1. WHAT HAPPENED?

Presidential Decree No.585 dated 08.08.2023 (the “Decree”) suspended the effect of DTTs with 38 states, including EU states, Switzerland, UK, US, Singapore and other “unfriendly” states.[1]

The Decree suspended DTT provisions that concern the scope of income tax which the state of income source and the state of residence can claim.

At the same time, the provisions that allow to avoid double taxation, i.e. to receive credit for (offset) taxes paid in a foreign state and to resolve the conflict of double residence, remain intact, and the opportunity to exchange information is also left in effect. It may be that by leaving these provisions in effect the lawmakers attempted to mitigate the negative effect from suspension of the DTTs.

Even though we are of the opinion that the remaining provisions still have some effect without the suspended items, one cannot be sure that following Russia’s suspension of the DTTs the “unfriendly” states will not follow suit, whereby the remaining provisions will in fact also be suspended.

Suspension of the DTTs took effect on the date the Decree was published, i.e. on 08.08.2023.[2]

2. WHAT DOES THIS MEAN?

The DTTs being suspended leads to the following consequences:

2.1  Discounted tax rates and exemption from taxation as provided by the DTTs cannot be applied, in particular:

-         For foreign entities receiving income in Russia, the discount tax rates as established by the DTTs will not apply. The tax withheld in Russia when paying dividends to foreigners will be 15%, and 20% when paying royalties and interest.

All the above-said income paid starting from 08.08.2023 will be taxed at the rates as per the Russian Tax Code (the “Tax Code”), even if the income was accrued prior to this date.

-         Certain types of income which under the DTTs were not taxed in Russia will now be taxed as per the Tax Code. For example, this concerns income from international shipping.

-         Income of employees working for Russian companies remotely, given the adopted amendments to the Tax Code could be taxed in two countries.

-         Suspension of regulations governing permanent representative offices could lead to double taxation of certain operations in Russia.

2.2  Problems with eliminating double taxation

As noted above, if a DTT is in effect, double taxation is eliminated through an offset.

That said, suspension of a DTT entails the need to consider the following aspects for purposes of the potential offset:

• Russian entities offsetting taxes withheld abroad

Russian companies will still be able to offset profit tax paid abroad, since this opportunity is contained in Russian laws[3] and is not lost with the suspension of the DTTs.

At the same time, the opportunity for individuals to offset foreign tax depends on whether the offset is provided for in the DTT. Even though the DTT norms on elimination of double taxation are not suspended, they are supplementary, and in most DTTs they apply to “income taxed in accordance with this Agreement.” Therefore, formally individuals will not be entitled to offset in Russia the taxes paid abroad after 08.08.2023 (take note that depending on the contents of a specific DTT, such possibility could still exist).

That said, the intent to retain the possibility of offset was on several occasions voiced in mass media by representatives of the Ministry of Finance, and we presume that this possibility will be formalized through amendments to Article 232 of the Tax Code or specific explanations from the Ministry of Finance.

• Foreign entities offsetting taxes withheld in Russia

As a rule, an entity can offset in their state of residence only the amount of tax which can be withheld in the state of the income source based on a DTT (within the rate under the DTT).

In this case, there is a risk for foreign entities receiving income from Russia to not be able to offset the tax in their state of residence (e.g. when the tax is withheld in Russia at the rate of 20% whereas the DTT provides for a 15% rate).

Various tax rules both in Russia and in other countries presume different regulation depending on the presence or absence of a DTT (e.g. the possibility for a foreign controlled entity to be exempt from profit tax based on the effective rate). With the partial suspension of the DTTs, such benefits remain in effect.

3. WHAT CAN WE EXPECT IN THE FUTURE?

Suspension of the DTT provisions could remain a temporary measure as stated in the Decree; however, it is possible that foreign states will denounce the DTTs with Russia as, for example, Latvia, Denmark and Ukraine.

The DTTs themselves do not have provisions governing such a procedure as suspension, and with this in mind, the suspension of the effect of provisions of a DTT in one state formally does not have an impact on the effect of the DTT in the other state. However, it is obvious that states with which DTTs have been suspended can take reciprocal measures and also suspend the DTTs (whether isolated provisions or in full), even though such a procedure is formally not provided.

As of today, the reaction of the “unfriendly” states to the suspension of the DTTs is still unknown.

That said, in order to denounce a DTT in accordance with standard DTT provisions, a notice is required no less than 6 months prior to the beginning of the tax period from which the DTT will no longer be in effect. Therefore, given Russia’s intention to keep the DTTs, the agreements can be denounced no earlier than starting year 2025.

4. WHAT SHOULD YOU DO?

Suspension of the DTTs can lead to a substantial increase in the tax burden for international groups of companies, and in this regard, we recommend first of all to undertake the following actions:

• Conduct an analysis of intra-group obligations and payments made from Russia and assess the additional risks tied to suspension of the DTTs, both in respect to intra-group payments and risks of a permanent representative office being formed (due to national rules being applied) and in respect to personal obligations;
• Consider the possibility of reorganizing the current structure and/or restructuring intra-group obligations and payments, including in favor of friendly entities;
• In the event the tax burden is significantly increased, consider redomiciling the foreign companies of Russian beneficiaries to “friendly” states, as well as to Russian territories with special tax regimes;
• Individuals, in particular those being beneficiaries of business in “unfriendly” states, might consider relocating outside Russia;
• Beneficiaries of Russian companies, as well as remote employees working in states with which DTTs have been suspended might consider relocating to “friendly” states.

Our team will be glad to analyze the impact of suspension of a DTT on you and your business, as well as develop recommendations for minimizing risks and adverse consequences.

This overview was prepared by Principal Associate of the Tax practice at Capital Legal Services Ekaterina Smolovaya, Associate Anastasiya Lokotko and Paralegal Anna Metlyakhina.