Update. Partial suspension of the Double Tax Treaties with “Unfriendly States”

On August 8, 2023 the President of the Russian Federation signed and published new Decree 'On suspension by the Russian Federation of certain provisions of the Double Tax Treaties' No. 585 (the “Decree No. 585”).

The list of partially suspended Double Tax Treaties (the “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.

Decree No. 585 comes into force immediately and suspends the key provisions of the DTTs regulating taxation of income, while certain provisions such as tax credits, exchange of tax information, etc. remain in force.

Decree No. 585 does not have a retrospective effect, and the tax rates that have already been applied before August 8, 2023 would not be recalculated. At the same time, Decree No. 585 does not specify any date for restoring full effect of the DTTs.

Partial suspension of the DTTs is a second Russian countermeasure against including Russia into the list of non-cooperative jurisdictions for the tax purposes (the so-called “EU blacklist”).

Previously, the Ministry of Finance of the Russian Federation has included all “Unfriendly States” into the blacklist of “offshore jurisdictions” (the Order No. 86н dated June 15, 2023).

As a result, starting from July 1, 2023 any transactions between a Russian company and a company from one of the “Unfriendly States” (irrespective whether it is a related or a third party) exceeding RUB 120 mln per year (approx. EUR 1,145 mln) are subject to the Russian transfer pricing rules and special disclosure in Russia.

What is the tax effect of partial suspension?

Decree No. 585 impacts potential and scheduled payments of dividends, interest, royalties, and other similar “passive” types of income from Russia under the DTTs with “Unfriendly States”, i.e. the beneficial tax rates provided by the DTTs are no longer available. The standard withholding tax (WHT) rates apply starting August 8, 2023:

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

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

• {{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 a tax exemption).

The latter change may have a potentially substantial effect as the tax authorities obtain 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) to distribution of profit that is subject to 20% WHT rate at the source of income in Russia.

These standard tax rates apply irrespective of the amounts of payments and existence / absence of the special approvals of the Governmental Commission (i.e., even payments below RUB 10 mln per month, which do not require the special approval, are subject to the WHT). The tax must be withheld by the Russian company acting as a tax agent, i.e. the amount of income will be decreased by the amount of tax if no “gross-up” provision applies in the agreements between the parties (this does not apply to dividends).

The standard WHT rates apply at the time of payment, e.g., if the foreign shareholder has already issued the Resolution on distribution of dividends by its Russian subsidiary before August 8, 2023, but the actual payment is made after that date, the beneficial DTTs’ rates cannot be applied.

This list of negative tax effects of the DTTs’ suspension is not exhaustive, as other mechanisms are also affected (e.g., international transportation services, and rules for permanent establishments).

Our key recommendations

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

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

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

• {{3)}} possible risks of requalification of payments in cases with the intercompany agreements, disproportional distribution of dividends, etc.

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