Russia and Cyprus have on 16 April 2009 initialed an agreement to amend the Double Tax Treaty which was originally established in 1988 between the Soviet Union and Cyprus and ratified by the Russian Federation in 1998. One year and five months after the amended agreement was initialed, the revised Double Tax Treaty between Russia and Cyprus, was signed by President Medvedev during his official visit to Cyprus on 7 October 2010. It is expected that the amended treaty will be ratified by the Parliaments of the two countries and will become effective from 1 January 2011.
This event was the culmination of the efforts of the two countries’ respective Ministries of Finance, following nearly two years of tough negotiations, which resulted in a compromised solution for the good of both countries.
The most important positive advantage is the removal of Cyprus from the Russian “Black List” which was placed there in 2008, which means that Russian companies with Cypriot subsidiaries can qualify for the Russian dividend participation exemption.
Most important amendments:
Dividends, interest and royalties
No changes in the Nil rates of withholding tax for interest and royalties. For dividends, the withholding tax of 5% and 10% remained unchanged. The only change is that in order to benefit for the lower rate of 5% the minimum investment in capital of the company must be €100,000 instead of $100,000 as it used to be before.
The definitions of dividends and interest have been amended in accordance with the new OECD Model Treaty.
Dividends now include distributions from mutual funds and other collective investment vehicles (with the exemption for real estate funds) and they are subject to the normal withholding tax rates of 5%/10%. The definition of Dividends has been extended to include distributions from shares held in the form Depositary Receipts.
The definition of interest now includes income from debt-claims of every kind, whether or not secured by mortgage or carrying a right to participate in the debtor’s profits but does not include penalty charges for late payment or interest which is reclassified as dividends by virtue of other provisions. Due to the Russian Authorities, application of “thin capitalization” rules, interest which is reclassified as dividends will be subject to the same withholding tax rates as dividends.
Abolition of Capital Gains Tax Exemption for real estate companies
Currently, the existing DTT exempts all capital gains derived by a Cypriot shareholder from the sale of shares in a Russian subsidiary from Russian taxation, whether or not that subsidiary owns immovable property in Russia. Under Cypriot domestic law such capital gains are exempt from taxation.
Article 7, of the Protocol now provides that gains derived by a resident of the contracting state from the sale of shares of a company which has more than 50% of their value from immovable property situated in another contracting state may be taxed in that country. This provision is in line with the OECD Model Tax Convention on Income and Capital. This provision is planned to come into effect 4 years after the Protocol takes effect and is expected to be applicable in the year 2015.
In the following cases, the exclusive taxing right will remain with the country of residence of the seller:
- the disposal qualifies as a corporate reorganization or
- the disposed shares are listed on a recognized stock exchange or
- the seller is a pension fund, provident fund or the government of either of the two countries
Limitation of benefits (LoB)
The limitation of benefits introduced does not apply to companies registered in either country
The inclusion in the Protocol of the LoB article introduces the limitation of benefits which aims in preventing any potential treaty abuses from existing or newly incorporated companies whose purpose is to obtain the tax benefits granted by the Treaty. Such limitation does not apply to Russian or Cypriot companies and therefore one can conclude from this that the intention is to apply to companies which have been registered outside Cyprus, but are tax resident in Cyprus by virtue of the exercise of management and control.
Exchange of information
Article 26 of the OECD Model and recently introduced legislation by the Cyprus government (in 2008) is the basis for this amendment.
- More clarity in relation to the powers and obligations of the tax authorities, aimed at improving the administrative procedures through which information can be collected and exchanged between the Tax Authorities of the two countries. It is stated that if one country may not need information for its own purposes should not prevent it from collecting this information in reply to a request from the other country. It is also clearly stated that information cannot be supplied which is not obtainable under the laws or in the normal course of the administration of a contracting state
- Information exchange can be extended not only to taxes covered by the tax Treaty, but also with regard to any other indirect taxes (e.g. Vat)
- Banking secrecy does not form grounds for refusal to exchange information with a competent authority of the other state, however the lifting of these rules are subject to the detailed provisions of the domestic legislations of the countries. For Cyprus, that means that the approval of the Attorney General is needed before any information can be exchanged.
- may be deemed to be in Russia if an individual who is present there for a period or periods exceeding 183 days in any 12-month period, and more than 50% of the gross revenues attributable to active business activities of the company are derived from such services or
- for a period or periods exceeding in the aggregate 183 days in any 12 month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in Russia
- As a result if a foreign company is deemed to have a Russian PE, is liable to 15% withholding tax on dividends. In addition, Russian withholding tax may apply to other passive income such as interest and royalties to the extent that this income is received by a foreign company from a Russian source and is attributable to its PE created in Russia.
It is advisable that clients who may be affected by the changes, take appropriate action to circumvent any negative implications of the provisions of the new Treaty. Midland Consult is always available to advice clients who consider that the new provisions may impact on their existing structures.