Elena Novikova

On August 8, 2023 the President of the Russian Federation signed and published new Decree 'On suspension by the Russian Federation of certain provisions of the Double Tax Treaties' No. 585 (the “Decree No. 585”). The list of partially suspended Double Tax Treaties (the “DTTs”) includes 38 “Unfriendly States”: Albania; Australia; Austria; Belgium; Bulgaria; the Czech Republic; Canada; Croatia; Cyprus; Denmark; Finland; France; Germany; Greece; Hungary; Iceland; Ireland; Italy; Japan; Lithuania; Luxembourg; Macedonia; Malta; Montenegro; New Zealand; Norway; Poland; Portugal; Romania; Singapore; Slovakia; Slovenia; South Korea; Spain; Sweden; Switzerland; the UK and Northern Ireland; and the US. Decree No. 585 comes into force immediately and suspends the key provisions of the DTTs regulating taxation of income, while certain provisions such as tax credits, exchange of tax information, etc. remain in force. Decree No. 585 does not have a retrospective effect, and the tax rates that have already been applied before August 8, 2023 would not be recalculated. At the same time, Decree No. 585 does not specify any date for restoring full effect of the DTTs. Partial suspension of the DTTs is a second Russian countermeasure against including Russia into the list of non-cooperative jurisdictions for the tax purposes (the so-called “EU blacklist”). Previously, the Ministry of Finance of the Russian Federation has included all “Unfriendly States” into the blacklist of “offshore jurisdictions” (the Order No. 86н dated June 15, 2023). As a result, starting from July 1, 2023 any transactions between a Russian company and a company from one of the “Unfriendly States” (irrespective whether it is a related or a third party) exceeding RUB 120 mln per year (approx. EUR 1,145 mln) are subject to the Russian transfer pricing rules and special disclosure in Russia. What is the tax effect of partial suspension? Decree No. 585 impacts potential and scheduled payments of dividends, interest, royalties, and other similar “passive” types of income from Russia under the DTTs with “Unfriendly States”, i.e. the beneficial tax rates provided by the DTTs are no longer available. The standard withholding tax (WHT) rates apply starting August 8, 2023: {{1)}} 15% WHT rate for dividends (instead of 5% or 10%); {{2)}} 20% WHT rate for interest payments (instead of a tax exemption or 10%); {{3)}} 20% WHT rate for royalties (instead of tax exemption or other lower WHT rates); and {{4)}} 20% WHT rate for distribution of profit (other than dividends) (instead of a tax exemption). The latter change may have a potentially substantial effect as the tax authorities obtain more opportunities and fiscal reasons to requalify any suspicious payments and/or payments with low economic justification (even “active” types of income such as payments for the intragroup services) to distribution of profit that is subject to 20% WHT rate at the source of income in Russia. These standard tax rates apply irrespective of the amounts of payments and existence / absence of the special approvals of the Governmental Commission (i.e., even payments below RUB 10 mln per month, which do not require the special approval, are subject to the WHT). The tax must be withheld by the Russian company acting as a tax agent, i.e. the amount of income will be decreased by the amount of tax if no “gross-up” provision applies in the agreements between the parties (this does not apply to dividends). The standard WHT rates apply at the time of payment, e.g., if the foreign shareholder has already issued the Resolution on distribution of dividends by its Russian subsidiary before August 8, 2023, but the actual payment is made after that date, the beneficial DTTs’ rates cannot be applied. This list of negative tax effects of the DTTs’ suspension is not exhaustive, as other mechanisms are also affected (e.g., international transportation services, and rules for permanent establishments). Our key recommendations Considering the abovementioned changes, it might be reasonable for an international group of companies with Russian subsidiaries to check: {{1)}} anticipated payments of dividends, interest, royalties, and other similar types of income and assess possible increase of tax burden; {{2)}} the contractual structures (in particular, loan agreements and license agreements), whether they provide for a “gross-up” provision (if applicable); {{3)}} possible risks of requalification of payments in cases with the intercompany agreements, disproportional distribution of dividends, etc. This analysis shall contribute to better understanding of the further tax position of Russian subsidiaries, new tax implications, and possible tax risks.

As a matter of important update that may impact potential and scheduled payments of dividends, interest, royalties and other similar “passive types” of income from Russia, please be informed that on 18th of May 2023 Russian Media has announced that Double Tax Treaties (the “DTTs”) with “Unfriendly States” will be temporarily suspended by the Presidential Decree in June 2023 . This initiative was prepared by the Ministry of Foreign Affairs of Russia and the Ministry of Finance of Russia in the middle of March 2023 as a countermeasure for including Russia into the list of non-cooperative jurisdictions for the tax purposes (the so-called “EU blacklist”). Since the joint initiative was prepared, no additional information on the form, terms and other details of suspension was announced. Now it seems that DTTs will be suspended based on the Presidential Decree that most likely will have an immediate effect, with no transition period and exact date of restoring effect of the DTTs. Although the DTTs do not provide for such mechanisms of suspension, the DTT with Latvia was already suspended by the Presidential Decree No. 668 dated 26 September 2022 with simple notification of the Latvian Government on suspension of the DTT until Latvia will exclude its violations under the DTT or until the DTT will be fully terminated (similar to the DTT with the Netherlands that was terminated in 2021). What is the tax effect? No beneficial tax rates provided by the DTTs will be available for payments of so-called “passive types” of income from Russia to the US, UK, Japan, Canada, EU and other “Unfriendly States” implemented sanctions against Russia. As a result, only standard tax rates will apply: {{1)}} 15% WHT rate for dividends (instead of 5% or 10%); and {{2)}} 20% WHT rate for interest payments (instead of tax exemption or 10%); and {{3)}} 20% WHT rate for royalties (instead of tax exemption or other lower WHT rates); and {{4)}} 20% WHT rate for distribution of profit (other than dividends) (instead of tax exemption). The latter change may have an underestimated effect as the tax authorities will have more opportunities and fiscal reasons to requalify any suspicious payments and/or payments with low economic justification (even “active types” of income such as payments for the intragroup services) into distribution of profit subject to 20% WHT rate at the source of income in Russia. These standard tax rates will apply irrespective of the amounts of payments and existence / absence of the special approvals of the Governmental Commission (i.e., even payments with the amounts below RUB 10 mln per month, which does not require the special approval, will be subject to the WHT). This list of negative tax effects of the DTTs’ suspension is not exhaustive as other mechanisms will also be affected (e.g., international transportation services, opportunities for the tax credits, rules for the permanent establishments, exchange of tax information, etc.). In line with the temporary suspension of the DTTs the Ministry of Finance of Russia considers increase of the tax liabilities of Russian companies for non-submission or late submission of the special reports on payments of income to the foreign companies (the cash penalties will be from 5% to 30% of the amount of WHT mentioned in the report, depending on the term of delay). What is a “windfall tax”? On 10th of May 2023 the Ministry of Finance of Russia has published information about strong increase of the deficit of the State budget. Temporary suspension of the DTTs and application of the standard WHT rates shall have a positive effect for increase of the budget, however, as announced this will not be the main tool for the budget replenishment. In this regard the Ministry of Finance of Russia has prepared the Draft Law introducing a new tax obligation for the larger Russian companies (with minor exemptions) and foreign companies having permanent establishments in Russia for the tax purposes (the so-called “windfall tax”). The object of taxation will be the “excess profit”, defined as the difference between the average profit for 2021–2022 and the average profit for 2018–2019 (the pandemic year 2020 will not be considered). The amount of excess profit shall be determined according to tax accounting data (the sum of tax bases for the corporate income tax). The “windfall tax” shall apply, if such difference will be equal to or greater than RUB 1 bln. The tax rate will be 10% and the tax will be due in January 2024. At the same time, the tax rate can be discounted by 5%, if the funds are voluntary transferred to the budget by the taxpayers in October-November 2023. The Government expects that “windfall tax” will increase the budget by approx. RUB 300 bln. The Draft Law is now on consideration with the business representatives and trade associations and the final version is not published yet. It is expected that the Draft Law will be inserted to the legislative bodies for their consideration until the end of May 2023. The “windfall tax” is announced as one-time payment. However, the Russian Tax Code will be shortly amended by the general term “taxes of an extraordinary nature', which may indicate the opportunity to introduce and collect similar taxes in the future. Our recommendations Considering expected changes, it might be reasonable for the international group of companies with Russian subsidiaries to check: {{1)}} anticipated payments of dividends, interest, royalties and other similar types of income and review possible increase of tax burden; {{2)}} the contractual structures (in particular, loan agreements and license agreements), whether they provide for the “gross-up” provision (if applicable); {{3)}} amounts of profit before taxes for 2021-2022 and 2018-2019 for their compare and assessment of potential application and figures of the “windfall tax”. This analysis shall help with better understanding of the further tax position of Russian subsidiaries, new tax implications and possible tax risks.

On 28 November, Elena Novikova, ALRUD Tax Practice Of Counsel, spoke at the conference “Tax control: outcomes of 2022, expectations for 2023” on the topic “Tax considerations of providing financing and debt restructuring: tax authorities approach and major risk areas”. In her speech Elena touched on the questions regarding debt financing most frequently raised during tax inspections and mentioned the issues that raise the attention of the tax authorities. The speaker used the real-world examples to emphasize the importance of rationally substantiating the business goal, and shared the key conclusions from the recent case law. To finalize her speech, Elena reported on the option of tax-free debt relief. The practice-driven tax control conference is held for the 9th time, gathering tax consulting leaders and attracting unfaltering attention of the audience. It is a perfect occasion for the participants to meet the professional community leaders and the Federal Tas Service representatives, and to take advantage of unique expertise.

On 5 October 2022, the Russian Federal Tax Service published the draft Order “On the Approval of the List of States (Territories) That Automatically Exchange Financial Information” (the “Draft Order”). The existing list of countries and territories that exchange such information is to be extended to include Kazakhstan, Maldives and Oman. At the same time, a proposal has been made to exclude the Cayman Islands and Switzerland, which previously announced it would suspend all forms of tax information exchanges with Russia, including automatic exchange under the CRS standard. The Draft Order is under public discussion, which will last until 19 October 2022. If the document is adopted, it will come into force 10 days after the date of its official publication. The explanatory note to the Draft Order indicates that 96 countries and territories have declared their willingness to exchange information with Russia. What will change? Given that many of Russia's HNWI actively use Swiss accounts for portfolio investments and other transactions, the adoption of the Draft Order would require significant changes in the structure of transactions performed using such accounts. The absence of automatic exchange with a particular country significantly limits the list of transactions that can be performed by currency residents with accounts opened at banks in such a jurisdiction. In particular, holders of the accounts opened in Switzerland, which has traditionally been used for portfolio investments, would be prohibited from crediting funds in the form of dividends or interest on securities, as well as proceeds from sell/redemption of securities and other financial assets. Transferring funds between personal accounts, crediting interest on the balance of funds deposited in an account, crediting funds received from non-residents under employment contracts for work outside of Russia and certain other transactions would be allowed. What strategies are available? Holders of the Swiss private bank accounts may be advised to: Review transactions that are planned to be executed via such accounts Assess the feasibility of selling existing financial assets before the new list of exchanging countries takes effect Transfer funds/investment portfolios to their accounts in countries that will continue to automatically exchange information with Russia Assess the possibility of transferring funds/investment portfolios to controlled foreign companies (taking into account restrictions imposed by the counter-sanctions) Redirect cash flows associated with crediting funds (e.g., under lease agreements) to other jurisdictions. What’s next? The refusal of Switzerland and other countries to cooperate with Russia on tax issues may lead to changes in another list – the list of countries that do not exchange tax information with Russia. In particular, depending on whether a specific country is on this list, CFC owners determine whether an audit is required of CFC financial statements that should be submitted to the Russian tax authorities together with the annual notification on controlled foreign companies, as well as assess the possibility of applying certain exemptions from the taxation of CFC profits (e.g., based on the effective tax rate criterion). If a country is included in the list of non-exchanging countries, CFC owners may, for example, incur additional costs for auditing financial statements, and may have to declare CFC profits and claim an offset of foreign tax instead of claiming the exemption of such profits from taxation. ALRUD experts are monitoring developments and will be glad to analyse your situation and develop an action plan that takes into account the latest legal requirements and helps to meet your needs. We hope that the information provided herein will be useful for you. If you or any of your colleagues would like to receive our newsletters via e-mail, please fill in the 'Subscribe' form at the bottom of the page. Note: Please be aware that all information provided in this letter was taken from open sources. Neither ALRUD Law Firm, nor the author of this letter bear any liability for consequences of any decisions made in reliance upon this information.

On April 22, 2022, Elena Novikova, Of Counsel in ALRUD Tax Practice, spoke at the conference «Tax control in 2022. Main trends, challenges, and prospects». Elena spoke on «Business splitting: legal optimization or tax crime, where is the line?». In her speech Elena spoke about the main trends in tax disputes related to business splitting, and spoke about the basic criteria used by the tax authorities in assessing the business structures of taxpayers. Using examples from practice, the speaker explained in detail that with a rational reasoning of business purpose, even potentially 'losing' cases may be considered in favor of taxpayers. Particular attention was paid to the topic of using IT-benefits which is relevant for many companies. The final part of the presentation reflected circumstances that may trigger a tax audit. The «Tax Control» practical conference takes place for the eighth time and is very popular with the audience. Recognized lawyers and advisors in the field of taxation, heads of tax practices, representatives of leading consulting companies, as well as representatives of the Federal Tax Service of Russia meet at a single platform.

Experts from the Private Clients and Tax practices prepared the Russian chapter for the Thomson Reuters Practical Law Private Client Global Guide. This overview covers the current status of key legal issues that are of concern to high-net-worth individuals: individual tax reporting; currency control issues; family and inheritance law; the ownership and inheritance of Russian and foreign real estate; trusts and other estate planning instruments; and the creation and financial support of charitable organizations. The overview was compiled by Senior Partner Maxim Alekseyev, Counsel Kira Egorova, Counsel Elena Novikova, Consultant Elena Skoptsova, and Associates Maria Petrova and Sofia Imamutdinova. The full publication is available here