Service s letter establishes case law, or judicial precedent, as the new priority source of law and interpretation regarding the application of tax treaties, as opposed to clarifications issued by the Finance Ministry as the competent authority for double taxation treaties. The letter consists of two parts: in the first part the Federal Tax Service sets out its conclusions based on court cases involving the beneficial ownership concept, while the second part, spanning six pages, contains a summary of the most prominent cases (those involving Credit Evropa Bank ZAO, MDM Bank, Bank Inteza AO, Olyokminsky Rudnik OOO, Severstal PAO, Vladimirskaya Energosbytovaya Kompaniya PAO, TD Petelino OOO and Ekvant OOO). EY has previously issued alerts on most of those cases. Below we outline the main points of the letter. Main Points The beneficial ownership rules, which were introduced in the Tax Code with effect from 1 January , establish a set of criteria that a recipient of income must meet in order to qualify for relief under tax treaties. The Federal Tax Service explains to its territorial agencies how those criteria have been interpreted by courts and how they should be applied in practice. Citing Ruling No. 5 of the Plenum of the Russian Supreme Court of 10 October 2003 and Ruling No of the Presidium of the Supreme Arbitration Court of 15 November 2011, the Tax Service makes an implied argument for the beneficial ownership concept to be applied to periods preceding This is done by referring to the recommendation made by the Plenum of the Supreme Court in 2003 for acts of international organizations to be used where difficulties arise in interpreting the rules and principles of international law. In other words, the fact that the provisions of a tax treaty were applied before 2015 does not deprive tax authorities of the right to interpret the treaty in line with the Commentaries on the Model Tax Convention. Whether the Commentaries on the Model Convention are an act of an international organization remains open to debate. The Tax Service concludes that the Convention and the Commentaries may be treated as an additional source of interpretation of a treaty depending on the specific case. This wording leaves open the possibility that OECD documents would only be used in certain cases. Basing its arguments on prevailing case law on the application of the beneficial ownership concept, the Tax Service proposes that lower income tax rates should be granted to companies which: Have an economic presence in their country of residence; Have broad powers to dispose of income; Use income in the business activities of a foreign company (receive economic benefit from the income). These criteria are fairly general in nature. A tax agent may encounter practical difficulties in proving that they are met. For example, in the case of the third criterion, is it sufficient for a company to have a profit, and what constitutes proof of economic benefit being derived? Paragraph 12.4 of the OECD report on the beneficial owner concept refers to the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass the payment received to another person. In the OECD report, as in Article 7 of the Tax Code as it currently reads, a person is not considered to be the beneficial recipient of income if it passes the income on and itself has limited powers to 1 Amended versions of Articles 7 and 312 of the Russian Tax Code. 2

3 dispose of the income, performs intermediary functions and does not assume any risks. Furthermore, the OECD Commentaries mention a number of circumstances in which a person is not prevented from being considered as having beneficial ownership of income. It would be useful in this regard for tax authorities and taxpayers alike to have more detailed guidelines on how different types of income would be treated in particular scenarios. The letter lays down a position that has been expressed by the tax authorities on a number of previous occasions: in order to disallow the application of lower rates, a tax authority only has to prove that the immediate recipient of income does not have beneficial ownership of income, and is not obliged to establish the ultimate beneficial owner of the income. The good news is that tax authorities are required to take due account of documentation that enables the true beneficiary to be identified beyond doubt if such documentation is provided by a taxpayer or tax agent before a decision based on a tax audit is issued. The Tax Service directly specifies those factors to which tax authorities must pay particular attention: The extent to which decisions are independently made by the directors of foreign companies; The possession of powers to dispose of income; The performance of business functions; Indications that business is carried on (personnel, an office, general business costs); The bearing of commercial risks in relation to assets; The receipt of economic benefit from income. A new development is the requirement for tax authorities to assess the economic activities of a group as a whole. The Tax Service also points out that it has the right to request additional information from foreign jurisdictions, analyse company reports and make use of commercial databases and information in the public domain. In practice, all these tools are already used by the tax authorities. In the appendix to the letter the Tax Service cites a number of court rulings, in some of which the rules for testing a company s beneficial ownership of income and the consequences of that test being failed are applied to periods before Since, in the Russian legal system, unlike precedent-based systems, rulings on specific cases do not have binding force (except for rulings of the Plenum of the Supreme Court), the setting of general rules on the basis of specific court decisions does not seem to be entirely justified. It would be more constructive for a Russian competent authority to lay down detailed rules on the interpretation of the beneficial ownership concept. We hope that this will come to pass in one form or another in the near future. Conclusions Practice relating to the application of the beneficial ownership concept is constantly evolving 2. It is therefore advisable for companies which pay dividends, interest, royalties and other types of income and apply lower withholding tax rates: To analyse existing structures and assess their susceptibility to the beneficial ownership concept; To gather evidence (documents, reports, transaction records) that foreign recipients of income are the beneficial owners of the income, so as to be in a good position to defend the application of lower 2 See, for example, our alerts dated 28 March, 20 July and 3 November 2016 and 16 February

4 withholding tax rates if questions arise during an audit; If necessary, to carry out restructuring in order to minimize future risk; To request foreign recipients of income to provide documentary confirmation of their status as the beneficial owners. Clause 1 of Article 312 of the Tax Code now makes it a requirement for such confirmation to be obtained before income is paid. Authors: Oleg Lvov Irina Bykhovskaya Marina Belyakova For additional information please contact the authors of this publication: Irina Bykhovskaya +7 (495) Irina.Bykhovskaya@ru.ey.com Marina Belyakova +7 (495) Marina.Belyakova@ru.ey.com Oleg Lvov +7 (495) Oleg.Lvov@ru.ey.com 4

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