Tax inevitability – Newspaper Kommersant No. 44 (7489) of 03/16/2023

In response to the inclusion of Russia in the tax black list of the European Union, the Ministry of Finance and the Ministry of Foreign Affairs proposed to suspend double taxation agreements (DTAA) with unfriendly countries. In total, we can talk about 40 agreements, including the DTT with Cyprus, Luxembourg, the USA and Switzerland. Freezing bilateral treaties, in particular, will prevent legal entities and individuals from applying reduced or zero tax rates on income from dividends, interest and royalties. Citizens renting overseas real estate will also be subject to double taxation (although the full consequences for individuals are still unclear). Lawyers note that DTTs worked in 2022, but their application was limited due to sanctions, so their freezing will increase taxes for Russian businesses that maintain a (sometimes forced) presence in unfriendly countries.

The Ministry of Finance and the Ministry of Foreign Affairs on Wednesday, March 15, proposed to suspend double taxation agreements with unfriendly countries – it was proposed to issue a corresponding decree to the president. Such a measure should be a response to sanctions, as well as to the February inclusion of Russia in the black list of jurisdictions that do not cooperate with the EU on tax issues (see “Kommersant” dated February 14). The departments do not provide a list of frozen DTTs. In total, Russia has about 80 such bilateral agreements – of which about 40 are concluded with unfriendly countries (these are, in particular, the EU countries, including Malta, Cyprus, Luxembourg, as well as the USA, Great Britain, Switzerland, Japan and Singapore).

It is proposed to suspend the action of the DTT “until the restoration of the violated rights of Russia.”

The suspension means that the reduced or zero withholding tax rates stipulated by the agreements will no longer apply. As a rule, DTT provides for a reduced tax on dividends (5-10% versus Russian 15%) and a zero rate on interest payments and royalties (instead of 20%). Individuals under agreements can count in Russia the amount of income tax paid abroad (and vice versa).

Let us explain that in 2022, two tax agreements were suspended – with Latvia and Ukraine. But the initiative in these cases came from Riga and Kyiv and was a reaction to the start of a military operation in Ukraine. The Russian side noted that the military events are not grounds for a unilateral termination. Until 2022, there was another denunciation – with the Netherlands. But it was connected solely with the terms of the agreement itself – this country did not give in to the desire of the Russian Federation to tighten its policy on dividends going abroad. Moscow and Amsterdam could not agree on a revision of the agreement in terms of raising the rate on the withdrawal of dividends and interest to 15% – we recall that we managed to do this with Cyprus, Malta and Luxembourg (see “Kommersant” dated April 12, 2021).

Galina Naumenko, tax partner at the Tekhnologii Confidence consulting company, notes that it is not yet clear from the wording of the Ministry of Finance and the Foreign Ministry which agreements may be affected by the decision made public on March 15.

They are definitely supposed to be suspended with the EU countries, in which the blacklist against Russia has already been launched (this is the smaller part of the EU), among other options – all EU countries or all unfriendly states.

MEF Legal Partner Alexander Erasov notes that the use of DTT has historically been very large, but in 2022, cross-border business activity has declined in many areas, and additional restrictions on currency regulation have been introduced in Russia. “This, of course, also affected the scope of DTTs, but they still continue to work, and their suspension will be a serious change in the business environment,” the expert says.

As Sergey Nazarkin, Managing Partner of NSV Consulting Limited, notes, the application of DTT benefits was significantly hampered in Russia even earlier due to the introduction of deoffshorization tools. In 2022, this became even more difficult due to sanctions, for example, in terms of obtaining a tax residency certificate in an unfriendly country or confirming the tax paid there for further offset in the Russian Federation. With the decision to suspend, explains Ilya Gorshkov, deputy head of the International Law and Taxes practice at Lemchik, Krupsky and Partners, individuals who received income in 2022 on the territory of unfriendly countries, for example, from renting apartments or commercial use other property, will not be able to apply the foreign tax credit when paying tax in Russia.

Kept’s partner Alexander Tokarev proceeds from the fact that it is unlikely that “an unfriendly country will continue to apply the DTT if Russia suspends it.” And if for foreign companies the scale of the consequences is unlikely to be critical, then Russian ones may suffer – especially groups that are now engaged in restructuring their “foreign circuit”, the expert says.

Galina Naumenko also agrees with this – international business “to a large extent has left Russia or is unable to receive regular income from it,” so the suspension of the DTT can be painful precisely for Russian companies that still have a presence in the EU. The tax burden, Ilya Gorshkov believes, can grow by 15-40%. “Whoever can, will try to restructure their activities in unfriendly countries, but many will not succeed, because they do not let Russian business go well there – registrars do not register transfers of ownership, notaries do not certify transactions,” warns Galina Naumenko.

Evgenia Kryuchkova