Cyprus-Russia Tax Alert - 12 October 2010
Protocol to tax treaty signed
By Alexander Krylov, Pieris M. Markou and Shereen Chirambo
Cyprus and Russia signed a protocol to the 1998 tax treaty between the two countries on 7 October 2010. Although most of the changes in the protocol were agreed upon on 16 April 2009, it was not until 27 September 2010 that the protocol was finalized and approved, after minor changes were made during a visit of the Cypriot Minister of Finance to Moscow. The protocol will become effective as from 1 January of the year following the year both Cyprus and Russia complete their ratification procedures.
The most significant effect of the protocol is that, because it now includes an exchange of information provision that complies with the OECD standard, Cyprus should be removed from Russia’s black list, thus enabling Russian companies to benefit from Russia’s participation exemption on dividends received from Cypriot companies. The black list was introduced in 2007 in conjunction with Russia’s participation exemption. Under the participation exemption, dividends received by a Russian company from a foreign subsidiary are exempt from tax provided the Russian recipient holds at least 50% of the charter capital of the payer company for at least 365 calendar days and the subsidiary (payer company) is not resident in a country included on the black list.
Features of protocol
Although the protocol does not make any changes to the rates of withholding tax on dividends (which remain at 5% or 10%), the application of the 5% rate will require a direct investment of at least EUR 100,000 in the capital of the company paying the dividends, instead of USD 100,000 under the existing treaty.
The 0% rates on interest and royalties provided for in the treaty have not been changed.
The protocol also amends the definitions of dividends and interest to align them with the wording of the latest version of the OECD Model Treaty. The definition of dividends now includes payments on shares in mutual investment funds and similar collective investment vehicles (other than investment funds organized primarily for the purpose of investing in immovable property), as well as depository receipts on shares. The revised definition allows the Russian tax authorities to apply the domestic thin capitalization rules to recharacterize “excessive‟ interest payments as dividends and tax such amounts in Russia at source, albeit at the reduced withholding tax rates applicable to dividends. Corresponding changes are made to the definition of interest.
The protocol includes provisions limiting treaty benefits for transactions involving shares and other corporate rights in real property-rich companies and benefits provided to mutual investment funds organized primarily for the purpose of investing in immovable property. The major change made by the protocol is source-state taxation of capital gains on the sale of shares in real property-rich companies. Currently, the treaty allocates taxing rights to the country of residence of the selling entity.
These provisions will come into effect no earlier than 1 January 2015 if ratification takes place by the end of 2010, because the treaty sets a four-year period from the date on which the protocol will enter into force.
As noted above, the protocol includes an expanded exchange of information provision, which brings the provision into compliance with the latest standards established by the OECD Model Treaty. This provision broadens the authority of, and the obligations imposed on, the two countries with regard to the exchange of information and mutual cooperation in the collection of taxes. This is aimed at improving information exchange, achieving greater transparency and enhancing the efficiency of control over tax violations.
Major practical aspects of protocol
- Cyprus’ inclusion on the black list has been a barrier preventing Russian companies from qualifying for the participation exemption. Once the protocol is in effect, dividends received by Russian companies from Cypriot subsidiaries will be able to qualify for the Russian participation exemption.
- To benefit from the 5% withholding tax rate on dividends, the new minimum EUR 100,000 direct investment in the capital of the company paying the dividends should be tracked.
- Companies that invest in real estate or that conduct operations with shares and other property rights of companies in the real estate sector should plan their transactions accordingly or consider potential restructuring of their activities.
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