Tax Flash by PwC experts

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1 Tax Flash by PwC experts February 2019/Issue No. 2 The bill ratifying the MLI introduced in the State Duma In brief The bill ratifying the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the Convention or MLI ) has been introduced to the State Duma 1. It is likely that starting from 2020 it will limit tax benefits granted by most treaties to which Russia is a party. In particular, taxpayers that paying out passive income overseas (including interest, dividends or royalties) will face higher risks. Tax legislation is becoming fairer, perhaps, and definitely more comprehensive. Most countries are ready to pay such a price for the return of diluted profits. In detail MLI who has signed and why? In June 2017, Russia and 67 other countries signed the MLI. 2 It is a unique instrument developed by OECD to prevent tax base erosion and profit shifting (BEPS). It will enable the signatories to implement BEPS principles swiftly, as it covers a large number of double tax treaties (DTTs). 3 The instrument is quite flexible. At their own discretion, signatories may define which treaties will be covered and which specific provisions will apply. When will Russia s DTTs change? DTT provisions will change as Russia s partners adopt domestic procedures required by the Convention. As at the beginning of February 2019, the Convention has been signed by 87 countries, including 20 that have already ratified it in domestic law (Austria, Australia, France, Great Britain, Guernsey, Ireland, the Isle of Man, Israel, Japan, Jersey, Lithuania, Malta, Monaco, New Zealand, Poland, Serbia, Singapore, Slovakia, Slovenia, and Sweden). The MLI sets different commencement dates for applying provisions on withholding tax, other taxes and mutual agreement procedures. For withholding taxes, the new rules will apply to payments made from 1 January of the year following the year in which the MLI comes into force for each DTT partner. Thus, from 1 January 2020, the new rules will apply to Russia s DTTs with those partners that have already ratified the MLI, as well as with those that will have ratified and filed ratification According to the OECD, the MLI will cover over 1,200 DTTs. 1 Tax Flash by PwC experts February 2019 / Issue No. 2

2 documents with the OECD by 1 October or 1 December 2019 (the instrument allows different dates). We expect many jurisdictions to ratify the MLI by the above dates. Which of Russia s DTTs will change? Russia has chosen 71 DTTs, including DTT with Austria, China, Cyprus, France, Hong Kong, Ireland, Latvia, Luxembourg, the Netherlands, Singapore and the UK. 4 When assessing the MLI s applicability, it is necessary to consider whether the other party to the DTT has signed the Convention. For example, Russia has applied the Convention to its DTT with the US. However, the US is not a signatory of the Convention, which means that the provisions of the MLI can not apply to the Russia-US treaty. Russia s list does not include Brazil, Germany, Japan, Switzerland and several other countries, which means that the DTTs with these countries will not be affected. What will change? The Convention provides for a number of key measures: The mandatory minimum standard, which includes (1) provisions addressing international treaty abuses, 5 and (2) provisions aimed at improving mutual agreement procedures. Optional provisions (the decision is at the country s own discretion) The minimum standard: provision on international treaty abuses The signatories to the MLI have three options: Option 1. Adopting only the principal purpose test (PPT). Option 2. Adopting the PPT test and the simplified limitation on benefits provision (LoB). Option 3. Adopting the detailed LoB in combination with the mechanism to address conduit financing (beyond the scope of the MLI). PPT Most DTT partners have chosen to apply it Simplified LoB Russia has chosen to apply this option, but most of the contracting jurisdictions have not opted for it. A benefit under the DTT shall not be granted if obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit. The following persons shall be entitled to benefits under DTTs: individuals; the contracting jurisdiction itself or political subdivisions thereof; entities, if the principal class of their shares are traded on recognised stock exchanges; certain non-profit organisations; entities engaged in providing retirement benefits, etc. Tax benefits are available to entities engaged in the active conduct of business if the income is derived from that business. If simplified LoB is introduced, it is important that DTT benefits not be granted to holding companies, corporate administration centres, group financing centres (including cash pooling) and investment business entities (except for professional market participants), as their activities do not fall under the term active conduct of business, as defined in the Convention. 4 Russia is a party to 84 DTTs final-report en.htm 2 Tax Flash by PwC experts February 2019 / Issue No. 2

3 This is the default option to ensure meeting the minimum standard The simplified limitation on benefits provision will apply only if: Each party to a DTT has chosen to apply it; One party to a DTT has chosen to apply the simplified limitation on benefits provision, while the other party has chosen to apply the primary purpose test, but the other party also either: allows asymmetrical application of the simplified limitation on benefits provision in such situations; or has agreed to mutual application of the simplified limitation on benefits provisions with DTT partners that apply it. The simplified LoB will not apply to most of Russia s DTTs (including those with Cyprus, Luxembourg, the Netherlands, Singapore, the UK and other countries that have chosen to adopt the PPT this option is easier and have not provided for the asymmetrical application of the LoB) The list of the countries choosing to apply the LoB may include India and Canada. The latter wishes to introduce the provision based on a bilateral agreement. The minimum standard: improving mutual agreement procedures With respect to improving mutual agreement procedures, the MLI stipulates that contracting jurisdictions may choose to adopt the arbitration procedure. Russia has not upheld the arbitration procedure provision. This means that the mutual agreement procedure will remain the only way to resolve disputes between Russian and foreign competent authorities. Optional provisions Dividends New criteria for ownership of company assets will be introduced in the Article Dividends. The ownership conditions set by the provisions of a particular DTT must be met throughout a 365-day period preceding the date of the payment of the dividends. This provision is additional and does not replace the existing criteria for the application of reduced tax rates. Provisions on capital gains from alienation of shares or interests of entities deriving their value principally from immovable property The treaties will include the provision that such income will be taxed where the immoveable property is situated. The test on the volume of immovable property must be made each day during the 365-day period preceding the transaction. Permanent establishments Construction site activity: splitting up of contracts is not allowed This provision addresses the artificial division of contracts into multiple parts to avoid the existence of a permanent establishment. However, the provision will not apply to the exploration and production of mineral resources. Narrowing the definition of the term activities of preparatory or auxiliary character Business activity does not constitute a permanent establishment only provided that such activity is in the list of exemptions under the DTT and is not of principal character. Under the new provision, business processes may not be divided into separate activities that may be interpreted as activities of preparatory or auxiliary character to avoid the existence of a permanent establishment. Tightening of the provisions relating to agency Stipulates that where an agent is acting on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role 3 Tax Flash by PwC experts February 2019 / Issue No. 2

4 (commissionaire) arrangements leading to the conclusion of contracts, that enterprise shall be deemed to have a permanent establishment Anti-abuse rule for permanent establishments situated in third jurisdictions Stipulates that a contracting jurisdiction where the income is derived has the right to tax the income of a permanent establishment if it is exempt from income tax in the jurisdiction of residence of its headquarters and is taxed at reduced rates in the jurisdiction where such permanent establishment is situated. Provisions relating to hybrid mismatches: entities or transactions that are treated differently under the tax laws of contracting jurisdictions Fiscally transparent entities Income must be taxed in one of the contracting jurisdictions. A contracting jurisdiction may refuse in using an exemption or deduction (credit) if the income tax has not been actually paid in the other contracting jurisdiction. Dual resident entities Where a legal entity is a resident of both contracting jurisdictions, the competent authorities of the contracting jurisdictions will determine by mutual agreement the contracting jurisdiction of which the legal entity will be deemed a resident. In the absence of an agreement, the legal entity will not be entitled to tax exemptions provided by the DTT. Russia has chosen to apply the option under which where an entity is qualified as a resident of both contracting jurisdictions, its tax residence will be determined only by mutual agreement procedure. Methods for elimination of double taxation Russia will continue to apply a deduction of tax paid abroad from the tax on the world-wide income calculated in accordance with the Russian rules. The takeaway To apply international tax treaties, it will be necessary to analyse whether the MLI affects them and to what extent. The position chosen by each country must be ratified by a domestic law. The positions could be asymmetrical. Given that most countries have already announced their positions, and many countries are expected to ratify the Convention in 2019, we recommend that you assess now which of your transactions and entities will be affected by these developments. 4 Tax Flash by PwC experts February 2019 / Issue No. 2

5 Let s talk We would be happy to answer any questions you may have. Financial Services (FS) Energy, Utilities and International Tax Structuring Mining (EU&M) (ITS) Vladimir Burov Galina Naumenko Ekaterina Lazorina vladimir.burov@pwc.com galina.naumenko@pwc.com ekaterina.lazorina@pwc.com Consumer and Industrial Ekaterina Malygina Mikhail Filinov Products (CIP) ekaterina.malygina@pwc.com mikhail.filinov@pwc.com Enrika Shevchenko Indirect Tax (VAT and Tax Reporting Compliance/ enrika.schevchenko@pwc.com Customs) Tax Reporting & Strategy Natalia Scherbakova Vladimir Konstantinov Ekaterina Ryabova (Saint-Petersburg) vladimir.konstantinov@pwc.com ekaterina.ryabova@pwc.com natalia.sherbakova@pwc.com Private Wealth Services People and Organisation Technology, Media, (PWS) (P&O) Telecommunication (TMT) Alina Lavrentieva Karina Khudenko Natalia Vozianova alina.lavrentieva@pwc.com karina.khudenko@pwc.com natalia.vozianova@pwc.com PwC Legal Alla Romanchuk Government & Public Sector alla.romanchuk@pwc.com (G&PS) Yana Zoloeva Transfer Pricing (TP) Kirill Nikitin kirill.nikitin@pwc.com Mergers & Acquisitions (M&A) Ekaterina Koropova ekaterina.koropova@pwc.com Tax and Legal Services Russia and CIS Leader yana.zoloeva@pwc.com Maxim Kandyba maxim.kandyba@pwc.com Raisa Alexakhina raisa.alexakhina@pwc.com Inga Shakhnazarova inga.shakhnazarova@pwc.com Andrey Kolchin andrey.kolchin@pwc.com Natalia Kozlova natalia.kozlova@pwc.com All rights reserved. PwC and PricewaterhouseCoopers refer to OOO PricewaterhouseCoopers Advisory or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate legal entity. The information contained herein does not constitute professional advice. PwC assumes no responsibility for any damages caused to any parties if their actions/omissions have resulted from reading of this report. For assistance with specific matters, we recommend that you contact a PwC professional in the respective line of service. 5 Tax Flash by PwC experts February 2019 / Issue No. 2