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Tax Treatment of Income on Russian Sovereign Bonds
On 16 April 2010 the Ministry of Finance issued clarification on tax issues related to issuance of Russian sovereign bonds and payments thereon. The Letter is signed by the Deputy Minister Sergey Shatalov. In its essence the Letter contains clarifications on tax treatment of interest and capital gains on Russian sovereign bonds derived by resident and non-resident taxpayers. Taxand Russia discusses the details of this letter.
The Letter confirms absence of WHT on interest paid to individuals (due to domestic tax exemption) and non-resident legal entities (due to the fact that Russian Federation does not qualify as withholding agent).
Capital gains derived by non-resident individuals on alienation of bonds are not subject to WHT unless the sale is made to a withholding agent which is a Russian resident legal entity or a permanent establishment (PE) in Russia of a non-resident legal entity.
Capital gains on alienation of bonds by non-resident legal entities are exempt from Russian tax under domestic law, unless they represent accumulated interest or are derived through a PE in Russia.
Considering that even in the latter case the Russian Federation would not qualify as withholding agent, there would be no withholding tax at source on this income.
The Letter further clarifies that a gross up clause, under which the issuer of bonds undertakes to compensate tax, if increased or introduced, is fully compliant with Russian law.
The purpose of the Letter appears to be to clarify the major tax consequences related to income from Russian sovereign bonds and explain that the tax regime related to this income is rather favourable.
It is worth mentioning that absence of withholding tax does not in itself result in exemption from the Russian tax obligations. The taxable income which was not taxed at source should be declared through self-assessment.
Nevertheless, under many Russian tax treaties, e.g. tax treaties with the US, UK, the Netherlands, Cyprus, Luxembourg and many other jurisdictions, interest and capital gains on bonds derived by an individual or legal entity resident in a tax treaty state, would be exempt from tax in Russia.
Buyers of Russian sovereign bonds should check whether the interest and capital gains on such bonds are exempt from Russian tax under the relevant tax treaty and obtain tax residence certificates to confirm their entitlement for tax treaty benefits.
Should the relevant tax treaty contain no exemption from withholding tax in Russia, investors may consider structuring investment in Russian bonds through special purpose vehicles in more favourable jurisdictions. This applies when there is a business case for such a structure, e.g. beneficial ownership test would be met and the main intention is not to avoid paying Russian tax. Alternatively the investors may decide to pay tax in Russia and use unilateral or tax treaty relief measures to avoid double taxation.
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