Imminent Changes to the Tax Treaty of the Russian Federation and the Republic of Cyprus in response to the Covid-19 pandemic

On  the 25^th of March 2020, the President of the Russian Federation Mr. Vladimir Putin announced a series of measures in response to the Covid-19 pandemic. From the international tax perspective it was announced that dividends and interest withholding tax rates in treaties for the avoidance of double taxation should be raised to 15%. It was further stated that should an agreement not be reached with a treaty country then the  treaty shall be unilaterally terminated. It is not entirely clear whether these measures have been developed after the pandemic started in Russia or if this might be a part of a more general Russian tax treaty policy. Nevertheless these measures may have a serious effect on the tax treatment of bilateral cross-border investments and need to be seriously considered.    

In accordance with information received, an official notification was sent to the Republic of Cyprus on the 1^st of April 2020 by the State Secretary- Deputy Minister of Finance Mr. Alexey Sazanov, requesting the implementation of certain changes to the existing Agreement between the Government of the Republic of Cyprus and the Government of the Russian Federation for the avoidance of Double Taxation with respect to taxes on income and on capital (the “DTT”).The requested changes are a request for a raise of the withholding tax rate for dividends and interest to 15%.

The above can also be confirmed from the fact that the Prime Minister of the Russian Federation has proceeded with a statement confirming that the aforementioned notification was sent to the Republic of Cyprus on the 1^st of April 2020.

In accordance with the official notification sent, in the absence of a positive feedback from the Republic of Cyprus by the 15^th of June 2020 the Russian federation will terminate the DTT in accordance with the Vienna Convention of 1969. It should be noted that the Vienna Convention provides for a complex international procedure to be followed in order to proceed with an invalidity/termination of a treaty (Article 54 and Articles 65-68) In addition the actual DTT between the two governments also provides for a termination procedure which in our opinion under international law should be read in combination with the Vienna Convention (Article 31).

Based on the above, it is possible that the Russian Federation can proceed with taxing up to 15% WHT on dividends and interests in situations where the ultimate beneficial owner is a Russian Tax Resident however this cannot take place automatically and the procedures under international law shall need to be followed.

It is expected that a similar approach will be followed with Treaties with Luxembourg, the Netherlands, other EU Member States and Switzerland as has been reported after communication between the Head of Ministries of Foreign Affairs of both countries Mr.Sergey Lavrov and Mr. Nicos Christodoulides .[1]

However it is worth noting that the application of a relatively high withholding tax on interest will effectively come at the cost of Russian borrowers as financing of large projects in Russia, e.g. through Eurobonds or bank loans normally contain provisions on gross-up of interest payments by Russian borrowers. In these cases the absence of any tax minimization motive will make foreign financing more expensive, which is counterproductive for the recovery of the economy after the crisis ends. Moreover, for state owned enterprises this will be even less efficient as this would constitute a  re-allocation of financial resources  within the state economic sector. 

Considering possible alternatives and the fact that Russia adopted the SLOB provision as a main anti-avoidance clause under MLI, it might be worth discussing the replacement of simple increase of dividend and interest withholding rates with the adoption of SLOB or similar provisions aiming at challenging only artificial structures and arrangements.  

A Limitation of Benefits clause in general  leads to a denial of tax treaty benefits to companies owned by more than 50% by non-residents of the respective jurisdiction where there are no active operations and/or not a clear non-tax reason for structuring investments through the respective country.

A suggestion to meet possible tax issues arising from these imminent changes is of course to prepare for the possible scenarios and to be able to proceed quickly with e.g. changing the tax residency of the ultimate beneficial owners of affected structures, or with considering other alternative solutions which we can discuss, depending on the final wording of the agreed changes.

In any case it is now clear  that the current state of affairs will change and most likely will change quickly, i.e. by the end of 2020. Which exact changes may be adopted is not entirely clear by now, so it might be worthwhile to prepare for several scenarios so as to be able to be one step ahead when the negotiations will finalise and the new provisions of the Russia-Cyprus DTT will be defined.

It could be too early to reach specific conclusions since it is possible that a different agreement may be reached between the governments and as such we shall be monitoring the situation closely and update you accordingly.

Please do not hesitate to contact us for any further clarifications you might require.

Michalis C. Zambartas, Advocate                    

e-mail: michalis@zambartaslegal.com , tel: +35722262108

[1] Russia: changing double taxation treaty with Cyprus nothing political (Updated)