Amendments to the Russia-Cyprus Double Tax Treaty

Practical Law UK Articles 1-386-3778 (Approx. 5 pages)

Amendments to the Russia-Cyprus Double Tax Treaty

by Irina Dmitrieva, White & Case LLP

Status of the Protocol

The Protocol is expected to be signed by the governments of Cyprus and Russia (the States) before the end of 2009. It would then enter into force after it is ratified in Cyprus and Russia and the respective notifications are exchanged.

If signature, ratification and exchange of notifications take place before the end of 2009, the Protocol and the relevant changes to the Treaty will be effective as of 1 January 2010 (except for new rules on taxation of capital gains and assistance in tax collection).

Amendments to the Treaty

The Treaty (as many other treaties which Russia has signed) follows the OECD Model Tax Convention. Many of the changes proposed by the Protocol would bring the Treaty more closely into line with the latest version of the OECD Model Tax Convention and commentaries on it.

Tax residency of companies (Article 4)

The Treaty connects the "resident" status of a company to its place of management (which is the tax residency criterion in Cyprus) or place of registration (which is currently the tax residency criterion in Russia). Where the company is recognised as a tax resident of both States, the place of effective management is decisive.

The Protocol would clarify that if the place of effective management cannot be determined, it is determined by mutual agreement of both States.

Permanent establishment (Article 5)

The definition of the "permanent establishment" would be extended by including the following supplementary grounds where a Cyprus company may be found to have a permanent establishment in Russia:

Provision of services (i) through an individual if (ii) such individual is present in Russia for more than 183 days during any 12-month period and (iii) income from such services constitutes more than 50% of the Cyprus company's income from active business activities during the relevant period; or
Provision of services (i) in respect of one or several connected projects (ii) through one or more individuals (iii) for a period exceeding 183 days (in aggregate) during any 12-month period.

These additions correspond to guidelines in commentaries to the latest version of the OECD Model Tax Convention.

Taxation of income from immovable property (Article 6)

It is proposed to levy tax on the income of mutual equity funds investing only in immovable property in the same manner as income from immovable property situated in the other State (that is, such income is not exempt from income tax in the State where the immovable property is situated).

From the wording of the Protocol it is unclear whether this new rule will apply to either:

Income derived by a Cyprus resident from a Russian mutual equity fund investing in Russian real estate (which would be a change to the current taxation regime).
Income derived by a Cyprus mutual equity fund from Russian real estate (which can be more readily classified as a clarification to the current regime).

This rule may become clearer once the Russian and Greek versions of the Protocol are available.

Taxation of income from international traffic (Article 8)

Income from international traffic (by ships, aircraft or road vehicles in certain circumstances) would be exempt from Russian withholding tax only if the recipient has its place of effective management in Cyprus (and not just if it is resident in Cyprus, as it is under the current wording of the Treaty). The new wording of Article 8 would correspond to that in the OECD Model Tax Convention.

Taxation of dividends (Article 10)

It is proposed that a 5% withholding tax would apply to dividends resulting from direct investment in the capital of a Russian company in the amount of not less EUR100,000 (as opposed to the current threshold of US$100,000). A 10% withholding tax would continue to apply in all other cases.

The dividend taxation regime would be extended to apply to the following:

Income from depositary receipts (it is yet to be seen whether this means income received by the nominee holder of shares or income received by holders of depositary receipts (that is, the beneficial owners of shares)).
Any payments on shares of mutual investment funds or similar collective investment vehicles.
Interest which, under the domestic laws of the source State, is treated as a dividend (that is, interest on controlled debt which is recognised as a constructive dividend under Russian thin capitalisation rules).

Taxation of interest (Article 11)

Interest income would continue to enjoy exemption from withholding tax. However, it would be clearly stated that this exemption does not apply to interest which constitutes a constructive dividend under Russian thin capitalisation rules.

Taxation of gains from disposal of property (Article 13)

The rules on the taxation of capital gains would be brought into compliance with the OECD Model Tax Convention. Russia would be given the right to levy withholding income tax on gains from the disposal of shares deriving more than 50% of their value from Russian real estate. Under the Russian Tax Code such tax obligation exists for the disposal of shares in Russian companies.

However, the Protocol limits Russia's taxing right in the following three cases:

Disposal of shares in the course of corporate reorganisation.
Disposal of shares listed on a recognised stock exchange (as this is the case under the Russian Tax Code too).
Disposal of shares by a pension fund, a provident fund or the government of Cyprus.

Importantly, changes to Article 13 enter into force four years later than the Protocol. Reportedly, this deferral is intended to allow Russia to amend its current treaties with other countries.

Mutual agreement procedure (Article 25)

Where a person considers that actions of one or both States breach the Treaty, they are now allowed to present their case to the competent authority of either State within three years (as opposed to the current right to present it only to the competent authority of their home State, within two years).

This change is certainly a positive one and follows the commentaries to the OECD Model Tax Convention.

Exchange of information (Article 26)

Article 26 would be brought into alignment with the OECD Model Tax Convention. (Equivalent amendments to Russian treaties with the Czech Republic and Germany are expected to enter into force on 1 January 2010.)

In essence, the main changes to the rules on exchange of information are:

Information exchange would no longer be limited to taxes covered by the Treaty; it would be possible, for example, in respect of VAT as well.
Information requests would be allowed not only where it is "necessary for carrying out the provisions of the [Treaty]", but rather where it is "foreseeably relevant" both for carrying out the Treaty provisions and the "administration and enforcement of domestic laws".
Information requests would need to be processed, and may not be declined, even where:
- the State which receives such a request does not need such information for its own tax purposes; or
- the requested information is held by a bank, nominee or a person acting in an agency or fiduciary capacity or relates to the identity of the owners of the company.

Assistance in collection (Article 27)

Article 27 would be brought into alignment with the OECD Model Tax Convention.

The scope of co-operation in collection of taxes would be expanded as follows:

It would apply, apart from taxes, to the collection of interest, administrative penalties and the costs of collection.
It would apply whether or not the relevant taxpayer has sufficient property in the State requesting the assistance.
If the State requesting the assistance can apply measures which will assist in securing the collection of taxes by creating security under its domestic laws, it can request the other State to apply such measures as well.
The request is to be processed without proceedings with respect to the existence, validity or the amount of a tax claim needing to be brought before the courts or administrative bodies of the other State (to which the request has been made).

The request for assistance in collection may be refused if any one of the following applies:

The requested measures are contrary to the domestic laws or public order of the State to which the request has been made.
The State requesting the assistance has not pursued all reasonable collection measures.
The requested collection assistance would result in a burden on the State to which the request has been made which is disproportionate to the amount of the tax claim involved.

The new wording of Article 27 enters into force once the relevant legal basis is introduced by Cyprus, in domestic legislation.

Limitation of benefits (new Article 29)

The new Article 29 of the Treaty would deprive a resident of Cyprus of any benefit under the Treaty (either in the form of tax reduction or tax exemption) if the competent authorities of Russia and Cyprus, as a result of their consultations, establish that the main (or one of the main) purpose(s) of the creation of such Cyprus resident was to obtain the benefits under the Treaty which would otherwise not be available.

This limitation applies only to a company which is not registered in Cyprus, but created tax residency in Cyprus (that is, in certain rare cases where a company is registered, for example, in the British Virgin Islands or the UK, but has its place of management in Cyprus). Hence, Article 29 is not meant to apply to companies registered in Cyprus or Russia.

"Black-list" under Russian participation exemption rules for dividends

It has been reported that once the Protocol enters into force, Russia would remove Cyprus from a so-called "black-list" of countries, dividends from which deprive Russian corporate shareholders from claiming participation exemption for dividends.

Once this is effected, Cyprus would be used more frequently for structuring Russian outbound investments.

Amendments to the Russia-Cyprus Double Tax Treaty | Practical Law