|Anna Voronkova||Rezida Valitova|
Russian de-offshorisation refers to a combination of initiatives such as controlled foreign company (CFC) rules, the beneficial ownership concept, and tax residency rules for foreign companies that are designed to combat tax base erosion and the use of offshore companies by Russian businesses.
The key de-offshorisation goals are:
- To prevent funds from being transferred offshore without taxation by limiting the use of double tax treaties (DTTs) through the use of the beneficial ownership concept;
- To tax funds which are held offshore by:
- broadening the tax residency rules for companies; and
- enacting CFC rules;
- To tax capital gains arising as a result of the indirect transfer of ownership in Russian "property-rich companies".
The amendments fix the beneficial ownership concept into legislation and provide a domestic mechanism designed to avoid aggressive tax planning, and which can be used in parallel with other anti-abuse instruments.
Beneficial owner concept
The 'actual recipient of income' rule (better known in international practice as the beneficial owner rule) is not a novelty in Russian tax law. The new amendments simply fix the beneficial ownership concept as previously formulated by the Russian Ministry of Finance into its official legislative clarifications.
When applying a DTT, a beneficial owner of income that has been paid out of Russia is a person or entity who has the right to use the income, as well as a person or entity for the benefit of whom another person has the right to use and dispose of the income.
A foreign company cannot enjoy any of the benefits under a DTT between Russia and the foreign company's jurisdiction if the foreign company (1) has limited authority to dispose of the income, or merely functions as an intermediary in relation to the income; (2) has no additional functions or risks with respect to the income; (3) further distributes the income to an entity that is not entitled to any benefits under a DTT concluded with Russia.
When determining whether a company is a beneficial owner or not, the functions performed and risks borne by that particular company must be taken into account.
The Russian Ministry of Finance suggests that the following documents may be used to substantiate beneficial ownership of income claims (Letter of the Russian Ministry of Finance #03-08-05/36499 of July 24 2014):
- Documents confirming that the recipient of income enjoys discretion with regard to the disposal and use of the received funds, including documents confirming that the recipient of the income has no legal obligations towards third parties in respect of the income;
- Documents confirming that the recipient of income has had that income taxed, and that no tax savings are achieved in subsequent transferals of funds to third parties; and
- Documents confirming that the recipient, in substance, performs entrepreneurial activities.
As we see it, understanding the beneficial owner concept is particularly important to foreign investors, given the fact that non-compliance with the rules might lead to withholding tax (WHT) being applied at domestic rates on onward payments of dividends, interest, and royalties to foreign companies.
The 'look-through' approach has been specifically set into law for situations in which the immediate recipient of income is not the beneficial owner. However, an ultimate beneficial owner of income may still claim benefits for distributed income that is sourced in Russia if two conditions are met:
- There is in force a DTT between Russia and the jurisdiction where the ultimate income recipient is a tax resident that provides for withholding tax (WHT) relief; and
- The Russian payer is aware of the ultimate beneficial recipient before payment.
This approach thus provides for no WHT if the beneficial owner is Russian and for application of the relevant DTT provisions if the beneficial owner is foreign.
Issues to consider
To mitigate possible risks for potential investors, investment structures should be planned that take into consideration the following grey areas in the concept:
- Administrative regulation: there is no clear method by which beneficial owners can be identified, and there is no definitive document list which must be provided in order to confirm beneficial owner status;
- The 'look-through' approach: the applicability of such method in case of direct investment, minimum cash and shareholding participation requirements for applying a reduced WHT under the relevant DDT;
- No beneficial owner requirement in the DTT: from a literal interpretation of the proposed provisions, it is unclear whether a national definition of beneficial owner should apply if the DTT does not separately require that a taxpayer must be the beneficial owner in order to enjoy the benefits of a given article in the DTT (for example, regarding interest pursuant to the DTT between Russia and Luxembourg, or between Russia and Cyprus).
- Retrospective effect: the new law fixing the beneficial owner concept came into force at the beginning of 2015. However, during informal discussions, the tax authority's representatives indicated that they intended to apply the introduced concept retrospectively, as the enacted amendments fixed the rules that were previously formulated by the Russian Ministry of Finance in its official legislative clarifications.