For the first time, the presidium of the Supreme Arbitrazh Court will consider the issue of how the non-discrimination provisions of international double tax treaties relate to Russian thin capitalisation rules, which in certain cases provide for interest accrued on a taxpayer's debt to be reclassified as dividends.


A case(1) before the Kemerovo Regional Arbitrazh Court has been referred to the presidium of the Supreme Arbitrazh Court in relation to an application of the thin capitalisation rules set out in Articles 269(2) to (4) of the Tax Code.(2) The articles in question provide that interest which accrues on a debt and exceeds a certain threshold must be reclassified as a dividend. The reclassification affects debt obligations to a foreign company where it holds more than 20% of the issued capital of the Russian taxpayer, as well as certain other debt obligations connected with a foreign company where it holds a majority share in the taxpayer. For the taxpayer, the reclassified interest cannot be deducted as expenses for profit tax purposes.

The case has been considered at three levels, with the courts holding that certain amounts owed by the Russian taxpayer met the criteria for controlled debt in Article 269(2) of the code. Under the general rule, the taxpayer was unable to deduct the disputed interest for profit tax purposes. However, the courts held that such application of the provisions was unacceptable in light of the non-discrimination provisions in Russia's double taxation treaties with Switzerland and Cyprus. (In the course of the litigation it was established that the taxpayer's capital during the disputed periods was controlled by a Swiss resident and a Cypriot resident.) Since international tax treaties take precedence, the courts overruled the tax authority's decision that had prevented the taxpayer from deducting the disputed interest as expenses for profit tax purposes.


To date, state arbitrazh (ie, commercial) courts have mainly regarded the code's provisions on thin capitalisation as being in conflict with the non-discrimination rules in international double taxation treaties. This case is significant because the same approach was applied to interest accrued by the taxpayer for payment to Russian companies that were affiliates of a foreign company with a majority share in their capital.

In referring the case to the presidium for review, the panel of Supreme Arbitrazh Court judges noted that expenses which are deductible for the purpose of the taxation, in Russia, of the profits of Russian companies should be determined by national legislation. The court's ruling stated that:

"[I]n the opinion of the panel of judges, the cited provisions of the treaties are not concerned with the methodology or procedure for calculating profit tax (including the procedure for deducting expenses for profit tax purposes) of the contracting states. Neither do they rule out the application of Article 269(2) of the code, which establishes a limit on deductible interest paid on debt obligations to companies that hold a major share in the capital of the Russian taxpayer."

In relation to the matter in dispute, the panel suggests that the taxpayer's claim for invalidation of the tax authorities' decision should be dismissed.

If the presidium applies the approach advocated by the panel, this will change the way in which other arbitrazh courts approach similar cases, putting taxpayers in a worse position to pursue disputes on the issue with the tax authorities.

Taxpayers with debts covered by thin capitalisation rules should consider how the interest on such debt may be affected if the tax authorities' position in this case is upheld, taking into account the fact that double taxation treaties (with states other than Switzerland and Cyprus) will be disregarded. This will include treaties that, in certain cases, explicitly allow for the unlimited deduction of interest paid by Russian taxpayers for business purposes.

For further information on this topic please contact Andrey Nikonov, Vladimir Voinov or Vladimir Boriskin at Pepeliaev Group by telephone (+7 495 967 0007), fax (+7 495 967 0008) or email ([email protected], [email protected] or [email protected]).


(1) Case A27-7455/2010.

(2) Ruling 8654/11 of the Supreme Arbitrazh Court dated August 12 2011.