Protocol to the Russia-Cyprus Double Tax Treaty is Signed.
Protocol to the Russia-Cyprus Double Tax Treaty is Signed.
Legal Update No. 177.
Goltsblat BLP advises that, on 7 October 2010, a Protocol amending the Agreement between the Governments of Russia and Cyprus for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital dated 5 December 1998 was signed. The Protocol, which constitutes an integral part of the Agreement, will come into force when the relevant intra-state procedures are completed and will apply from the start of the calendar year following its effective year.
The most significant changes introduced by the Protocol (according to its text attached to Directive of the Russian Government No. 1431-р, dated 2 September 2010), include:
Taxation of capital gains on sale of shares deriving more than 50% of their value from immovable property
Gains derived from the alienation of shares in a company with more than 50% of its value consisting of immovable property in a contracting state may be taxed at source in this state. These gains do not include gains received from alienation of shares during a corporate reorganisation or alienation of shares listed on a recognised stock exchange or gains derived by a pension fund, provident fund or the government of a contracting state. This provision will apply from the beginning of the fifth calendar year following the effective date of the Protocol, i.e., in any case no earlier than 2015. Please note that this provision may literally apply to sale not only of Russian but also foreign shares and ownership interests.
Admissibility of thin capitalisation rules
Dividends now include income taxable in the same way as income from shares under the legislation of the dividend-paying company’s domicile, even if the dividends are received in the form of interest. Such dividends have, at the same time, been excluded from the concept of interest. Russian companies with Cypriot participation will thus be subject to the rules of clause 2, Art. 269 of the Russian Tax Code regarding recharacterisation of interest on controlled debt as dividends. Yet it is not clear so far whether this will suffice for practical application of the thin capitalisation rules, as no amendments have been made to Article 24 “Non-Discrimination” of the Agreement. The courts have often referred to its provisions in denying the right to apply these rules (see resolutions of the Federal Arbitration Court for the Moscow Circuit, dated 23 September 2009, No. КА-А40/9453-09-2 and the Federal Arbitration Court for the North-Western Circuit, dated 23 September 2009, on case No. А26-6967/2008).
Withholding taxes apply to income from mutual investment funds
The Protocol states that the income of mutual equity funds investing only in immovable property will be taxed at source as income from immovable property. It also clarifies that payments on shares in mutual investment funds or similar collective investment vehicles are treated as dividends.
Broader opportunities for information exchange and tax collection assistance
Article 26 “Exchange of Information” and Article 27 “Assistance in Collection” have been restated, significantly broadening information exchange between Russia and Cyprus and their tax collection opportunities, with Article 27 becoming effective when Cyprus passes the required legislation. The amendments are fully consistent with the text of the Model Convention of the Organisation for Economic Cooperation and Development (OECD) with respect to taxes on income and on capital.
Provision is made for information exchange and tax collection assistance (including interim remedies) not only in relation to the taxes referred to in the Agreement but also any taxes levied on behalf of either of the contracting states, if these are consistent with the Agreement. It is also mentioned that no obligation is imposed on a contracting state to supply information that would disclose any trade, business, industrial, commercial or professional secret or trade process, or information disclosure of which would be contrary to public policy (ordre public), or information that is not obtainable under the laws or in the normal course of administration of that contracting state.
The required investment threshold for a reduced tax rate for dividends is set at 100,000 euro
The current Agreement states that dividends are taxed at a reduced rate of 5% if the beneficial owner of the dividends has invested directly at least the equivalent of 100,000 US dollars in the company’s capital. The Protocol raises the threshold to 100,000 euro.
Determination of the place of effective management
Article 4 of the Agreement concerning determination of residence has been supplemented with a clause stating that, if the place of effective management of a person other than an individual cannot be determined, the competent authorities of the contracting states shall endeavour, having regard to all factors they consider relevant, to determine the place of effective management in each individual case.
Limitation of benefits
A new provision states that if the parties agree by means of consultations that one of the main reasons for creating a resident entity was to obtain benefits under the Agreement, such benefits will be refused. It is noteworthy that, according to the Protocol, this provision will only apply to companies not registered in either of the contracting states, i.e., it will not apply to companies established in Cyprus or Russia. A literal interpretation suggests that this provision is intended for companies that are not registered but resident in Cyprus (for instance, by virtue of their place of management being in Cyprus). This has not been a very common practice so far as regards income originating in Russia, so this new development will apparently be of limited practical significance.
New permanent establishment criterion for services provided through individuals
Permanent establishment criteria have been adjusted for taxation purposes if services in the other contracting state are provided through an individual other than an agent, broker or any other person of independent status. Under the new rules, a permanent establishment will arise if services are performed:
through an individual who is present in that other state for a period or periods exceeding, in aggregate, 183 days in any twelve month period and more than 50 % of the gross revenues attributable to the active business activities of the enterprise during this period or periods are derived from the services performed in that other state through that individual, or
for a period or periods exceeding, in aggregate, 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and perform such services in that other state.
Services performed by an individual on behalf of one enterprise will be considered to be performed by another enterprise through that individual only if that other enterprise supervises, directs or controls the manner in which these services are performed by the individual or if this individual has and normally exercises in this state the authority to conclude contracts on behalf of the enterprise, unless the individual is only engaged in the auxiliary and preparatory activities referred to in paragraph 4, Art. 5 of the Agreement.
These rules might potentially be used by the Russian tax authorities to claim that Cyprus companies actually (in the opinion of the controlling authorities) managed from Russia have permanent establishments in Russia. To avoid tax risks, these rules will need to be taken into account in planning the structure of the management and operations of Cyprus holding companies engaged in activities related to Russia-based assets.
Other amendments introduced by the Protocol include the place of effective management criterion for taxation of international traffic and some changes aligning the text of the Agreement with the above-mentioned OECD Model Convention.
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