20 March 2018
Russia is one of the fastest growing markets for the international wealth management industry. This is partially due to the fact that political uncertainty drives Russian money to ‘safer lands’ offshore. The poor legal system and lack of enforcement mechanisms in Russia allow the non-Russian ownership structures for Russian resident individuals to be legitimate and low-risk. One of the main tools of wealth planning for Russian HNWIs is the use of double tax treaties to mitigate tax exposure on repatriation of money offshore.
To date, Russia has concluded over 70 double tax treaties with most of its trade partners. Most of the treaties are based on the OECD Model Convention.
Last year, the Russian government approved a new Model Treaty on Double Taxation and Income and Property Tax Evasion (the ‘Model Treaty’). The Model Treaty does not correspond exactly to the OECD Model Convention. It does not have statutory effect, but is intended to be used as a basis for negotiations in relation to new double tax treaties between the Russian Federation and foreign states. However, it may also be used as a basis for amending current treaties by means of a protocol.
The main impact of the Model Treaty is that the newly concluded double taxation treaties will considerably widen powers of taxation of the income source state. This clearly demonstrates the desire of Russian tax authorities to increase tax revenue at the point of repatriation of income received from investments in Russia. Most amendments to articles contained in the previous model treaty, including those on dividends, interest and capital gains taxation, are designed to restrict the conditions for the application of reduced withholding taxation at source.
Some examples of new restrictions concern: taxation of profit distribution within associated companies; re-qualification of interest payments as dividends in accordance with domestic law provisions (in effect, the income source state’s power to apply domestic ‘thin capitalisation’ rules now extends to cross-border controlled debt interest payments); and fundamental changes in provisions regulating ‘other income’ (these extend the source state’s power to tax ‘other income’.
Another important provision closes a loophole previously used by vigorous tax planners: the absence of a mechanism for taxing foreign companies in Russia, eg on a sale/acquisition outside Russia between foreign companies of Russian-located assets. These provisions include powers whereby one state may raise inquiries with another state demanding tax collection and apply injunction measures.
The Model Treaty also contains a number of provisions aimed at the prevention of tax avoidance and abuse of treaty provisions (eg the concept of beneficial owner, limitation of exemptions), as well as provisions which have a more fiscal character compared to the previous Model Treaty and to most existing tax treaties with Russia. As mentioned, in practice, the most common holding structure projects designed for Russian corporate groups use the most favourable jurisdictions to minimise overall tax exposure within the group. The provisions of the new Model Treaty limit the exemptions provided for under a treaty if such exemptions will lead to the abuse of advantages resulting from treaty provisions (so-called ‘treaty shopping’).
A key question is how far the changes to the Model Treaty may influence the application of existing treaties. Following the revision of its treaty with Cyprus, which showed Russia pursuing a more fiscal international tax policy, countries including Luxembourg, Switzerland, Austria and the Netherlands have also been ‘short-listed’ for review of existing treaties. In fact, in March 2011, the Swiss and Russian governments announced the completion of negotiations and confirmed agreement on changes to their existing double tax treaty. The protocol has not yet been published; it is intended to be put to the local Swiss authorities for consultation first. It is likely that exchange of information provisions and overall tax avoidance issues will be the major changes. These changes will inevitably impact on the profession’s approach to international corporate and personal asset structuring solutions involving Swiss elements.
The Model Treaty therefore serves as an indicator of government policy in the area of international taxation and should be taken into account when assessing tax risks in the application of various concepts in relation to existing treaties, which successfully meet current international tax planning objectives. These provisions shall be closely considered for the existing and future international investments structuring in Russia and the clients shall be informed of the increased risks and additional requirements for careful planning of cross-border transactions at an early stage.