Russia suspends tax treaties with "unfriendly" countries
In a significant move, Russia has suspended certain provisions of its double tax treaties (DTTs) with jurisdictions that are deemed “unfriendly” due to their imposition of sanctions on Moscow.
Decree No. 585 on the suspension by the Russian Federation of certain provisions of the Double Tax Treaties.
Background
The ongoing conflict between Ukraine and Russia has resulted in several Western nations imposing unilateral economic sanctions against Russia. Earlier this year, the EU included Russia on the “EU blacklist” (formally known the list of non-cooperative jurisdictions for tax purposes). In retaliation, Russia has taken countermeasures, the most recent being the partial suspension of DTTs with 38 countries, including the USA, Japan, Australia, and most European nations. The partial suspension of certain provisions of the DTTs was initiated by the Russian Federation through Decree No. 5851 (Decree).
Details of the Suspension
- Effective date: the partial suspension came into effect immediately after the publication of the Decree on August 8, 2023.
- Countries affected: the list of suspended DTTs includes 38 “Unfriendly States”: Albania, Australia, Austria, Belgium, Bulgaria, the Czech Republic, Canada, Croatia, Cyprus, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Lithuania, Luxembourg, Macedonia, Malta, Montenegro, New Zealand, Norway, Poland, Portugal, Romania, Singapore, Slovakia, Slovenia, South Korea, Spain, Sweden, Switzerland, the UK and Northern Ireland, and the US.
- Partial suspension: the Decree has suspended the provisions of the DTTs regulating the taxation of the following types of income:
- Income from immovable property;
- Dividends;
- Interest;
- Royalties;
- Capital gains;
- Income from employment / independent personal services; and
- Income of the members of administrative and supervisory boards / director fees.
- 15% for dividends
- 20% for interest payments
- 20% for royalties
- 20% for other profit distribution, excluding dividends.
The above provisions regulate taxing rights between both jurisdictions or limit the application of source taxation (e.g., withholding tax). The partial suspension will have a significant effect on dividends, interest, royalties, and other similar passive income types derived from Russia.
This entails that beneficial tax rates previously available under the suspended DTTs will no longer apply. As a result, Russian domestic withholding tax rates will apply, which are as follows:
As a result of the partial suspension, only a few DTT provisions will remain in force, including those concerning personal scope, tie-breaker rules, and exchange of information. The elimination of double taxation, a key clause in these DTTs, is strictly applicable to the income types explicitly defined in the treaty.
It should be noted that only those types of income that are explicitly mentioned in the DTT will be covered by the article dealing with the elimination of double taxation. Therefore, should any provision pertaining to a specific income be suspended, the related double taxation avoidance mechanism will no longer be in effect for that income category.
No retroactive effect
The Decree does not have retroactive effect, meaning that tax rates that have been applied before the effective date of the Decree (August 8, 2023) will not be recalculated.
Vienna convention
According to article 57 of the Vienna Convention on the Law of Treaties (1969) the operation of a treaty can only be suspended (i) in conformity with the provisions of the treaty or (ii) through mutual consent of all parties and after consultation with the other contracting state. However, Russia's recent Decree to suspend bilateral DTTs appears to be unilateral, with no mutual agreement from treaty parties. While the decree cites "unfriendly acts" against Russia and its citizens, it lacks clarity and further details. Even though the decree seems to allude to sanctions imposed by treaty counterparties, these sanctions don't impact the DTTs concluded with Russia. As such, Russia’s suspension may not be in line with the provisions of the Vienna Convention. It is worth noting that the Decree appears to mandate the Ministry of Foreign Affairs to inform concerned states about the suspension, granting these states a three-month window to voice their objections, potentially leading to arbitration or other dispute resolution methods.
GCC - Russia tax developments
As Russia distances itself from what it labels as "unfriendly countries", it is proactively strengthening its relationships in the Gulf region.
A notable example is the recent DTT that Russia signed with Oman. The new treaty, set to enter into force from January 1, 2024, entails a general 15% withholding tax on dividend income and favourable rates for companies with substantial stakes in dividend-paying entities, as well as exemptions for state-owned bodies.
Although the UAE and Russia have already concluded a DTT, tax benefits are only available to public entities of both countries. As such, the treaty does not apply to private companies. A new DTT is currently under negotiation between both countries and to this effect, the UAE and Russia recently held a second round of negotiations in Dubai. It is currently not known whether the scope of the new treaty will be expanded to include private companies.
Implications for Businesses
The suspension will have broad-reaching consequences for businesses, especially those involved in international operations with exposure to Russia:
- Taxation: domestic tax regulations in both countries will now be fully applicable, eliminating any preferential withholding tax rates for dividends, interest, or royalties.
- Tax claims: there will be no limitation of tax claims on capital gains, such as on the sale of shareholdings.
- Permanent Establishments: foreign businesses with a permanent establishment in Russia may face the risk of being taxed both in Russia and their home country due to the suspension of DTTs.
- Mutual Agreements: Absence of a legal basis for mutual agreement procedures may cause ambiguities.
Businesses will undoubtedly seek restructuring of their cross-border corporate structures, and may consider friendly jurisdictions as alternatives. They will need to closely analyse loan agreements, license agreements, and other contractual arrangements to determine their next steps and potential tax liabilities.
Because the UAE is considered a “friendly” jurisdiction, some international businesses are considering restructuring into the UAE, either through the incorporation of new entities or by redomiciling existing entities into the UAE, and to benefit from the UAE’s extensive tax treaty network consisting of more than 142 DTTs.
Conclusion
The suspension of DTTs by Russia is a direct result of the economic sanctions placed upon it. This recent move will undoubtedly have substantial implications for international businesses with operations in or dealings with Russia. Businesses should prepare for increased tax burdens and may consider restructuring strategies to mitigate adverse financial impacts.
1 Decree of the President of the Russian Federation No. 585 on the suspension by the Russian Federation of certain provisions of the Double Tax Treaties.
