Under a general rule a tax resident of one contracting state is entitled to apply favorable provisions of the DTT (reduced withholding tax rates or tax exemption) in respect of taxation of passive income sourced from another contracting state if the recipient is the beneficial owner of the respective income.
Up to now the Russian Ministry of Finance applied the term "actual recipient (beneficial owner)" from the standpoint of Russian tax legislation only in several letters (the Letter of the Russian Ministry of Finance of 30.12.2011 #03-08-13/1, 21.04.2006 #03-08-02, etc.). Furthermore, the term was actively used in several landmark court cases (The Eastern Value Partners Limited case; The Securitization of Trust Bank case, etc.).
The newly issued Letter can be viewed as the most complete compilation and systematization of approaches of Russian tax authorities as to determination of the term "actual recipient (beneficial owner)" for the purposes of application of DTT before the introduction of the relevant concept in the Russian tax legislation. Please note that according to the Plan of the Russian Ministry of Finance aimed at the deoffshorization of the Russian economy the draft law on the "actual recipient (owner) of income” concept should be prepared by the end of Q2 2014.
Please find below the major points of the Letter:
- The term “actual recipient (beneficial owner) of income” should not be used in a narrow technical sense, but rather it should be understood in the context and in light of the main principles of the DTTs, including the prevention of misuse of provisions of the DTT and substance-over-form concept.
- In order to be recognized as actual recipient (beneficial owner) of income the entity should not only have the legal right to such income, but should also be an immediate recipient of benefits. This means that the entity should actually benefit from the income received and determine subsequent economic fate of such income.
- One should also consider the functions performed and the risks undertaken by a foreign legal entity upon determination whether it can be treated as an actual recipient (beneficial owner) of income.
- The favorable provisions of the DTT should not apply if the income received under transaction (or several transactions) according to which the foreign entity claiming the application of the reduced tax rates on passive income pays directly or indirectly all or nearly all of such income (at any time and in any form) to another entity which would not have the right to apply favorable provisions of DTT in case such income was paid directly to that entity (conduit transactions).
The aforementioned provisions are predominantly based on the OECD approach as to the determination of beneficial owner, in particular, on the proposed changes to the Commentaries to The OECD Model Tax Convention outlined in the special Report of 2012 (Revised Proposals Concerning The Meaning of "Beneficial Owner" in Articles 10, 11 , 12 (19 October 2012 to 15 December 2012)).
Please also note that the Letter additionally states that the responsibility for the correctness of the calculation and withholding of tax (including the correct application of favorable provisions of the DTT) should be imposed on a tax agent.
Taking all the above into consideration, the use of conduit (transit) companies in the current structures of back-to-back financing, cascade transfer of dividend flows and certain license (sublicense) structures may entail additional tax risks associated with challenging of beneficial rights to the relevant income of foreign group companies. Moreover, in the short Russia intends to ratify the Convention on Mutual Administrative Assistance in Tax Matters and to conclude tax information exchange agreements with offshore jurisdictions which could significantly enhance the position of the Russian tax authorities in respect of challenging of bona fide nature of purposes behind the current structures of international tax planning.
We will keep you informed with regard to the proposed changes and initiatives in the field of international taxation. We will also be glad to assist you in estimation of potential impact of the proposed changes on your business.