Evolution of Russia's beneficial ownership concept understanding

On April 28 2018 the Federal Tax Service (FTS) issued Letter Number SA-4-9/8285@ concerning the beneficial ownership concept. The letter is addressed to the subordinated tax offices. In its letter, the FTS set out its observations of arbitration court practice relating to the beneficial ownership concept and provided its view on what criteria should be met by a company in order to be regarded as a beneficial owner.

Aspects of the letter are quite disputable and trigger various new questions. Despite this, the letter is notable since it shows the evolution of the authorities' understanding of the beneficial ownership concept. The Russian tax authorities insisted for 25 years (up until April 9 2014 when the Finance Ministry issued Letter Number 03-00-R3/16236) that beneficial ownership in a treaty sense could be evidenced by a document giving the legal right to receive Russian-sourced income. After the issuance of the letter and subsequent amendments to the Tax Code, Russia adopted the more usual sense of the concept with an emphasis on a substance-over-form approach, implying that the recipient of the income is regarded as its beneficial owner if the recipient has the right independently to use and (or) dispose of that income.

In practice, when auditing, the authorities required recipients of Russian-sourced income to demonstrate not only that they had the right to use and dispose of the income independently, but also that they had a sufficient (in the authorities' view) level of substance. In the new letter of April 28, the authorities stated that the beneficial ownership concept is a universal tool which applies to any cross-border transactions in order to prevent tax base erosion and profit shifting. In the authorities' view, when reviewing the application of the concept, in addition to other factors, it is crucial to analyse the circumstances surrounding the incorporation of the foreign recipient and its financing and operating activity. If the recipient does not carry out entrepreneurial activity, this may indicate its artificial nature. The receipt of investments and the financing of related parties are not evidence enough that the recipient carries out independent entrepreneurial activity.

The FTS treats the analysis of the foreign recipient's activity as one of the key factors for the assessment of its beneficial owner status. In practice, following the higher authority's view provided in the letter, the lower tax offices – instead of analysing whether the recipient determines the economic fate of income received, its functions and risks – may focus on examining whether the recipient carries out entrepreneurial activities independently. If this is deemed not to be the case, the authorities may seek to deny the use of a treaty benefit. The 'independent carrying out of entrepreneurial activity' requirements sound very similar to the 'active conduct of a business' test envisaged by the Simplified Limitation of Benefits (S-LOB) provisions. Unlike the S-LOB provisions, which require the involved treaty countries' agreement, the use of the 'universal' limitations imposed by beneficial ownership does not require reaching such an agreement. The interpretation of beneficial owner status provided in the letter may allow the authorities to apply the concept to a wider range of transactions than one may expect.