Russia, it might be said, has passed successfully through the initial period of tax law formation. This is probably true, yet many significant tax issues remain outstanding, one of them, the most significant for cross-border tax planning, being anti-abuse regulation. Recently, however, certain steps have been taken in this respect, the most notable being new transfer pricing regulations and the latest tax treaty developments.
New transfer pricing regulations
The new regulations will come into effect in 2012. The amendments expand existing transfer pricing regulations significantly and implement a framework compliant with the OECD guidelines in most material respects. Inter alia, the new regulation introduces the concepts of advance pricing agreements (“APA”) and corresponding adjustments and outlines functional analysis and comparability standards. On the other hand, the rules will not extend to royalties and interest (though we cannot exclude the possibility that this provision might be subsequently adjusted by the legislators) and do not recognise cost-sharing arrangements. The basic aspects of the new transfer pricing regulations in Russia are summarised below.
Transfer pricing control may extend to transactions with both related and unrelated entities under certain conditions. All cross-border related-party transactions will be controlled. Domestic transactions between related parties may be controlled if the revenues generated therein during the calendar year exceed approximately USD 100 mln (this sum being reduced to USD 33 mln. in 2014), subject to certain exceptions. Lower thresholds are set for severance tax payers and entities applying beneficial tax regimes (e.g., special economic zone, zero profit tax rate, etc.).
In addition, transactions between unrelated parties are controlled if they are made (i) with regard to certain traded commodities (including oil and petroleum products), or (ii) with residents of listed low-tax jurisdictions, both subject to a threshold of 2 USD mln. per calendar year.
Moreover, any transaction might be recognised by court as being controlled if it does not meet the relevant criteria for reasons created artificially by the taxpayer.
The new rules contain a list of criteria for entities to qualify as related parties, this being based on a 25% share of direct or indirect participation. The courts will retain the right to recognise persons and entities as related on grounds not directly specified in the Law.
Transfer Pricing Methods
The three traditional methods (CUP, Resale Price and Cost Plus methods) available under the existing rules are extended and supplemented by the Transactional Net Margin and Profit Split methods, thus making all the five OECD recommended methods available. The new regulations introduce a hierarchy of methods, giving priority to the CUP and Resale Price methods in specific cases.
Arm’s Length Price
The 20% price fluctuation (safe harbour) is abolished and replaced by a quasi-interquartile market price / profitability range. Generally, at least four comparables are required to calculate the range, while the CUP method may be applied even if only one comparable is available.
The prices applied under the state price regulations or antimonopoly rulings, APA-approved or established by an appraiser in cases when appraisal is mandatory under the Russian legislation are deemed arm’s length and cannot be adjusted.
Sources of Information
A two-tier structure is introduced for sources of information to be used for benchmarking. The prioritised sources include exchange quotations, customs statistics and official state data, data from information and price agencies, and internal comparables. In the absence or lack of information from the above sources, the tax authority may use other information, which should, in any case, be publicly available.
Taxpayers are required to notify the territorial tax authorities of controlled transactions and prepare full-scope documentation supporting the prices applied, which may be requested only during a transfer pricing audit.
Although the new transfer pricing framework requires considerable upworking and difficulties in its implementation may well be anticipated, it undoubtedly constitutes another step towards bringing the Russian tax environment in line with international practice.
Latest tax treaty developments
Last year, the Russian government launched a campaign to update existing double tax treaties. For instance, amendments to the double tax treaty with Cyprus were signed in 2010 and amendments to the double tax treaty with Switzerland have been signed this year. In addition, the draft amendments to the double tax treaty with Luxembourg have recently been approved by the Russian government. According to the draft, inter alia, the dividend withholding tax will be reduced by up to 5%, subject to certain requirements. These changes will make Luxemburg a very attractive jurisdiction for structuring investments into Russia compared to the Netherlands and Cyprus. These amendments follow the trends provided for by the model agreement on avoidance of double taxation established by the 2010 Resolution of the Russian government.
The most essential changes introduced by the amendments to the double tax treaty with Switzerland include the following:
No withholding tax will be charged on interest
According to the amendments, any interest arising in a contracting state and paid to a resident of the other contracting state will be exempt from withholding tax. This will increase quite considerably the appeal of Swiss financial structures compared to the existing regime, which requires 5% tax to be withheld on interest payments to banks and 10% on payments to other lenders.
At the same time, the amendments will permit national thin capitalisation rules to be applied, allowing parts of excess interest paid on loans from shareholders and their affiliates to be classified as dividends.
Changes in the tax regime for mutual funds
The amendments to a number of articles of the treaty provide a more detailed classification of payments on units for withholding tax purposes. The amendments thus establish that payments on units of real estate mutual funds and mutual investment funds are regarded as dividends when 50% of the income of the fund comes from shares and as interest, if this is not the case. It should be noted that, under the amendments, income from real estate mutual funds will not be subject to the article on income from immovable property allowing such income to be taxed in the country where the real estate is located, in contrast to the approach used in the amendments to the treaties with Cyprus and Luxembourg.
Tax will be charged on sale of shares in companies with more than 50% of the assets relating to real estate
The amendments provide for the right to deduct withholding tax on income from sale of shares in a company with more than 50% of the assets consisting, directly or indirectly, of immovable property in the contracting state. This rule will not apply to income from shares quoted on registered stock exchanges or where the immovable property making up 50% of the assets of said company is used as its place of business.
A new procedure has been introduced for exchanging information between competent authorities
The treaty has been supplemented with an article on exchange of information, the wording of which complies with the relevant text of the OECD Model Tax Convention. Information may be exchanged on taxes covered by the treaty and on value added taxes, insofar as the taxation thereunder is not contrary to the treaty. It is established, however, that a party may refuse to provide the requested information if this involves disclosing any commercial, business, industrial or professional secrets or trade processes, or if disclosure thereof would be contrary to public policy (ordre public) and if the information may not be obtained by virtue of law or in the course of the usual administrative practice of the contracting state.
There are specific limitations on exchange of information: in particular, no information may be exchanged on an automatic and spontaneous basis; requests of a random nature (“fishing expeditions”) are prohibited; the request should bear the requisites, including the name, of the audited person, the tax purpose of the request, the tax period, etc., as well as the name and address of the person that is requesting the information. Exchange of information is permitted only when all the normal procedures for collecting information on the national level have been exhausted. The practical meaning of the procedure for exchanging information will, in many respects, depend on the evolution of the domestic administrative procedures used by Russia and Switzerland in this respect.
Limitations on benefits and anti conduit measures
A new provision has been added stating that application of benefits under the treaty may be limited in the event of treaty benefits being used to reduce the withholding tax on dividends, interest and royalties through intermediary and conduit arrangements aimed solely at tax evasion.
Other amendments include exclusion from dividends of payments to private and state pension funds, as well as governments, political subdivisions, local authorities and central banks of contracting states, as well as some other amendments bringing the treaty closer in line with the above-mentioned OECD Model Tax Convention.
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