Letter No. ED-4-13/15696@ “On holding companies’ beneficial ownership of income from sources in the Russian Federation” dated 8 August 2019 was published on the official website of the Russian Federal Tax Service on 13 August 2019. This letter evidences quite a serious change of the Service’s approach to the problem, which for many years has been the subject matter of tax disputes and professional discussions.
Holding and investment companies can be encountered in many multinational structures. Usually their functions are limited to transactions for the acquisition and disposal of share, membership interests in other (operating and non-operating) companies of the group, investment and financial activity, the protection of assets from bad-faith actions of third parties, etc. Accordingly, their activity and the substance of their presence in the country of registration (personnel, office, and volume of transactions) are often not on such a large scale as, for instance, those of operating companies.
Until now the tax authorities have followed the approach that such companies under no circumstances have beneficial ownership of dividends and other income received by them, and, consequently, they cannot use a reduced tax rate withheld at source of payment.
The Russian Federal Tax Service in its letter No. ED-4-13/15696@ dated 8 August 2019 justifiably points out that the formal approach cannot be applied to this matter: “The fact that ‘holding activity’ and ‘investment’ are mentioned among the activities of a foreign recipient of income may not be viewed as a self-contained and sufficient criterion for whether or not there is beneficial ownership of income”.
The Federal Tax Service explains to tax inspectorates that in such cases “they are required to analyse whether there is an element of artificiality in the holding company’s activities, including the signs that the company lacks independence in decisions adopted with respect to an asset owned by the company and with respect to the examined income from a source in the Russian Federation”.
This explanation is undoubtedly an important step in bringing Russian law enforcement practice closer to the concept of beneficial ownership of income as understood in the Commentary to the OECD Model Tax Convention. The key feature of the beneficial ownership of income is independence in disposing of the income rather than the number of employees, office area or taxes paid by the holding company. For this reason the creation of a substantial presence in the country of registration can possibly justify the use of benefits under double taxation treaties, but it is only indirect evidence of the company’s independence, but not the only possible evidence and not always sufficient.
Obviously, the next problem that is to be resolved in practice is identifying signs of a lack of independence in the holding company’s decision making. After all, every company of the group is affected or even (in the terminology of the tax authorities) ‘under the control’ of the parent company, head company or even ultimate beneficiaries. This is a standard feature of any group of companies, and not only those that want to use tax benefits. The influence of the head company and shareholders on subsidiaries, which undoubtedly happens in any group, needs to be distinguished from the situation in which the management of subsidiaries coordinated any significant management decisions with the head company and in fact makes no independent decisions.
The hope remains that the Russian Federal Tax Service will, in the near future, decide on this matter also, and the tax authorities will stop referring to ‘the company being under control’ each time they need to justify their conclusions that tax optimisation was illegal.
What to think about and what to do
The position of the Russian Federal Tax Service can become a serious argument in the case of disagreements with tax inspectorates concerning a recipient holding company’s beneficial ownership of income. At the same time, multinational groups that have such companies in their group, should analyse the level to which the holding companies’ management has independence in decision making, both when such companies dispose of received income and with respect to assets belonging to them. This analysis should be conducted not by formal corporate documents, which establish the powers of the company’s management, but by other documents which can evidence the independence of the decision being made. The company should collect evidence (‘a protection file’) which in the case of claims of the tax authority can confirm that a holding company is sufficiently independent.