Potential termination of the Russia–Netherlands tax treaty
Alexander Tokarev of KPMG explains why businesses should be planning ahead to prepare for the potential termination of the Russia–Netherlands tax treaty effective from January 1 2022.
In March 2020, President Vladimir Putin increased withholding tax (WHT) rates on dividends and interest on transactions through transit countries. If this is opposed, then Russia will unilaterally terminate its treaties with them. The first countries to receive notification of the ministry’s intent were Cyprus, Malta, Luxembourg, and the Netherlands. In 2020, protocols to increase WHT rates were signed with the island jurisdictions and Luxembourg. However, according to the Ministry of Finance for the Russian Federation (RF Ministry of Finance), the Dutch were offered similar terms to those already agreed with Cyprus, Luxembourg and Malta, but talks yielded poor returns.
As follows from public records, the Dutch Ministry of Finance insisted that the list of benefits be extended to cover not only public companies but also companies carrying out real business. The RF Ministry of Finance found the approach pursued by the Dutch to be unacceptable, as it still presumed and preserved room for withdrawing cash from Russia, and opted for denunciation.
Although both parties have indicated they are still on speaking terms, all signs seem to indicate that termination of the double tax treaty (DTT) is a realistic option. If the official notification on termination of the DTT is sent to the Dutch government prior to July 1 2021, the DTT will terminate as of January 1 2022.
Should the DTT be denounced, dividends will be taxed in Russia at 15%, while interest and royalties will be taxed at 20%. Russian WHT will also apply to gains on sales of shares and equity interests made up of real estate in Russia. Even those companies which could be expected to continue to enjoy tax benefits, such as public companies or banks (in the event that the DTT is renegotiated similarly to the Cypriot one) will be stripped of this right if the DTT is denounced.
Should the DTT be terminated, the Netherlands will be left in a group of offshore jurisdictions that have no DTTs with Russia (BVI, the Cayman Islands, etc.) covering the taxation of passive income received from sources abroad. Groups with Dutch companies within their structures will be forced to consider the relocation of those companies to other jurisdictions. This leads to uncertainty, as DTTs with the most suitable alternatives – Cyprus and Luxembourg – have already been reagreed. Then there is the risk that the other jurisdictions chosen by a company for relocation in their own turn receive ‘good luck letters’ from the RF Ministry of Finance, thus rendering the relocation efforts pointless.
A look-through approach might be a good option for consideration, but it has little, if any, functionality in terms of applying the reduced 5% WHT rate to dividends where another foreign company in the ownership chain is declared as the beneficial owner of dividends. But for some countries, at least, the tax rate may be reduced to 10%, which is better than 15%.
As for interest and royalties, a look-through approach may be actionable but special focus should be given to cash flows. In this case, a Dutch company would be required to act as an intermediary, which is not always possible, and additionally this may trigger historical tax risks, meaning benefits in previous tax periods are challenged.
Another option is to remove Dutch sub-holding companies from the structures. Possible ways of doing this, as well as their tax implications, should be carefully considered, including MLI provisions (the principal purpose test). In addition, from the Russian tax perspective, any new recipient of Russian-source income should still be considered as the beneficial owner of that income in order to benefit from the DTT with Russia.
It is not known at the present time whether Russia will choose to exit from its DTT with the Netherlands. Whatever the outcome – be it a DTT amended along the lines of the Cypriot scenario, or no DTT at all – the use of Dutch companies in structures with Russian companies will likely, in most cases, lose tax effectiveness. As such, given the constantly changing tax environment, it may be a good time for businesses to reconsider current structures to maintain tax-efficiency.
Partner, KPMG Russia and the CIS