Evasive bargain


 

Judging by the official rhetoric a devious yet widely spread practice euphemistically called international tax planning is in deep trouble. As public pockets are feeling the pinch, the voices of those who refuse to differentiate between tax avoidance and evasion - it is avoision they see - are becoming stronger and louder.

‘If we provide banks with loans, can we have them working with tax havens?’ asks French President Nicolas Sarkozy. And he is not alone. Pope Benedict XVI called, in an unusually down to earth policy paper from the Holy See, for the closure of tax havens as a 'necessary first step' to restore the global economy to health. 'They have given support to imprudent economic and financial practices’, the paper says, ‘and have also played a significant role in the imbalances of development, allowing a gigantic flight of capital linked to tax evasion.'

This chorus has recently been echoed by Dmitry Medvedev, the Russian President, who demanded that improper use of double tax treaties must be stopped. Tax practitioners should now feel scared.

These treaties allocate the power to tax the same person in two countries and in theory exist to boost trade between these two countries. In practice, double tax treaties are a commodity shopped around the globe by anyone at any time, whenever they are needed.

In its basic form treaty shopping occurs when a resident of a country that does not have a tax treaty with Russia or a treaty that is less good than that between Russia and some other country, sets up a legal entity, a so-called conduit company, in this other country with the principal purpose of obtaining treaty benefits.

For instance, a Dutch company receives dividends from Russia. The dividends, exempt from the bulk of taxation in Russia due to the Russia-Netherlands tax treaty then move on to a company in Bermuda. Thus, though a treaty is supposed to promote trade between two contracting countries, it is in fact an open ended promise to the whole world and a channel to tax havens.

That is why, statistically, Cyprus is by far the most important trade partner of Russia: no other nation invests as much in Russia as this sunny, Lilliputian republic; developed industrial nations - even taken together – cannot compete.

Now, when the Russian President declared war against treaty shopping, the Ministry of Finance prepared amendments to the Tax Code, limiting the application of treaties where the beneficiary is not genuine.

The proposed changes are remarkable, first of all, in their candour and brevity. It is not often that the actual words of the President become law, free of legalistic hypocrisy.

The bill states that double tax treaties will not be applied where an ultimate beneficiary is not resident in a treaty country. And that’s it: absolutely clear, wonderfully short, and incredibly useless.

The first point of concern, of course, is the Vienna convention on the Law of Treaties, the article 26 of which states that ‘every treaty in force is binding upon the parties to it and must be performed by them in good faith’ and article 27 provides that ‘a party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.’

Moreover, Russia unlike some other countries does not stand for the ‘supremacy principle’ and in the event of contradiction between the domestic law and an international treaty the later prevails.

Thus, though it appears very tempting to add a few lines to the Tax Code instead of going through a tedious process of renegotiation of numerous international treaties, it is not clear how the change is going to make a difference: where a treaty already contains an anti-shopping clause the new rule is not needed; where it does not, it will most likely be of no effect.

Yet the first step is the most difficult one. Abuse of international tax conventions is a wide-spread disease, and there is no universal cure. It seems, though, that the attitude to tax evasion is changing globally and Russia should not buck the trend.

January 29, 2010
text: E. Andreeva
picture: NatalyArt - Fotolia.com

 

 

CLEAR GUIDELINES SHOULD BE SET OUT INSTEAD

TEXT: Arseny Seidov, partner, Baker & McKenzie

The Russian Ministry of Finance has started paying greater attention to treaty shopping and other anti-avoidance issues involving the use of double tax treaties. At the end of 2009 the Finance Ministry proposed to introduce a short section into the Russian Tax Code regarding eligibility for treaty benefits. According to the draft law, when applying a particular double tax treaty, if it is determined that the beneficial owner of certain Russian-source income is an individual or a company that is not a resident of the state that concluded the relevant double tax treaty with Russia, this double tax treaty may not apply to such individual or company and income received by them.

Curiously, the draft section basically does not add anything new to most of Russia’s double tax treaties. Specifically, for treaty benefits to apply, articles on dividends, interest and royalties in those tax treaties require the recipients of the relevant types of income to be their beneficial owners. At the same time, the treaties do not provide for any mechanism to determine whether a particular person should be deemed a beneficial owner of certain income. In other words, countries are generally free to adopt a mechanism themselves and set criteria in domestic law for proving beneficial ownership status. And many jurisdictions follow this route. In some countries tests are quite tough: comprehensive questionnaires must be completed and sensitive data disclosed on the foreign income recipient.

Thus, the proposed amendments can hardly help the Russian Government combat treaty shopping and tax avoidance in the international arena. Clear guidelines and procedures should be set out instead. For example, the Russian Tax Code could empower the Russian Ministry of Finance to establish regulations on passing the beneficial ownership test. Without these rules and the personal liability of individuals for the reliability of data disclosed, international tax fraud would not be eradicated. At the same time, the rules should not be too burdensome to comply with or subject to the discretion of the local tax authorities. It is important to maintain a proper balance between the interests of the state and business.

 

 

TRANSITION TO THE “SUBSTANCE OVER FORM” PRINCIPLE
TEXT: Anton Grebenchuk, Senior Consultant, Tax&Legal, KPMG in Russia and the CIS
According to the current wording of article 7 of the RF Tax Code, the principles of international agreements concluded between the Russian Federation and other countries take precedence over the principles of Russian tax law. The RF Ministry of Finance has prepared a draft law (addenda to article 7) under which the provisions of an international agreement will not apply if the actual beneficial owner is not a resident of the country with which Russia concluded the international agreement.

The goal of the adjustments to article 7 is to “form the legislative mechanisms needed to counteract the use of international agreements to minimize taxes when the final beneficiary is not a resident of the country with which the agreement was concluded”, in execution of the objective expressed in the Budget Address of the Russian President for 2010-2012.

If the adjustments to article 7 are passed in the version sent by the RF Ministry of Finance for the consideration of the RF Ministry of Justice, we believe that a number of challenges may arise concerning their practical application.

First, the addenda to article 7 would introduce a new term to Russian law, that of an “actual beneficial owner” but would not specify the criteria for recognizing a foreign company as a beneficial owner. It is likely that the Russian tax authorities will apply OECD approach according to which an entity cannot be regarded as the beneficial owner if it acts as an agent, nominee or a “conduit” company for another person, who in fact receives the benefit. However OECD principles are not obligatory in Russia. This may lead to ambiguous interpretation of the addenda to article 7.

Secondly, in the text of the draft law the recognition of a foreign company as an actual beneficial owner does not depend directly on the identity of its owner or final beneficiary.

Third, requirements pursuant to which preferential tax terms on withholding tax at the source of dividend, interest and royalty payments only apply to actual beneficial owners have already been stipulated by a number of international agreements concluded by the Russian Federation (for example, on the payment of dividends under the Treaty between Russia and Cyprus). Accordingly, in their present wording the official adjustments to article 7 do not change much for those companies already using these principles.

Fourth, the Russian tax authorities may have difficulty receiving information on the identity of the owner of a foreign company or the final beneficiary of dividends, interest and royalties to be paid from Russia to the company.

For these reasons, it is difficult at this point to determine the effect which the adjustments to article 7 could have on taxpayers.

This draft law is more evidence of the continuing transition to the use of the “substance over form” principle in Russia when determining tax implications, including during the performance of international transactions. However, in Russia it will take more than one legislative adjustment for this process to create the necessary legal framework and the criteria for effective tax planning (even if significant changes are made to the current text of the draft law).

In conclusion, it should be noted that the adjustments to article 7 of the Tax Code have not yet been submitted for the consideration of the State Duma, so it is still unclear when the draft law would be enacted.

 

 

Russia wants to put an end to offshore deals but doesn’t know how
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