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Luxembourg Tax Alert 2019-11

Luxembourg Tax Alert 2019-11

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Philippe Neefs

Partner, Head of Transfer Pricing

KPMG in Luxembourg

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Beneficial ownership concept in Russia

According to Russian tax law, any income distributed by a Russian company to a foreign company is subject to Russian withholding tax (WHT) at 15% for dividends and 20% for royalties, interest and other income, unless reduced by a tax treaty.

To benefit from tax treaty provisions, the income’s non-resident recipient must be:

  • the beneficial owner of the respective Russian-sourced income
  • a tax resident in the respective tax treaty country.

Definition of beneficial ownership in Russian tax law

On 1 January 2015, the concept of a beneficial owner was introduced into Russian tax legislation. A beneficial owner of an income (BO) is defined as:

1. A person who has the right to use and/or dispose of the received income at their discretion by virtue of:

a) direct or indirect participation in an entity (non-incorporated structure) or
b) control of the entity (non-incorporated structure) or
c) other circumstances.

2. A person who has the right to use the income on behalf of another person.

In addition, BO status is separately applied to every dividend payment and/or to a group of payments within one agreement’s framework.

Types of income at risk

In principle, the BO concept should only be applied to passive income such as dividends, royalties and interest.

However, the Russian tax authorities have indicated that the BO concept applies to all types of income, including:

  • rental payments
  • penalties for violating a contract
  • capital gains from the sale of immovable property or shares in a property-rich company — i.e. when a company’s assets consist of more than 50% immovable property located in Russia.

How to prove beneficial owner status

From 2017 onwards, the BO must provide to a Russian company (tax agent) documents confirming its BO status, as the tax agent pays the Russian-sourced income and is therefore responsible for paying WHT on this income. The tax agent should keep these documents and provide them to the Russian tax authorities at their request.

However, neither Russian tax law nor clarifications from competent authorities indicate which documents can be considered as proof. But based on current practice, the following documents are usually accepted to confirm the BO status of the recipient of Russian-sourced income:

  • A beneficial-ownership confirmation letter issued on behalf of the recipient of the Russian-sourced income.
  • Additional documents, such as the so-called “defense” file, that support statements made in the confirmation letter.

According to Russian tax law, the tax agent is responsible for the WHT payment. If the tax agent cannot prove the Russian-sourced income’s BO status to the Russian tax authorities, the tax agent is obliged to pay:

  1. Unpaid tax — usually the Russian tax authorities deny that the beneficial tax treaty rate applies and instead taxes the income at the Russian WHT rate.
  2. A penalty — 20% of the unpaid amount of the tax.
  3. Late payment interest. 

Beneficial owner criteria for tax purposes

Based on our analysis of the courts, the Russian tax authorities use the following criteria and arguments to challenge BO status:

  • Subsequent, or “transit”, income distribution. For example, income received from Russian companies is transferred upstream either in or almost in full, or used to repay debt obligations to affiliated companies either on the same day or within a short period.
  • The absence of economic reasons for the interposition of a foreign company in the group structure.
  • The foreign company’s weak substance. For example:
    • A foreign company’s assets consisting exclusively of participating in Russian companies and/or of loans granted to them.
    • A foreign company that has no employees, pays no or only minimal taxes, has nominee directors and outsources the company’s maintenance to a foreign jurisdiction e.g. accounting, compliance, domiciliation etc.  
  • The absence of an authority (independence) regarding the use of received Russian-sourced income. I.e. the functions the foreign company performs and the risks it bears regarding this income should be taken into account.

Given the above points, a foreign company must respect the below conditions to justify that it is the BO of the Russian-sourced income:

  • The existence of non-discretionary (not limited) authority in the hands of a foreign legal entity on disposal of Russian-sourced income.
  • The performance of a real independent business activity that establishes a real economic profit center.
  • The absence of transit character of cash flow that is evidence of a company’s mere conduit or a pass-through role.

Conclusion

According to Russian law, the responsibility of the WTH computation and payment is shifted to the tax agent. If the tax agent cannot prove the BO status of the Russian-sourced income recipient to the Russian tax authorities, they are obliged to pay the unpaid tax, penalties and late payment interest. 

Therefore, it is in the tax agent’s best interest to analyze the BO status of the foreign recipient of Russian-source income with the criteria listed above. And, they should obtain BO status confirmation from the foreign company and prepare the so-called “defense” file to justify the BO status to the Russian tax authorities. KPMG Luxembourg has already helped several clients document the BO status of their Russian-sourced income.

The foreign recipient should structure transactions to meet the BO status as listed above. 

For queries please contact:

Alona Gavrylova
Manager, International tax, Russian desk
E-mail: alona.gavrylova@kpmg.lu
Phone: Tel. +352 22 51 51 5512

Any tax advice in this communication is not intended or written by KPMG to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing, or recommending to another party any matters addressed herein.The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.

Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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