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17 August 2018
In April 2018 the Federal Tax Service (FTS) issued a letter providing an extensive explanation of the tax authorities' application of the beneficial owner of income (BOI) concept.(1) This concept was previously referred to only in the international tax treaties between Russia and other states, but has – in recent years – been actively implemented into Russian tax legislation. In this regard, the FTS's letter is of great interest, as it summarises the approach of both the courts and the tax authorities with regard to resolving BOI issues.
The letter states that the BOI concept will not be interpreted as having a narrow, technical meaning; rather, it will be interpreted based on:
In particular, the goals and objectives of Russia's international tax treaties are incompatible with the exemption of withholding tax when a resident of another state who receives income acts as a frontperson for the actual beneficiary of the income. Further, the international tax treaties will not apply where:
The letter also reviews the court practice regarding disputes between taxpayers and the tax authorities and briefly assesses the most common issues that the courts are asked to resolve.
The main issue being examined in disputes concerning the application of Russia's international tax treaties is the assessment of the relevant business objective and the proper qualification of the substance of transactions entered into by taxpayers. The application of tax preferences is recognised as unlawful where it can be concluded that the main objective of a set transactions (operations) was to:
Examples of the above include:
The letter also indicates that taxpayers should:
The letter confirms that the tax authorities' approach, which is supported by the courts, is that the burden of proof to show that an owner of income is a beneficial owner lies with the tax agent making the payments subject to withholding tax to a foreign person.
According to the letter, activities which are carried out only with regard to the investment and financing of group (holding) companies or interrelated persons cannot be considered to constitute entrepreneurial activities. In addition, the FTS believes that companies serving only the interests of their own group and its affiliates cannot benefit from Russia's international tax treaties if their income receipt is not commercially feasible. Thus, on inspection, a Russian tax authority can refuse to recognise as a BOI a foreign holding company which has only management and consulting functions with regard to its Russian subsidiary legal entities.
This conclusion may be disputable, as holding companies which have no operating business are often formed for reasons other than tax preferences and the location of such companies is often influenced by other factors. However, an approach similar to that discussed in the FTS's letter would mean that a management company's role in the entire business structure of an international holding would be considered solely in terms of a tax benefit.
On the basis of the FTS's letter, arrangements regarding the holding of Russian assets by an international business which did not previously raise concerns now require reassessment from a tax-risk perspective.
For further information on this topic please contact Valery Narezhniy at Gorodissky & Partners by telephone (+7 495 937 6116) or email (firstname.lastname@example.org). The Gorodissky & Partners website can be accessed at www.gorodissky.com.
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