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Amendments to the Cyprus-Russia Tax Treaty
7 October 2010 saw the signing of a Protocol on Amendments to the 1998 Double Taxation Treaty 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 2007 in the Russian Tax Authorities "List of Offshore States" amongst 42 countries. The Russian black list essentially barred Russian Companies to obtain a tax exemption on dividends from their Cypriot subsidiaries.Taxand Cyprus and Taxand Russia discuss one of the most important amendments to the Tax Treaty, 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 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.
Nevertheless 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 provision 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 has been fearing that there will be an abuse of power by the Tax Authorities, in the sense that they will proceed to obtain more information than authorized by the Article. Therefore it is expected that the A.G. of Cyprus will exercise his powers with great care before giving his consent.
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.
The issue which needs to be addressed in first place is the issue of substance. Substance refers essentially to how legitimate looking is a company (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 crucial issue will be of course somehow clarified with practice down the road. However it needs to be looked at now, not in 3 or 5 years. For sure, all current Russian Structures will need to be revised and possibly restructured. This needs to be done immediately and the substance requirement assessed on a case by case basis. Please note that when Russian and foreign compnaies undertake any restructuring in the wake of the signing of the Protocol, and also when they continue using 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:
T. +357 22 699 222
T. +7 495 967 00 07
Look out for the full article in the upcoming Taxand's Take.