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Russia Opens Up Opportunities for Corporates by Re-Visiting Tax Treaties
Several recent court rulings may reflect a new trend in court practice that open up opportunities for the unlimited deductibility of interest on loans for Russian CIT purposes, based on a larger number of DTTs concluded by Russia with other countries.Taxand Russia investigates.
On 23 September 2009 two of Russia's second highest courts issued rulings on the applicability of domestic thin cap rules to Russian taxpayers controlled by non-residents. Under Russian thin cap rules a resident company may be subject to thin cap limitations if it is controlled (by at least 20%) by a non-resident. The limitation may result in:
i) non-deductibility of excessive interest
ii) recharacterisation of excessive interest into dividends (Thin cap rules do not apply to resident companies without foreign control)
Most of Russia's DTTs contain non-discrimination clauses based on the par. 4 of Article 25 of the OECD Model Convention, under which foreign control should not worsen the tax position of a resident taxpayer. As this is exactly the result of the application of domestic thin cap rules, it appears that Russian thin cap rules do not always comply with non-discrimination provision under tax treaties.
Previously taxpayers successfully challenged domestic thin cap rules on the basis of tax treaties, although the relevant tax treaties contained specific clauses on full deductibility of interest for Russian subsidiaries of non-residents.
Tax treaties with Cyprus and Finland, on which court decisions of 23 September 2009 were based, do not contain a specific clause on deductibility of interest. Thus courts based their decisions on non-discrimination provisions in the relevant tax treaties.
Unlike the full deductibility clauses which present in only few tax treaties, non-discrimination clauses are present in most of the Russian tax treaties.
Therefore the decisions of the courts may support the argument for the deductibility of interest expense in excess of limitations imposed by thin cap rules for a large number of Russian companies with foreign investment covered by a non-discrimination clause in the relevant DTT.
Recently courts have adopted several decisions that enable Russian companies with foreign participation not to apply Russian thin capitalisation rules, based on the provisions of DTTs signed by Russia both with countries which provide for such a possibility, and also with some other countries.
To benefit from the tax treaty provisions on non-discrimination a Russian subsidiary of a resident in a tax treaty country would need to perform a 3 step analysis to identify:
1. whether the relevant tax treaty contains a non-discrimination clause
2. if such a clause exists, whether its application is limited in the tax treaty
3. if the non-discrimination clause applies, the subsidiary needs to check whether it uses all available benefits.
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