On 7 June 2017, Russia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI and BEPS respectively), along with 671 other jurisdictions, during a signing ceremony hosted by the Organization for Economic Co-operation and Development (OECD) in Paris. This event has been recognized as a groundbreaking attempt to close loopholes in thousands of double tax treaties (DTTs) worldwide. The purpose of this MLI is to efficiently re-negotiate and amend DTTs to meet the minimum standards agreed upon in the BEPS project, particularly on preventing tax avoidance. The first DTT modifications pursuant to the MLI are likely to enter into force and start affecting cross-border structures as of 2018, subject to completion of the ratification procedures in the participating states.
MLI in a nutshell
The MLI contains both provisions reflecting the minimum BEPS standards to be implemented by all participating states (the Minimum Standard) and provisions that do not reflect the Minimum Standard (the Advanced Standard), which may impose additional requirements.
The Minimum Standard provisions will apply by default to all DTTs covered by the MLI. Most importantly, these provisions will include the principle purpose test (the PPT), which allows local tax authorities to deny tax treaty benefits if it is reasonable to conclude that obtaining these benefits was one of the principal purposes of the underlying arrangement. This should provide a common approach to countering tax evasion using tax treaties compared to increasing the number of domestic rules, e.g., beneficial ownership rules, etc.
The Advanced Standard, including any additional requirements, is optional. Applying the Advanced Standard should be based on the matching notifications of participating states with respect to a particular DTT and, thus, cannot be applied unilaterally by a particular state.
The Advanced Standard addresses various provisions, including the following:
- Simplified limitation of benefits provision (SLoB), which introduces additional formal criteria for applying DTT benefits, i.e., requirements for qualifying recipients of income — individuals, publicly traded companies, active companies or passive companies mostly owned by shareholders from the same jurisdiction;
- Minimum 365-day holding requirement for applying reduced withholding tax rates for dividends;
- Minimum 365-day holding requirement for applying reduced withholding tax rates for capital gains from the sale of shares in property-rich companies;
- Broadening the scope of the permanent establishment rules: capturing commissionaire structures, additional criteria for applying exemptions for preparatory and auxiliary activities, etc.
What about Russia?
Russia has decided to directly amend 66 of its DTTs (most of the DTTs, including treaties with Cyprus, the Netherlands and Luxembourg that are commonly used for holding and financing purposes) through the MLI, including the new DTT with Belgium.
Russia used a rather strict approach to countering various tax avoidance mechanisms identified by the BEPS project and selected a wide range of the Advanced Standard provisions going beyond the Minimum Standard, including:
- 365-day holding requirement for dividends and capital gains to apply redemption or reduction of withholding tax;
- Taxation on the sale of shares in property-rich companies;
- Extension of the permanent establishment rule to commissionaires and agents working exclusively for the principal, etc.
Importantly, Russia chose to apply the SLoB provision for MLI purposes, which is similar to the provisions in the USA-Russia DTT. Using the SLoB may substantially limit the tax benefits for many holding and financing structures using intermediary companies for Russia. However, based on the MLI, the SLoB would only work if another participating state also chose to apply the SLoB. Therefore, Russia will keep a less restrictive PPT as the Minimum Standard with most countries, since only 11 other participating states2 chose to apply the SLoB.
Application of the PPT may nevertheless suggest a stricter approach to limiting DTT benefits compared to the limitation of benefits clauses that were practically ineffective under some DTTs (e.g., under the DTT with Cyprus) and the Russian court-made doctrine of unjustified tax benefits under Resolution No. 53 of the Russian High Arbitrazh Court, dated 12 October 2006. Since, under the PPT, tax benefits may be denied if one of the main purposes of the transaction was to get such tax benefits, Russia may develop its own interpretation of the rule, which in the current environment may be aggressive and may affect many cross-border structures with Russia.
Actual application of the Advanced Standard elections made by Russia depends on the matching notifications of the other participating states with respect to the Russian DTTs and should be specifically determined for each particular DTT.
Actions to consider
- Consider the exact changes that would apply to relevant DTTs between Russia and other jurisdictions based on the elections made;
- Review cross-border structures and consider the availability of DTT benefits in view of the respective PPT/SLoB tests;
- Consider the potential implications of the new extended permanent establishment rules under the relevant DTTs for commissionaire and agency structures, construction sites, etc.;
- Consider future limitations for new holding, financing and IP structures in view of the PPT/SLoB and the 365-day holding period for DTT benefits for dividends and capital gains;
- Consider the available restructuring opportunities and building a proper defense position on requirements for further application of tax exemption and reduced withholding tax rates in the view of the changes under the MLI.