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How to prove that a company is the beneficial owner of income?
Since 2015, new rules of application of international double tax treaties have been in effect in Russia. The recent Severstal court ruling is a case in point, where the taxpayer is faced with a nearly 1 billion RUB tax charge, for essentially failing to prove the beneficial ownership of income by the recipient Cyprus company.
When paying dividend, interest, and royalties to foreign companies from Russian sources the payer is required to ascertain the beneficial owner of income and, on that basis, decide on the application of the reduced rate of withholding tax.
In the Russian tax law the concept of “person effectively entitled to income” is specified in Article 7 of the Russian Tax Code. The meaning of the concept is that if the recipient of income is not the actual owner (does not decide on its economic destiny), the reduced tax rate under a valid international double tax treaty cannot be applied when paying this income from Russia.
The Russian Ministry of Finance in its letters has explained the concept of “beneficial owner of income”* (see Letters of the Ministry of Finance of Russia dated 09.04.2014 No 03-00-Р3/16236, dated 24.07.2014 No 03-08-05/36499) and by doing so it set out some of its guidelines for both tax payers and tax authorities. The interpretation of the concept of beneficial ownership of income has also been reflected in the arbitration practice on the basis of which the following important conclusions can be drawn:
- the number of disputes lost by tax payers to the tax authorities in relation to the application of reduced tax rates when paying dividend, interest and royalties to foreign companies, is increasing;
- tax authorities during inspections evaluate further movement of the income received by foreign companies from Russia and dispute both the non-withholding of the withholding tax by the Russian tax agent and the deduction of the respective expenses of Russian taxpayers, indicating the presence of “conduit” transactions;
- tax authorities are actively using available treaty provisions for the exchange of information with foreign tax administrations which enables them to receive and analyse not only publically accessible information (financial statements of the foreign recipient of income, websites, etc.) but also establish the presence or absence of substance of the income recipient, analyse the movement of funds, evaluate tax burden. etc. As time goes by, the number of these in depth tax inspections will increase.
Severstal ruling in detail
When is the company receiving dividends (interest, royalty) not regarded as the beneficial owner?
Case of PAO “Severstal” (Decision of the Arbitration Court of Moscow of 31.10.2016 on the Case No А40-113217/16-1070982)
At Stake: 1 bln Roubles
In this case the court considered whether it was lawful for the Russian tax agent to apply reduced rates on the dividend payable to Cyprus companies. The tax payer failed to convince the court that the recipients are effectively entitled to the income because the tax authority presented the following proof of absence of such entitlement, namely:
- practically all dividend received by the Cyprus companies was transfered one way or another (including the repayment of debt under the loan previously given) to the companies formed in the British Virgin Islands;
- the articles of association of Cyprus companies are practically identical;
- the rights of the Cyprus companies to alienate their own financial asset – the shares of PAO Severstal - were substantially limited, effectively it was not possible for them to sell these shares to a third person outside the group of companies;
- Cyprus companies did not have assets other than the shares of PAO Severstal;
- Cyprus companies did not have business activity other than receiving and paying dividends.
The court accepted the proof, and in its decision described the activity of the Cyprus companies as “functions of a technical agent” for transfer of money to affiliated companies in the BVI. And whereas the recipient of the dividend income from Russia plays the role of the agent, the advantageous rates of the Russian withholding tax do not apply. The Company was required to pay the tax that was not withheld, the penalty and the fine.
The case of PAO Severstal is not alone. Tax authorities win disputes if they prove the “transit nature of payments” and the absence of “real office and real business” (See Decrees of the 9th AAC of 29.09.2016 No 09АП-43945/2016 on the case of ZAO “Credit Europe Bank”, Decree of the Arbitration Court of the Moscow Okrug of 04.10.2016 No А40-241361/2015 on the case of АО «Bank Inteza », Decree of the Arbitration Court of the Moscow Okrug of 27.05.2016 No А40-116746/2015 on the case of PAO “MDM Bank”).
When is the company receiving dividend (interest, royalty) regarded as a beneficial owner?
Case of OAO “St Petersburg Telecom” (Decree of the Arbitration Court of the Moscow Okrug of 15.01.2016 No А40-187121/2014)
The company was paying a dividend to a Swedish company #1, which in turn was owned by another Swedish company #2. The taxpayer succeeded in proving to the court that its shareholder was the beneficial owner of the income because it was not transferring all or almost all dividend and was using the dividend received in its financial and investment activity, and therefore its eligibility for the reduced tax rate applied.
This positive decision of the court shows that it will be difficult for tax payers to prove to the tax authorities that the reduced rate under double tax treaties is justified where the company has no substantial presence in the country receiving the dividend (interest, royalty), and has no diversification of assets and income of the foreign company.
The risk of disputed reduced withholding rates in existing and previously used structures and transactions should be carefully reviewed.
“Transit” money flows, foreign companies without sufficient presence and substance in their jurisdictions and without a sufficient diversification of assets and income streams require special attention.
How can Consulco help?
The above court case law provide very specific guidelines and directions for strengthening the tax residency of your Cyprus company.
We are pleased to be in a position to provide service and assistance by :
- assessing all your Cyprus and foreign existing structures
- advising on ways of reducing potential tax risks;
- assisting with establishing substance, management and control in Cyprus for your companies with an office, staff and the engagement of Cyprus based professionals
- reccommending options for diversifying the assets and income of the cyprus company by active investments in Cyprus and London.
Please do not hesitate to contact us for any further information at: firstname.lastname@example.org
Consulco is an independent trust services and investment management group operating since 1993 and managed by Marios Hajiroussos, Dmitry Khenkin and Elena Hajiroussou.
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