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The taxation of dividends in the Russia & Cyprus Double Tax Treaty
Article 10 (2) of the Double Tax Treaty Agreement between the Republic of Cyprus and the Russian Federation states that withholding tax on dividends paid by a resident company of either country to the other shall not exceed 5% of the gross amount of the dividends, providing the beneficial owner has directly invested no less than $100,000 in the capital of the company paying the dividends. Taxand Cyprus and Taxand Russia provide an overview of a recent court case focusing on this area of the Treaty.
The Russian Federal Arbitration Court of the East – Siberian Circuit issued on 6 February 2014 the Judgment No. A19-2735/2013 for the application of the reduced withholding tax rate, as per Article. 10 (2) of the Double Tax Agreement. In the case under scrutiny, Yanden Enterprises Limited, a Cypriot resident company, received shares of Sayanskhimplast LLC, a Russian resident company, through share exchange agreements. As consideration for the Sayanskhimplast LLC's shares, Yanden Enterprises Limited transferred shares held in other two subsidiaries. As a result of these arrangements, Yanden Enterprises Limited became the sole shareholder of Sayanskhimplast LLC while the subsidiaries received participations in each other.
In 2010 Sayanskhimplast LLC paid dividends to Yanden Enterprises Limited to which the Russian Company applied the reduced withholding tax of 5% pursuant to the Tax Treaty. The Russian tax authorities contested the application of the reduced withholding tax rate and claimed that Sayanskhimplast LLC unlawfully applied this rate because the direct investment requirement in the Tax Treaty was not met.
The Court however opined that, based on article 7(3) of the Tax Code, “all unavoidable doubts, contradictions and ambiguities regarding the tax law should be construed in favour of the taxpayer”. It further explained that because the term "direct investment" is not determined clearly in the legislation, the Court rejected the arguments of the tax authorities that the acquisition of the shares of Sayanskhimplast LLC pursuant to the share exchange agreements cannot be considered a "direct investment". The Court adjudicated, in support of the decisions of the Lower Arbitration Court of Irkutsk region and the Arbitration Court of Appeal, that Yanden Enterprises Limited could be deemed as directly invested into the share capital of Sayanskhimplast LLC the required amount and, consequently, was entitled to apply the reduced withholding tax of 5%.
Also published in Thomson Reuters' Taxnet Pro, 3 April 2014
This important case highlights the beneficial provisions of the Double Tax Treaty between Cyprus and Russia, and re-confirms the numerous advantages of employing the Tax Treaty in international transactions. It also provides a clearer guideline as to how the courts examine the particular merits of each case, as well as setting a precedent to other arrangements of this type.