Tax treatment of Eurobond payments in the current situation: which way will it go?

Over the last few decades many Russian companies have raised debt financing from foreign capital markets. This has been done by setting up special-purpose companies ("Issuers") in accordance with the laws of foreign states. Issuers' activities were limited to organising the placement of debt securities among investors ("Eurobonds"). The Issuers would then use the funds raised to issue loans to Russian entities ("Loans"). The Loan conditions (term, amount, currency, interest rate, etc.) would be similar to the conditions of issue of the Eurobonds.

Until the change in the geopolitical situation in 2022, Russian borrowers made Loan payments to Issuers and Issuers in turn used the funds raised to make interest and redemption payments in respect of Eurobonds. Under subsection 8 of clause 2 of Article 310 of the Tax Code of the Russian Federation ("the Tax Code"), Russian borrowers were exempt from tax withholding obligations in relation to the payments concerned as long as certain conditions were met.

The newly introduced international restrictions have made it impossible for Russian borrowers to make Loan payments to Issuers in foreign currency. Accordingly, the Issuers likewise lack the funds needed to make Eurobond payments to Eurobond holders ("Holders").

Edict No. 95 of the President of the Russian Federation of 05.03.2022 ("Edict No. 95") established a temporary procedure for the fulfilment of obligations to certain foreign creditors connected with foreign states which commit unfriendly acts in relation to the Russian Federation, which also applies to Eurobond payments. Based on the provisions of Edict No. 95, the Bank of Russia Board of Directors decision of 23 December 2012 and Presidential Edict No. 529 of 8 August 2022, Russian borrowers may fulfil their Loan obligations to Issuers by making interest payments and full or partial redemption payments in respect of Eurobonds directly to the Holders. Those payments may be made by various means:

• via a Russian central depository — directly to Holders which are its depositors, and via other Russian depositories — to Holders which are depositors with those depositories;
• to type "D" accounts with credit organisations;
• directly to Holders' bank accounts.

Despite the adoption of Edict No. 95, no amendments have been made to the provisions of the Tax Code (including those concerning the tax withholding exemption which has historically applied).

In a number of guidance letters the Ministry of Finance of Russia has expressed the view that the exemption in question cannot be applied where payments are made based on the requirements of Edict No. 95, since the payments are not made to the Issuer.

At the same time, even if it is theoretically assumed that Russian borrowers can continue to rely on the exemption, applying it in practice may be complicated by the following factors:

• The Issuer may not be able to obtain a tax residence certificate from foreign tax authorities for 2023 and in later periods;
• Eurobond trading on foreign exchanges may be suspended/halted and/or Eurobonds may be delisted;
• the depository and clearing systems Euroclear and Clearstream, which provided centralised custody, record-keeping of Eurobond holders and processing of Eurobond settlements, stopped providing Eurobond settlement services in 2022.

If the exemption provided for in subsection 8 of clause 2 of Article 310 of the Tax Code cannot be relied on, the Russian tax implications will depend on how interest and redemption payments in respect of Eurobonds are classified for withholding tax and personal income tax purposes. Key to this will be the issue of whether those payments are treated as Russian-source income for withholding tax and PIT purposes or as income from sources outside the Russian Federation.

Since the Tax Code does not contain specific provisions concerning the tax treatment of such payments, it is impossible to rule out the risk that they may be viewed by the tax authorities as Russian-source income which is subject to withholding tax and PIT in Russia. In this scenario, depending on how the payments are structured, withholding obligations may potentially arise for the Russian borrower, the depository involved in transferring payments and/or other persons. It may be difficult in this case to claim tax treaty benefits or special procedures for the calculation of the tax base.

In view of the above, Russian borrowers, depositories and brokers which are involved in the transfer of interest and redemption payments in respect of Eurobonds may need to analyse the following issues:

• the need to deduct withholding tax and PIT when making payments in fulfilment of Eurobond obligations;
• the applicability of special exemptions from tax withholding functions;
• whether the payments concerned are classified as Russian-source income for withholding tax and PIT purposes;
• if the payments concerned are deemed to be Russian-source income, the question of who must act as the tax agent responsible for calculating and withholding tax, how the tax base is calculated and whether tax treaty benefits can be applied;
• whether Russian borrowers have an obligation to gross up payments if taxes have to be withheld.

The analysis may vary according to the structure of the Eurobond issue, the manner in which payments are made in fulfilment of Eurobond obligations and other factors.

B1 would be happy to provide assistance in analysing tax implications and risks and formulating recommendations to minimise them and in developing a technical position for taxation purposes. B1 is also ready to provide support in modifying documents on the basis of which payments are made with a view to minimising tax risks.