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16 October 2020
On 8 September 2020 Cyprus and Russia signed a protocol amending the double tax treaty (DTT) between the two states. The revised DTT will become effective as of 1 January 2021.
In April 2020 Russia initiated negotiations to review the minimum withholding tax rates applicable within the DTT. The newly agreed protocol (the 2020 Protocol) is the result of these discussions. Russia has sent similar proposals to amend its DTTs with other countries such as Malta, Luxembourg and the Netherlands. Importantly, the negotiations with Cyprus are the first to have been successfully concluded.
Cyprus and Russia have a history of cooperation on fiscal matters. Both countries first signed a protocol amending the DTT in 2010 (the 2010 Protocol). The 2010 Protocol was key to an effort made by the government to be excluded from Russia's blacklist of offshore jurisdictions. It made important amendments to 10 existing articles and introduced a new one (Limitation of Benefits of the DTT), which proved advantageous for business activities between Russia and Cyprus. The key changes made were aimed at aligning the DTT with Organisation for Economic Cooperation and Development (OECD) standards ensuring that existing and new structures in Cyprus display and conform with the well-known and globally accepted 'substance' requirements. Specifically, the definitions of 'dividend' and 'interest' were revised according to the OECD Model Treaty and the definition of 'permanent establishment' was aligned. The 2010 Protocol also improved the exchange of information between the two states and enabled tax authorities from either jurisdiction to deny any benefits arising from the DTT if it were determined that one of the main purposes of a company utilising the DTT was to obtain a tax advantage.
The 2020 Protocol is mainly characterised by an increase in the withholding tax rate for outbound dividend and interest payments. The rest of the DTT remains much the same and the amendments do not relate to highly sensitive matters such as tax residency requirements or those pertaining to permanent establishment (headquartering-related matters), which were satisfactorily dealt with under the 2010 Protocol.
From 1 January 2021 dividends paid to beneficial owners resident in the other contracting state will be taxed at no more than 15% of the gross amount (the rate previously applicable was 5% or 10% (the latter subject to conditions)).
The increase will not be uniformly applied. The previous rate of 5% will still apply if the beneficial owner is an insurance undertaking, a pension fund, a government entity or a central bank of one of the contracting states.
The 5% rate will also continue to apply to companies with shares listed on a registered stock exchange and which meet the following criteria:
In addition to the increase in withholding tax for dividend payments, the 2020 Protocol introduces a higher withholding tax on interest. From 1 January 2021 interest payments made to beneficial owners of the other contracting state will be subject to a withholding tax rate not exceeding 15%.
Similar exemptions that apply to dividend payments will also apply to interest (see above). The 5% withholding tax rate will thus apply to insurance institutions, pension funds, specific governmental bodies and banks. In addition, certain securities traded on registered stock exchanges will be exempt. The following securities will be taxed at the lower 5% rate:
Agreement on a new protocol is good news for both Cyprus and Russia considering that a termination of the DTT would have had adverse effects in both contracting states. Further, while the 2020 Protocol does increase withholding tax rates, it also contains several positive features.
Significant positives include the various exemptions provided for within the text. The most noteworthy being:
These may act as a springboard for corporate bond issuers, the Cyprus Stock Exchange and the new Cyprus IP regime, respectively.
Further, while foreign tax credit will not apply to dividend income because such income is not subject to tax in Cyprus, it may apply to interest payments received by a Cypriot company from a Russian-based entity, since interest income is subject to tax.
Despite the different exemptions, the key benefit of the 2020 Protocol is the certainty that it provides. In this regard, Cyprus has effectively obtained a first-mover advantage compared with other jurisdictions. In a time defined by COVID-19 and volatility, this is to be welcomed. It is considered that businesses will be unable to shop around for jurisdictions with pre-2020 Protocol benefits since Russia is seeking to implement similar amendments to its DTTs with other contracting states. Russia has also expressed a willingness to end DTTs where the other contracting state will not agree to the new withholding tax rates.
The existence of a DTT with Russia is just one of the factors influencing the decision of companies to base themselves in Cyprus. Besides the abovementioned benefits, Cyprus provides a litany of other advantages including, among other things:
Importantly, the decision to satisfy the conditions for participation in the Cyprus tax system should not, in any event, be a purely tax-driven exercise. Cyprus was among the first jurisdictions to ratify the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting and adopt its minimum standards (Action 6 – clarifying the purpose of existing DTTs, Action 7 – adopting a general anti-abuse rule based on the principal purpose test and Action 14 – making dispute resolution mechanisms more effective). Considerations such as the particulars of each investment project, type of company, thresholds on investment amounts, sectors oriented as well as conditions and exemptions are among many of the considerations that a taxpayer or business entity should address before embarking on any transaction or investment.
Nevertheless, countries are compelled to analyse their tax systems with a view to adjust their fiscal environment for foreign investment. Cyprus, in conjunction with ensuring proper legal and regulatory standards, has positioned itself as a global strategic partner for multinationals and other entities, which are looking for a strategy that places no reliance on any specific country.
Businesses in Cyprus that will be subject to the 2020 Protocol are advised to review their corporate structures and assess what impact, if any, the DTT changes will have on their overall effective tax exposure. Any potential reorganisation should properly adhere to corporate governance and the arm's-length principle.
For further information on this topic please contact Elena Christodoulou at Elias Neocleous & Co LLC by telephone (+357 25 110 110) or email (email@example.com). The Elias Neocleous & Co LLC website can be accessed at www.neo.law.
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