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Amendments to the Cyprus-Russia Double Tax Treaty Promises to Benefit Investors
7 October 2010 saw the signing of a Protocol on Amendments to the 1998 Double Taxation Treaty (DTT) between the Russian Federation and the Republic of Cyprus. The new Protocol has received much publicity in recent months and this is not surprising since it promises to bring about changes in the current taxation regime between the two countries. Although the 1998 DTT created a reciprocal trading and investment relationship between the two Countries, Cyprus was included in 2008 in the Russian Tax Authorities "List of Offshore States" amongst 42 countries. The Russian black list essentially barred Cypriot subsidiaries of Russian Companies to obtain a tax exemption on their dividends. Taxand Cyprus and Taxand Russia review the amendments to the Cyprus-Russia DTT and its benefits for investors. In particular one of the most important and widely discussed amendments was the new Article 26 on exchange of information.
The Treaty was significantly amended by the Protocol. Many of the Protocol's provisions clearly aim to combat aggressive tax planning. At the same time, the Protocol should create a better playing field and Russian businesses incorporated in Cyprus will not be seen with a suspicious eye. It was reported that as soon as the Protocol is brought into effect, Cyprus will be removed from the blacklist. The ratification of the Protocol will probably occur within the next year and it is expected to be put into force on 1 January 2012.
Article 26 (Exchange of Information)
It is noteworthy to state that the new Article 26 utilises an identical wording with the Organisation for Economic Cooperation and Development's (OECD) Model Tax Convention on Income and Capital.
The new Article 26 will allow the Competent Authorities of the Contracting States to exchange information which is deemed relevant for the administration or enforcement of domestic laws concerning all types of Taxes, insofar as these taxation laws are not contrary to the DTT. Any information received by a Contracting State shall be treated as confidential and may be disclosed by the Competent Authorities in court proceedings. The latter change has led to widespread criticism since it is feared that it might be used by Russian Tax Authorities to obtain unscrupulous information about the Russian beneficial owners of many Cypriot Companies.
The new Article 26 provides certain safeguards to the application of the general rule of exchange of information. The Contracting States shall need to follow procedures of collecting and supplying information which are in accordance with their domestic laws (or the laws of the other contracting state). In the case of Cyprus Authorities, Cypriot Law 72(I)/2008 on the Collection of Taxes, provides that the Director of the Inland Revenue shall only supply foreign tax authorities (signatories of a DTT) with information if he has received substantial details about the concerned person and the reason for the requesting of information. This provision seems to have been put in place to ensure that the foreign Tax authorities do not engage in "fishing expeditions" without having any real evidence against the person under investigation. As a further control mechanism, the Cypriot Law provides that the Director of the Inland Revenue shall only supply information if he has obtained the written consent of the Attorney General of Cyprus.
The Protocol makes further provisions that a contracting state authority cannot refuse to supply information merely on the grounds that it has no domestic interest in that information. A further ground of non-refusal is for information held by a bank, nominee, agency or fiduciary capacity. In addition, according to the Protocol, information which could qualify as trade, business or industrial secrets will not be caught with the ambit of the Protocol. That is, this information will not be exchanged.
The business community fears that there will be an abuse of power by the Tax Authorities, in the sense that they will proceed to obtain more information than authorised by the Article. Therefore it is expected that the Attorney General of Cyprus will exercise his powers with great care before giving his consent.
The table below shows the other principal amendments for Russian investors and comments thereon:
Type of income /
Current version of the Treaty
Amended version of the Treaty
5% withholding tax ap-plies to direct investment of at least USD 100,000, subject to all necessary requirements
5% tax rate ap-plies to direct in-vestment into share capital of at least EUR 100,000
Distributions from mutual funds regarded as dividends and taxed at source
Where direct investment is less than EUR 100,000, the 5% tax rate may be kept if investment is brought up to that level.
As there is no share capital in mutual funds, it may be that distributions therefrom will be always taxed at source at 10%.
Interest treated as dividends under Arti-cle 269 of the Russian Tax Code
Treated as interest
Treated as divi-dends for the pur-poses of the Treaty.
For the purposes of this provision of the Treaty, interest in excess of al-lowable limits under Ar-ticle 269 of the Russian Tax Code (thin capitali-sation) will be treated as dividends, and such inter-est being subject to Rus-sian withholding tax will not be in conflict with the Treaty.
Rendering services with respect to one or several related pro-jects through one or several authorised persons who is present in the contracting state over 183 days during a 12-month period
No special provisions
Such activities give rise to a per-manent establish-ment
Granting powers of at-torney for conducting activities on behalf of a Cyprus company leads to increased permanent establishment exposure, especially in the case of management or advisory activities where the authorised person is a beneficiary and works actively in Russia on behalf of such company. It must be noted that the 183 days test refers only to presence and not provision of service, i.e. much shorter timing of provision of service may suffice to create a PE.
Income from a mutual fund established pri-marily for property investments
No special provisions
Such income is treated as property income and may be subject to with-holding tax in Russia.
Tax structuring has often involved using mutual funds for property in-vestments. Once the amendments come into force, income received by corporate and indi-vidual non-residents from mutual funds will be taxed in Russia at 20% and 30%, respec-tively. In many cases, such structures will have to be modified.
Income on sale of participations in Russian companies which have over 50% of their assets in real estate
Exempt from Russian tax
Will be taxed at 20% in Russia. Alienation of shares in the context of reorganisation as well as shares in companies listed in a recognised stock exchange are excluded from this provision.
This provision is de-signed to combat the widespread way of sell-ing property under the appearance of selling equity interests. The provision will become effective in 4 years after the Protocol itself comes into force.
Assistance in collection of taxes
The article existed but did not specify any rights or obligations
The article sets forth a more detailed pro-cedure for tax col-lection assistance and applies to all types of tax.
It also defines what can amount to a revenue claim and provides that "an amount owed in respect of taxes of every kind" but also any "penalties and costs of collection" related to such amount.
This article will allow the Russian tax au-thorities to send tax collection requests to the Cyprus tax au-thorities, who, subject to the applicable re-quirements, will have to comply with such requests without go-ing through any fur-ther administrative or judicial procedures. The article will come into effect once Cy-prus adopts the relevant legislation.
Limitation of Benefits
The article is not included in the current version of the Treaty
Under the article, benefits available under the Treaty may not be granted if obtaining benefits under the Treaty is the primary purpose or one of the pri-mary purposes for which the company was established.
The provision does not apply to compa-nies registered in Cy-prus or in Russia. However, the provi-sions do apply, inter alia, to UK or BVI companies that have chosen to be tax resi-dents of Cyprus. In-come received by such companies may be taxed in Russia at rates specified by the domestic tax law, regardless of any benefits that were made available under the Treaty.
Having acceded to the European Union and implemented its disclosure standards, Cyprus is now viewed by the European countries as a compliant with international transparency standards jurisdictions. The signing of the Protocol is expected to make Cyprus more transparent for the Russian tax authorities as well. As a result, not all of the solutions currently used owing to the non-transparent nature of Cyprus will work going forward. Russian companies having Cyprus structures need to assess the implications of the amended Treaty for their existing structures and, where necessary, take steps to bring them up to date.
In the first instance, the issue of substance needs to be addressed. Substance refers essentially to how legitimate looking a company is (either holding or trading). In order to add substance to such an offshore holding, providing a registered address and a local director will not suffice anymore. What needs to be demonstrated is that the Company in Cyprus has indeed employees, busy offices, assets, real job execution, decision making and even an economic value for its Cyprus operations. Once it can be proved that the business is solid it will be difficult for the structure to be interpreted as designed solely for the avoidance of taxation.
There is no clear guidance on which minimum level of substance would suffice. This is a crucial issue which will somehow be clarified with practice down the road. However it needs to be looked at now, not in 3 or 5 years. All current Russian Structures will need to be revised and possibly restructured immediately and the substance requirement assessed on a case by case basis. Russian and foreign companies should be aware that if they undertake any type of restructuring in the wake of the signing of the Protocol and also continue to use structures that involve Cyprus companies, they should pay special attention to whether such steps have a business purpose.
Your Taxand contacts for further queries are:
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T. +357 2269 9222
T. +7 49 5967 0007
T. +7 49 5967 0007
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