On 30 December 2016 the Commercial Court of Voronezh Oblast delivered a judgement in case No. А14-10190/2014 (the “Decision”) under the claim of Ilyushin Finance Co. Open Joint Stock Company (the “Company”). The case is an example of a broad interpretation of the list of documents confirming entitlement to a reduced tax rate on payment of dividends provided by double tax treaties. In particular, when the requirement on the amount of capital investment is met by the purchase price of the shares of the company paying the dividends.
As follows from the Decision, a Cypriot company submitted an application to the Russian exchange intermediary (broker) ATON LLC to adhere to contracts for services on the securities and futures market. The exchange intermediary undertook to provide the Cypriot company with exchange services. Specifically, shares in the Company were purchased for the Cypriot company in 2013. The Company itself paid the dividends in question on those shares, withholding tax at the rate of 5% (the reduced tax rate for payment of dividends under the Russia-Cyprus treaty). The share purchase price was more than US$100,000. The securities transactions were conducted through the Cypriot company's custody account.
In the opinion of the tax inspectorate (the “Inspectorate”), the Cypriot company's application to conclude contracts with ATON LLC by adhering to the service terms does not evidence that there was an order to purchase the Company’s shares. The notice of purchase of the Company’s shares for the Cypriot company that the exchange intermediary sent to the seller of the shares is not a document confirming entitlement to apply the 5% tax rate, as the exchange intermediary itself made the notice. In addition, there were no payment documents confirming that the Cypriot company transferred funds to the exchange intermediary to purchase the Company's shares.
The court, which supported the Company's position, took the following circumstances into consideration:
- ATON LLC undertook to provide the Cypriot company with services under the contract for services on the securities and futures market, and for services under a custodial agreement.
- The transactions involving the Company’s shares were conducted through the Cypriot company’s custody account.
- The law does not require that an order to purchase securities be made in writing. Consequently, the argument that there were no instructions from the Cypriot company to purchase and sell the Company’s shares is invalid.
The court also noted that the Inspectorate's argument was invalid that ATON LLC and the Cypriot company had no real cash flow between them, but there were repeated share purchase transactions. For this reason, in the Inspectorate’s opinion, there was no real foreign capital investment. The Russia-Cyprus double tax treaty does not contain provisions establishing a minimum period a foreign company must hold the shares of a Russian legal entity in order for the 5% tax rate to apply. Furthermore, neither Russian law nor the Russia-Cyprus tax treaty prohibit the termination of obligations by set-off.