Suspension of certain articles of double taxation treaties with "unfriendly" countries

On 8 August 2023 the President of Russia signed Edict No. 585 ("the Edict") suspending the effect of certain articles of double taxation treaties with "unfriendly" countries. The Edict was issued in accordance with the provisions of clause 4 of Article 37 of Federal Law No. 101-FZ of 15 July 1995 "Concerning International Agreements of the Russian Federation" ("Law No. 101-FZ") owing to "the need to take urgent measures in response to unfriendly actions undertaken by a number of foreign states in relation to the Russian Federation and its citizens and legal entities". The Edict was published on the official portal of laws and regulations on the same day.

At the time of the publication of the Edict, Russia had double taxation treaties with 84 countries. The Edict applies to tax treaties signed by Russia with 38 countries, including Poland, the USA, South Korea, Bulgaria, Sweden, Luxembourg, Romania, the UK, Hungary, Ireland, Slovakia, Albania, Belgium, Slovenia, Croatia, Canada, Yugoslavia (as applied by Montenegro), Switzerland, Czechia, Denmark, Norway, Italy, Finland, Germany, France, Macedonia, Cyprus, Spain, Lithuania, Iceland, Austria, Portugal, Greece, New Zealand, Australia, Singapore, Malta and Japan.

According to the Edict, it enters into force from its publication date and will remain in effect until "the foreign states concerned remedy the violations committed by them of the lawful economic and other interests of the Russian Federation and the rights of its citizens and legal entities". Clause 3 of the Edict requires the Government of the Russian Federation to submit to the State Duma of the Federal Assembly of the Russian Federation a draft federal law suspending the effect of relevant provisions of double taxation treaties with "unfriendly" countries. In turn, clause 4 of Article 37 of Law No. 101-FZ provides that, if the State Duma rejects a bill proposing the suspension of an international agreement of the Russian Federation, the agreement in question will resume force with immediate effect.

Unlike the Presidential Edict of 26 September 2022 concerning the suspension of the double taxation treaty with Latvia, the Edict suspends particular provisions of treaties with the countries concerned, including provisions concerning the taxation of all kinds of income (including dividends, interest, royalties, business profits, miscellaneous income, etc.), permanent establishment provisions, non-discrimination provisions and provisions regarding the taxation of capital. Meanwhile, treaty provisions regarding the elimination of double taxation, the exchange of information, mutual agreement procedures and the definition of tax residence continue to have force.

The principal effect of the suspension of the individual provisions will be the loss of the ability to claim reduced rates of Russian withholding tax for key types of passive and other income received by foreign taxpayers from Russian sources (including income in the form of dividends, interest, royalties, payments on certain kinds of derivatives, et al.). These kinds of income will be subject to withholding tax in Russia at the standard rates: in the case of payments made to foreign entities: 15% for dividends and 20% for other kinds of income; in the case of payments to individuals: 15% for dividends and 30% for other kinds of income.

Most heavily impacted by the additional tax costs will be external financing arrangements made by Russian taxpayers which are still ongoing (including syndicated credits, Eurobond borrowings and other forms of external borrowings). More broadly, amendments have been made to Article 310 of the Tax Code of the Russian Federation to ensure that Russian borrowers and guarantors remain exempt from the obligation to withhold tax on interest payments in the context of Eurobond arrangements under the current circumstances. As regards other types of external borrowings, however, no exceptions or exemptions are currently in place.

In addition, many Russian taxpayers have entered into treasury transactions, cash pooling arrangements and hedging transactions on foreign markets which may likewise lead to additional tax expenses following the adoption of the Edict.

If particular transactions incur withholding tax in Russia, foreign counterparties may demand the activation of "gross-up" provisions in contractual documentation, which may result in additional costs for Russian counterparties (provided that the gross-up provisions in the contractual documentation cover the current circumstances) or in the termination of the relevant contracts. In this regard, issues may arise over the basis and timing of the termination given the need for the federal law suspending the relevant treaties to be passed by the State Duma of the Federal Assembly of the Russian Federation. Where arrangements need to be preserved, it may be necessary to restructure the transactions related money flows.

It is important to note the following points in relation to the above. On the one hand, if the standard rates of Russian withholding tax are applied it will no longer be necessary for Russian tax agents to carry out checks to ensure that the foreign recipients of income have the right to claim treaty benefits (including whether they are the beneficial owners of the income, whether they pass the principal purpose test, etc.) and (or) to obtain additional documents needed to calculate the tax base, which would reduce the administrative and operational burden on them and eliminate the risk of challenges from the tax authorities. On the other hand, tax agents may need to check for cases where foreign recipients of income change their position with regard, for example, to the application of the look-through approach and (or) renounce (after the adoption of the Edict) their beneficial owner status in favour of entities that are not tax residents of "‎unfriendly" countries. They may also need to evaluate any changes in the structure of transactions and related money flows in the light of the anti-evasion rules laid down in Article 54.1 of the Tax Code of the Russian Federation and (or) the principal purpose test.

A separate examination is needed of the issue of how the suspension of individual provisions will affect the applicability of certain rules that depend on the existence of an international tax agreement or the existence of a currently effective international tax agreement (including with regard to controlled foreign company provisions, reduced tax rates, the rules for defining tax residency, etc.).

There are certain positive aspects that are worth noting. In particular, since provisions concerning the definition of tax residence have not been suspended, there should be no risk of individuals or legal entities being deemed tax residents of two countries simultaneously. Also, since the provisions regarding the elimination of double taxation remain in place, the adoption of the Edict should not affect the right of Russian tax resident individuals to offset taxes paid abroad or the procedure for doing so. At the same time, it would be useful to have the official position of the Ministry of Finance of Russia on these issues.

It is also important to note the following. The adoption of the Edict may be partly a retaliatory measure against Russia’s inclusion in the EU’s list of non-cooperative jurisdictions for tax purposes (the "blacklist"), as a result of which, as from 1 January 2024, transactions with Russian counterparties will be subject to various restrictive measures imposed by EU countries (including the imposition of withholding taxes on payments to Russian recipients, limited deductibility of interest expenses, etc.). It cannot be ruled out that the countries concerned may take further retaliatory measures in response to the Edict, including the symmetrical suspension of treaties (in full or in part) or even the denunciation of treaties. At the same time, Article 3 of the Edict instructs the Government of Russia to ensure that measures are taken to reduce the impact that the consequences of the suspension of the provisions of the relevant double taxation treaties will have on the Russian economy. At the time of writing we are unaware of any planned amendments to Russian tax legislation.