Russia suspends tax treaties with unfriendly countries

Russia unilaterally partially suspends almost half of the agreements on avoidance of double taxation – with 38 countries “unfriendly” to the Russian Federation. As follows from the published new presidential decree, most of the provisions are frozen until the termination of the treaties or until the “violation of interests” of Russia is eliminated. In particular, we are talking about freezing the use of reduced or zero rates on dividends, royalties and interest. The suspension will not affect the norms that are important for individuals on the possibility of offsetting income tax if it is paid in another state. Lawyers note that the decree increases the tax burden on businesses – however, its consequences fully depend on the response of unfriendly countries.

Vladimir Putin signed a decree suspending certain provisions of double tax treaties (DTAs) with 38 unfriendly countries. These are, in particular, the USA, Great Britain, EU countries (including Cyprus and Malta), Australia, Singapore, Canada. The document entered into force on the same day, August 8. The government was instructed to submit to the State Duma a draft law on the suspension of the DTT.

Let us clarify that such agreements imply that companies and individuals who are tax residents of one country, but receive income in another, can pay taxes either in one of the states, or in both, but at reduced rates. In total, the Russian Federation has concluded such agreements with about 80 countries. The suspension was earlier initiated by the Ministry of Finance and the Ministry of Foreign Affairs (see “Kommersant” dated March 15) – as a response to the sanctions and the decision of the European Union to include Russia in the black list of jurisdictions that do not cooperate with the EU on tax issues.

It follows from the decree that most of the provisions of the agreements are suspended – from the definition of a permanent establishment to the procedure for taxing profits from commercial activities, property, capital, and income from international transportation.

Reduced or zero withholding tax rates are also being frozen, for example, with respect to income from dividends (the Russian rate of 15% instead of 5% or 10%), royalties and interest (20% instead of 0%) will be applied. The provisions relating to the elimination of double taxation remain untouched, for example, the possibility of offsetting income tax paid in another country by individuals remains.

The suspension is envisaged until “the elimination by foreign states of the violations committed by them of the legitimate economic and other interests of the Russian Federation, the rights of its citizens and legal entities” or until the termination of these DTTs in relation to Russia. The agreements themselves do not contain the possibility of their suspension, but there have already been precedents for such an approach – in 2022, agreements with Latvia and Ukraine were suspended on their initiative, an agreement with the Netherlands was denounced, in mid-July Denmark notified Russia of the denunciation.

The decree contains an instruction to the government to “ensure the adoption of measures aimed at reducing the impact on the economy of the Russian Federation” of the consequences of the suspension of the DTT. On August 8, the White House refrained from commenting, redirecting questions to the Ministry of Finance. The Ministry of Finance also could not comment on the decree.

As Natalya Kuznetsova, partner of the tax and law department at DRT, notes, the suspension of the DTT provisions will be most noticeable with countries that have traditionally been used in business structuring: these are Cyprus, Switzerland, and Luxembourg. Also, adds Alexander Erasov, a partner in the tax practice of MEF Legal, that this is also sensitive for agreements with countries with which there was a high level of cooperation, such as Germany, France, the USA, and Japan.

Lawyers agree that the decision will lead to an increase in the tax burden for both foreign and Russian businesses.

For many companies, Alexander Erasov believes, it may exacerbate the issue of continuing operations in Russia or abroad. According to Alexander Tokarev, a partner at Kept, a key consequence will be that foreign companies from 38 countries will not be able to claim benefits when receiving passive income from the Russian Federation (dividends, interest, royalties). Taking into account the current currency restrictions, Natalia Kuznetsova recalls, in practice this will not affect many – payments are already frozen, but those companies that still managed to obtain permits will also face this.

In terms of Russian business operating abroad, lawyers assess the consequences in different ways. Alexander Tokarev believes that the degree of “morbidity” of the decree will depend on the reciprocal steps of foreign partners. “Suspension or denunciation by foreign partners will mean that Russian businesses will no longer be able to take advantage of benefits and exemptions abroad when receiving income from residents of these countries,” the expert says. According to the head of the tax practice of NSV Consulting Anastasia Vasilyeva, the need to pay higher rates will affect payments from unfriendly jurisdictions now.

One way or another, adds Galina Naumenko, tax partner of Tekhnologii Doravii, according to most commercial agreements, the tax burden for withholding tax is shifted to the Russian counterparty, so it will actually be borne by him, and not by a foreign organization. For example, it will become more expensive for the entire business to buy non-Russian software, for pharmaceutical companies the purchase of medicines may rise in price due to an increase in royalty tax. “I hope that certain situations will be prescribed by the Ministry of Finance with amendments to the legislation of the Russian Federation in order to mitigate or delay the burden,” the expert says.

Evgenia Kryuchkova