The following article is an excerpt from Awara Russian Tax Guide, the first comprehensive book offering a full overview of all Russian taxation laws and rules. Awara Russian Tax Guide provides insight into the general framework of the Russian tax laws, the Tax Code and its principles. It describes the general rules of the Tax Code Part I and each type of tax and tax regime of Tax Code Part II, among them: Profit Tax, VAT, Personal Income Tax, Property Tax, Employer’s Social Contributions. The book also covers the now so important case law and taxation principles set by court precedents.
Double Taxation Treaties, abbreviated DTTs, are agreements concluded by and between two states aimed at eliminating taxation-related obstacles to the movement of capital, goods or income, at preventing tax evasion and discrimination, and also at establishing procedures for interaction between the states when collecting taxes.
DTTs concluded between Russia and other states are based on the Model Agreements on Avoidance of Double Taxation of Income and Property, approved by resolutions of the Russian Government in 1992 (now inoperative) and in 2010 (currently in effect). In turn, these model agreements reproduce to a significant degree the Model Tax Convention on Income and on Capital by the OECD (hereinafter the “Model Convention”). Despite the fact that Russia does not participate in the OECD, the Convention and the Commentary on it are used by Russian courts when making decisions in disputes involving the application of DTTs.
In particular, the Commentary on the Model Convention was applied in some of the most recent court decisions (see the Severny Kuzbass case, Resolution of the Supreme Commercial Court dated 15 November 2011).
By January 2012 Russia had signed 79 DTTs (see list of treaties in Appendix 1), and 78 of them are currently in effect. The majority of the DTTs are applied in relation to such Russian taxes as corporate profit tax (including income from business activities, income from real estate, interest, dividends, and royalties), as well as personal income tax (including income from independent activities, from work for hire, fees of directors, artists, and athletes, and from real estate). The DTTs include taxes on the property of enterprises and of individuals among the taxes excluded from double taxation. The DTTs do not extend to indirect taxes like value-added tax.
In most cases, the essence of the mechanism for preventing double taxation consists in the fact that taxes on income or capital to be paid in one country may be partially or completely deducted from the amounts of tax (or counted towards payment thereof) which are subject to payment in another country in regard to that income or capital. Income received under certain conditions may also be exempt from taxation or taxed at rates lower than the rates applied to taxpayers not falling under the operation of the DTTs.
Below, we look at some matters related to application of DTTs concluded by Russia in regard to types of income most characteristic for business, for instance, profit from business activity, dividends, interest, royalties, and income from real estate (capital gains).
DTTs extend to parties that are residents of Russia or of a state that is a party to a relevant agreement. Normally, DTTs do not apply when a party is not a resident of any of the participating states. For DTT purposes, resident is any individual or legal entity that, under the legislation of that state, is subject to taxation there based on dwelling place, permanent residence, place of registration, place of management, or place of foundation of a company or any other similar criterion. If the taxpayer is a resident of both states, additional criteria for determining residency status for DTT purposes are applied.
Under the majority of DTTs concluded by Russia, profit tax is not levied on the profit of foreign companies obtained from business activity in Russia, except in cases when a company is engaged in business activity via a permanent establishment set up in Russia. The DTTs set certain thresholds above which foreign organizations are recognized as having a permanent establishment.
Generally, the term “permanent establishment” means a fixed place of business through which an enterprise from a Contracting State regularly (partially or completely) engages in business activity in another Contracting State.
The term “permanent establishment” includes specifically:
a) place of management;
f) mine, oil or gas well, quarry, or any other place for extracting natural resources.
In case the national legislation sets higher thresholds for recognizing the existence of a permanent establishment (that is, ones less favorable for the taxpayer), the provisions of the appropriate DTT are applied (more favorable ones). For instance, in Russia, a construction site is regarded as a permanent establishment, irrespective of how long it has actually existed; whereas according to DTTs, a construction site leads to a permanent establishment if the length of its existence as a rule exceeds a certain period of time (generally speaking, 6, 12 or 18 months).
The profit received through a permanent establishment is taxed only for that portion which the permanent establishment could have received if it had existed as an independent entity under similar conditions.
Dividends paid out by a Russian company to a foreign company may be taxed both in Russia and in the country of which the foreign company is a resident. Dividends to which DTTs might apply may be taxed at rates lower than those set by national legislation. That said, DTTs may set certain requirements for the amount of interest from shares and the size of the investments of the recipient of the dividends.
Interest payable to a foreign resident is taxed at the source of the payment in Russia. Moreover, DTTs might stipulate an exemption from tax in Russia or a reduced tax rate at the source. Exemption and a reduced tax rate do not apply to interest related to the permanent establishment of a foreign resident in Russia.
In a situation where companies are interdependent, interest is exempt from taxation only to the extent which would be agreed to between independent entities; for the remaining excess portion, the accrued interest is taxed as profit tax in accordance with Russian law.
Income from royalties paid by a resident of Russia to a foreign resident is subject to Russian taxation at the source of payment. That said, DTTs may envisage tax exemption in Russia or a reduced tax rate at the source. Exemption and a reduced tax rate do not apply to royalties related to the permanent establishment of a foreign resident in Russia.
In the event that the payer of royalties and the recipient have special (dependent) relations, then the amount of income paid in the form of royalties is not taxed only on the portion that would have corresponded to the amount of royalties paid under similar conditions between independent entities.
As a rule, DTTs grant exemption or a reduced tax rate for dividends, interest and royalties provided that the recipient of the income acts as a beneficial owner. A beneficial owner is recognized to be any individual or legal entity enjoying benefits of receipt of income. The concept of beneficial owner is intended to limit the application of DTTs in cases when an agent or nominee acts as the recipient of the income, as well as to prevent tax evasion with the help of conduit companies.
The protocol to the DTT signed by Russia and Switzerland on 24 September 2011 specifically contains an amendment prohibiting the use of conduit arrangements, whereby income paid to a resident of a state that is a party to the DTT and which is taxed on preferential terms subsequently is transferred entirely (or almost entirely) to another party which would not be able to take advantage of similar tax benefits if that income were paid to it directly. However, Russian law does not require mandatory disclosure of the end recipients of the income.
DTTs contain provisions aimed at ruling out discrimination. Taxation on foreign citizens or companies from a foreign country in Russia should not be more onerous (discriminatory) in comparison with taxation of Russian citizens or companies in the same circumstances. This rule also extends to the activity of foreign entities which creates a permanent establishment in Russia. The prohibition on discrimination also means that Russian companies whose capital directly or indirectly belongs to (or is controlled by) residents of a foreign country should not be subjected in Russia to more onerous taxation in comparison with the taxation of other similar Russian companies.
It should be noted that the Russian tax authorities, applying rules on non-discrimination, believe that taxation of Russian companies owned by residents of one foreign country are subject to comparison (non-discrimination) with taxation of companies owned by residents of other foreign countries. Russian court practice follows the path of not applying the provisions on non-discrimination in cases of tax abuse practice (for example, when applying thin-capitalization rules).
Russian profit tax is levied on income received by a foreign resident from alienation of real property (capital gain) located in Russia. This rule extends likewise to income arising from the sale of shares or other corporate rights in Russian companies whose assets principally consist of real estate located in Russia. Moreover, some DTTs allow one to avoid paying profit tax in Russia in connection with a foreign resident’s sale of shares or other corporate rights in Russian companies whose assets principally consist of real estate located in Russia.
Exchange of Information
Most DTTs stipulate that the competent authorities of the contracting states exchange information necessary to implement the provisions of the DTTs or of national legislation of the contracting states concerning taxes to which the DTTs extend, to the degree to which the specified taxation does not contradict the DTTs. Exchange of information is not limited to information on the parties mentioned in the DTTs. Such information may be disclosed in the course of open court hearings or in court decisions. In practice, in some cases, the Russian tax authorities may use the information obtained from the tax authorities of other states against the taxpayers.
Furthermore, Russia is a party to Convention on Cooperation and Mutual Assistance in Tax Matters (Minsk, 1999). In 2011, Russia signed Convention on Mutual Administrative Assistance in Tax Matters (Strasbourg, 1988), which has not yet been enacted by the Russian Parliament.
The list of the countries which signed the Double Taxation Treaties with the Russian Federation
|Serbia and Montenegro (former Yugoslavia)|
|United Kingdom of Great Britain and Northern Ireland (UK)|
|United States of America (USA)|