Temporary suspension of the Double Tax Treaties with “Unfriendly States” and implementation of the “windfall tax”

As a matter of important update that may impact potential and scheduled payments of dividends, interest, royalties and other similar “passive types” of income from Russia, please be informed that on 18th of May 2023 Russian Media has announced that Double Tax Treaties (the “DTTs”) with “Unfriendly States” will be temporarily suspended by the Presidential Decree in June 2023 .

This initiative was prepared by the Ministry of Foreign Affairs of Russia and the Ministry of Finance of Russia in the middle of March 2023 as a countermeasure for including Russia into the list of non-cooperative jurisdictions for the tax purposes (the so-called “EU blacklist”).

Since the joint initiative was prepared, no additional information on the form, terms and other details of suspension was announced. Now it seems that DTTs will be suspended based on the Presidential Decree that most likely will have an immediate effect, with no transition period and exact date of restoring effect of the DTTs.

Although the DTTs do not provide for such mechanisms of suspension, the DTT with Latvia was already suspended by the Presidential Decree No. 668 dated 26 September 2022 with simple notification of the Latvian Government on suspension of the DTT until Latvia will exclude its violations under the DTT or until the DTT will be fully terminated (similar to the DTT with the Netherlands that was terminated in 2021).

What is the tax effect?

No beneficial tax rates provided by the DTTs will be available for payments of so-called “passive types” of income from Russia to the US, UK, Japan, Canada, EU and other “Unfriendly States” implemented sanctions against Russia.

As a result, only standard tax rates will apply:

• {{1)}} 15% WHT rate for dividends (instead of 5% or 10%); and

• {{2)}} 20% WHT rate for interest payments (instead of tax exemption or 10%); and

• {{3)}} 20% WHT rate for royalties (instead of tax exemption or other lower WHT rates); and

• {{4)}} 20% WHT rate for distribution of profit (other than dividends) (instead of tax exemption).

The latter change may have an underestimated effect as the tax authorities will have more opportunities and fiscal reasons to requalify any suspicious payments and/or payments with low economic justification (even “active types” of income such as payments for the intragroup services) into distribution of profit subject to 20% WHT rate at the source of income in Russia.

These standard tax rates will apply irrespective of the amounts of payments and existence / absence of the special approvals of the Governmental Commission (i.e., even payments with the amounts below RUB 10 mln per month, which does not require the special approval, will be subject to the WHT).

This list of negative tax effects of the DTTs’ suspension is not exhaustive as other mechanisms will also be affected (e.g., international transportation services, opportunities for the tax credits, rules for the permanent establishments, exchange of tax information, etc.).

In line with the temporary suspension of the DTTs the Ministry of Finance of Russia considers increase of the tax liabilities of Russian companies for non-submission or late submission of the special reports on payments of income to the foreign companies (the cash penalties will be from 5% to 30% of the amount of WHT mentioned in the report, depending on the term of delay).

What is a “windfall tax”?

On 10th of May 2023 the Ministry of Finance of Russia has published information about strong increase of the deficit of the State budget.

Temporary suspension of the DTTs and application of the standard WHT rates shall have a positive effect for increase of the budget, however, as announced this will not be the main tool for the budget replenishment.

In this regard the Ministry of Finance of Russia has prepared the Draft Law introducing a new tax obligation for the larger Russian companies (with minor exemptions) and foreign companies having permanent establishments in Russia for the tax purposes (the so-called “windfall tax”).

The object of taxation will be the “excess profit”, defined as the difference between the average profit for 2021–2022 and the average profit for 2018–2019 (the pandemic year 2020 will not be considered). The amount of excess profit shall be determined according to tax accounting data (the sum of tax bases for the corporate income tax). The “windfall tax” shall apply, if such difference will be equal to or greater than RUB 1 bln.

The tax rate will be 10% and the tax will be due in January 2024. At the same time, the tax rate can be discounted by 5%, if the funds are voluntary transferred to the budget by the taxpayers in October-November 2023. The Government expects that “windfall tax” will increase the budget by approx. RUB 300 bln.

The Draft Law is now on consideration with the business representatives and trade associations and the final version is not published yet. It is expected that the Draft Law will be inserted to the legislative bodies for their consideration until the end of May 2023.

The “windfall tax” is announced as one-time payment. However, the Russian Tax Code will be shortly amended by the general term “taxes of an extraordinary nature', which may indicate the opportunity to introduce and collect similar taxes in the future.

Our recommendations

Considering expected changes, it might be reasonable for the international group of companies with Russian subsidiaries to check:

• {{1)}} anticipated payments of dividends, interest, royalties and other similar types of income and review possible increase of tax burden;

• {{2)}} the contractual structures (in particular, loan agreements and license agreements), whether they provide for the “gross-up” provision (if applicable);

• {{3)}} amounts of profit before taxes for 2021-2022 and 2018-2019 for their compare and assessment of potential application and figures of the “windfall tax”.

This analysis shall help with better understanding of the further tax position of Russian subsidiaries, new tax implications and possible tax risks.