The Protocol to the Russia-Cyprus Double Tax Treaty, which was signed in Nicosia on 7 October 2010, has finally been ratified by the Russian State Duma on 15 February 2012 (Cyprus already ratified the Protocol in August 2011). The Protocol will be effective as from the year 2013. A summary of the main provisions is set out below.
Withholding Tax rates – no changes
One of the most beneficial as well as key aspects of the Tax Treaty is the favourable withholding tax rates applying to cross-border payments of dividend, interest and royalties.
The business community has welcomed the very positive and important decision not to bring any changes to the current withholding rates which will continue to apply as follows:
Dividends – 5%
Interest – 0%
Royalties – 0%
• The current provision that a direct investment in the capital of the Russian entity of less than USD100,000 results in a 10% withholding tax rate to apply, is amended such that the 10% withholding tax applies if the direct investment is less than Euro100,000.
New definition for dividends
The Protocol clarifies that distributions from mutual funds and similar collective investment vehicles (other than real estate investment trusts or real estate investment funds or similar vehicles primarily investing in immovable property) will be subject to the normal withholding tax rates applying to dividends i.e. 5%/10%. This clarifies an uncertainty that existed regarding the withholding tax rates that should apply on such distributions.
The definition of dividends has also been extended to cover distributions from shares held in the form of Depositary Receipts.
New definition for Interest
The substantially aligned with the OECD definition of “interest” clarifies, inter alia, that the term “interest” also covers income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits but it does not include penalty charges for late payment or interest which is reclassified as dividends by virtue of other provisions.
Any interest reclassified by the Russian tax authorities as dividends (e.g. due to Russian thin capitalization rules) will be subject to the withholding tax rates for dividends.
Exchange of information
This article has been revised in line with article 26 of the OECD Model Tax Convention on Income and Capital and reflects the changes that have already been introduced in the Cypriot tax legislation since 2008.
The changes are towards alignment to OECD policy standards on fiscal transparency and exchange of information on taxation matters.
Limitation of treaty benefits
The limitation of benefits introduced does not apply to companies incorporated in Russia or Cyprus.
Limitation of benefits applies to tax residents of Russia or Cyprus which are not companies registered in either of the two states and only in cases where the tax authorities of the two countries agree that the main purpose or one of the main purposes of the company was to obtain the benefits of the agreement.
The Protocol introduces a clarification of the existing “tie-breaker” clause in relation to residency so that in cases where the effective management cannot be determined, the tax authorities of Russia and Cyprus should consult between them and come to a mutual agreement in this respect.
The Protocol extends the definition of Permanent Establishment to cover activities of an enterprise resident in one country through services performed by individuals present in the other country for more than 183 days in a 12-month period, with certain specific criteria having to be met prior to such services being deemed to give rise to a Permanent Establishment in the other country.
Income from international traffic will be subject to tax in the country where the effective place of management of the person deriving he income is situated.It has been clarified that income received through a real estate investment trust, a real estate investment fund or a similar collective investment vehicle which is organized under Russian laws primarily for the purposes of investing in immovable property would be treated as “Income from Immovable Property” as per article 6 of the Treaty and may be subject to tax in the country where the immovable property is situated.
In General, capital gains from the disposal of shares remain under the exclusive taxing right of the country of residence of the seller.
The important change relates to disposals by a resident of one country of shares in companies which derive a substantial part of their value (more than 50%) from immovable property situated in the other country. In this particular case, the country in which the immovable property is situated will also have a right to tax the resulting gain. This change is in line with the OECD Model Tax Convention on Income and Capital.
The following aspects of this change should be noted:
This change will come into effect four years after the date the Protocol will come into force i.e. it will be applicable from 2017.
The exclusive taxing right will remain with the country of residence of the seller if:
• the disposal qualifies as a corporate reorganization or
• the disposed shares are listed on a recognized stock exchange or
• the seller is a pension fund, provident fund or the government of either of the two countries.
Ratification should result in Cyprus being removed from the so-called “black list” (Russian Ministry of Finance Order No.108n of 13 November 2007), which currently lists 42 countries. This would mean that the zero corporate profits tax rate would apply to dividends received in Russia from Cypriot sources (if other conditions on the ownership period and equity share in the Cypriot company are met; see Article 284.3 of the Russian Tax Code). At least taxpayers are fully justified in expecting such a development as officials have talked about taking Cyprus off the list numerous times, in line with what was officially agreed between the two countries.
If your company hasn’t yet prepared for the changes that take effect in 2013, you now have less than a year to do so.
Sales of non-listed shares represent a significant change, for which taxpayers have been given a four-year grace period. Starting from 2017, income of Cypriot companies from sale of shares of Russian companies owning Russian immovable property will be taxed in Russia.
Ratification of the Cyrus Protocol may soon be followed by ratification of protocols with both Switzerland and Luxembourg.