June 15 2012 Royalty scheme and information exchange with Cyprus Pepeliaev Group | Corporate Tax - Russia Corporate Tax On May 17 2012 the Federal Arbitrazh Court of the Urals District issued its ruling in Trading House "Monetka", a case which may mark an end to protracted and difficult information-gathering processes in support of tax dispute claims.A company, Element-Traid LLC, used the trademark MONETKA and paid royalties to a Cyprus company. At that time, the Cyprus company was a sub-licensee and paid royalties to a company in the British Virgin Islands. The owner of the trademark had been a director of the parent company, Element-Trade LLC, and Element-Traid had previously used the mark for free. The director subsequently sold the rights in the mark and Element-Traid began to use the mark, paying royalties abroad.The tax authorities suspected that Element-Traid's arrangement was an attempt to put part of its income beyond the reach of Russian taxation. Their assumption was that the royalty scheme was being applied purely for the purpose of avoiding tax on royalties paid from Russia to Cyprus (under the double taxation treaty between the countries) and later paid to the company in the British Virgin Islands, which is on the Russian Ministry of Finance's blacklist of low-tax jurisdictions.The novel aspect of the case was that the tax authorities used information from police channels to support their claims. Using double taxation treaty arrangements to obtain information can be a lengthy and difficult process. Instead, the authorities sought information from Interpol about the identity of the shareholder of the Cyprus company. They established that the shareholder was a relative of the director of Element-Trade, who had sold his rights in the trademark to the company in the British Virgin Islands. The tax authorities contended that there was no business purpose for the royalty payments to the British Virgin Islands if payments could be made to an affiliated entity.The court held that the authorities could not assess the business impact in this case, and that all of the costs in question were documented. However, the court viewed Interpol's information as appropriate evidence.It is arguably a good sign for taxpayers that the tax authorities are taking greater care to prepare and prove their claims. The case is particularly significant in view of the new protocol to the double taxation treaty between Russia and Cyprus, which will make it quicker and easier to exchange information.For further information on this topic please contact Andrey Tereschenko or Ivan Zelenin at Pepeliaev Group by telephone (+7 495 967 0007), fax (+7 495 967 0008) or email ([email protected] or [email protected]).