On May 17, 2017 the Federal Tax Service issued Letter # СА-4-7/9270@ (the “Letter”) with recommendations as to how to determine if a taxpayer is entitled to tax benefits under a double tax treaty (DTT) taking into account the beneficial owner of income concept.
On May 17, 2017 the Federal Tax Service issued Letter # СА-4-7/9270@
(the “Letter”) with recommendations as to how to determine if a taxpayer is entitled to tax benefits under a double tax treaty (DTT) taking into account the beneficial owner of income concept.
The Letter’s recommendations were developed on the basis of recent court cases such as “Kredit Evropa bank”, “Bank Inteza", “Severstal”, and “Petelino”.
Key Points – Confirming Beneficial Ownership
he Letter sets forth criteria that could confirm that a foreign company is the beneficial owner of Russian-sourced income:
* independence of directors in decision-making;
* power to dispose of the income;
* genuine business activities;
* availability of personnel, office and related general administrative expenses;
* use of the income in entrepreneurial activities (enjoying the economic benefits from the income)
* absence of any legal or actual obligations to further transfer the income, including the systemic nature of any transitory (back-to-back) payments.
The Letter also stresses that the local tax authorities should assess the economic activities of the group as a whole, not only the transactions being audited.
Sources of Information
The Letter recommends that the local tax authorities use the following
sources of information to assess the entitlement of a taxpayer to tax
benefits under a treaty:
* information about cash flows between companies received from foreign jurisdictions;
* financial statements of the company;
* commercial databases;
* publicly accessible foreign company registries;
* information from public sources.
During tax audits, the Russian tax authorities have already successfully used information received from foreign tax authorities and public sources, including from Wikipedia and Forbes magazine.
Determining the Beneficial Owner of Income
According to the Federal Tax Service, the local tax authorities should determine whether the immediate recipient of Russia-sourced income is the beneficial owner; the authorities, however, should not be obliged to investigate who the beneficial owner of such income is if the immediate recipient cannot be treated as such.
If the tax authorities establish that the immediate recipient of income is not the beneficial owner, then the general withholding income tax (WHT) rates should apply – i.e.15% WHT for dividends, 20% WHT for royalties and other income (10% WHT for the income from international traffic).
If the Russian tax authorities challenge the beneficial ownership status of a foreign company and the Russian company provides documentary proof that another person should be treated as the beneficial owner, the tax authorities should consider these circumstances in making a final decision as to the proper level of WHT based on the additional facts provided.
Types of Income At Risk
The Letter states that the OECD Model Tax Convention on Income and on Capital (MTC) and the Official Commentaries thereto should be used to interpret a DTT provision when assessing the applicability of tax benefits.
At the same time, the MTC stresses that the beneficial ownership concept should be applied only in relation to passive income such as dividends, royalties and interest.
Nevertheless, the Federal Tax Service notes that the beneficial ownership 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. a company the assets of which consist of more than 50% immovable property located in Russia).
In the Letter, the Federal Tax Service has clearly defined the criteria which, from a beneficial ownership perspective, should be taken into account when determining a taxpayer’s entitlement to DTT benefits. Therefore, a Russian taxpayer/withholding agent should analyze whether a foreign recipient of Russian-source income is indeed the beneficial owner of such income based on the criteria above. The Russian taxpayer/withholding agent should then obtain the necessary documents and confirmation (of beneficial owner status) from the company; the confirmation letter as well as other supporting documents should be kept in a file to show the Russian tax authorities during any tax audit (the “defense” file).