Quid pro quo: Suspension of dual taxation avoidance agreements with unfriendly states
President V. Putin signed a decree suspending th application by Russia of specific provisions of bilateral dual taxation agreements (DTAs) with 38 unfriendly states until the moment they stop violating the rights of Russian citizens and companies or until such agreement ceases to apply to Russia. Earlier, the DTAs allowed companies and individuals to pay taxes in one country only, or in both countries, but at a lower rate.
On August 8, 2023, the RF, per the Decree of the RF President # 585, unilaterally suspended most provisions of DTAs with Poland, the USA, South Korea, Bulgaria, Sweden, Luxemburg, Romania, Great Britain, Hungary, Ireland, Slovakia, Albania, Belgium, Slovenia, Croatia, Canada, Montenegro, Switzerland, Czechia, Denmark, Norway, Italy, Finland, France, Germany, Macedonia, Cyprus, Lithuania, Spain, Iceland, Austria, Portugal, Greece, New Zealand, Australia, Singapore, Malta, and Japan.
From words to deeds
In March of this year, the Russian Government, represented by the Ministry of Finance and the Ministry of Foreign Affairs, proposed to the President of Russia to suspend the operation of double taxation agreements (DTAs) with unfriendly countries. This proposal was justified by the inclusion of Russia in the so-called "EU black list," a list of non-cooperative jurisdictions in the tax sphere. You could have felt the effects of this list when trying to open an account in a foreign bank this or last year: the nationality of a person from this list gives the bank a formal right to refuse to open an account without explaining the reasons or demand to provide documents that would confirm the severance of ties with Russia to keep the existing account active. This listing complicates business operations and income generation from abroad for Russian citizens and companies, leading to loss of tax benefits, additional reporting and inspections, mandatory disclosure of beneficiaries, and significant barriers in utilizing European offshore advantages.
The Russian Government considered it an appropriate countermeasure to temporarily suspend agreements designed to reduce the tax burden caused by double taxation for individuals and legal entities. The President supported this initiative.
Most provisions regulating the taxation of various types of income, including business profits, interest, dividends, royalties, income from international transportation, and other incomes, were suspended. Currently, only general provisions remain in effect, including definitions, procedures for agreement execution and termination. Also, remain in effect provisions regarding the avoidance of dual taxation of residents by crediting the tax already paid in the country of permanent residence.
What this means for us:
Firstly, it will become even more challenging for strategic foreign investors remaining in Russia to receive profits from Russian companies. Considering the significant reduction in passive income payments by Russian companies to unfriendly countries, the decision globally cannot worsen the situation. However, it primarily affects non-residents in the process of liquidating, restructuring their companies, and transferring capital abroad. Controlled foreign companies (CFCs) will be required to conduct mandatory audits of their financial statements, given that almost all providers currently refuse to audit Russian companies.
Secondly, the already difficult management and structuring of Russian business through unfriendly countries will become even more complicated: there are fewer and fewer options for saving on tax payments. Although these measures will not cause significant additional harm since Russian companies are already paying higher rates in unfriendly EU countries. If unfriendly countries also refuse to apply the provisions of the Double Taxation Avoidance Agreements (DTAAs), Russian investors could lose up to a third of their profits from foreign stocks and bonds due to source tax withholding.
The concerns about the income of citizens who have relocated, expressed by experts earlier this year, were not fully realized. The provisions that allow for a tax credit for personal income tax already paid in another country were not suspended. It is sufficient to pay tax in the country where it is higher; it will be credited in the other country as before. This also applies to the income of individuals from the sale and disposal of property. Thus, this measure will not affect ordinary Russian citizens living in unfriendly countries and working under employment or service contracts.
When will we feel the consequences?
When the Russian President signs a decree, it does not immediately bring the suspension of the international agreement into effect. Under Russian law, treaties ratified by federal law are denounced or suspended following the same procedure. Adopting a federal law will clarify the specific tax implications of suspending most double taxation agreement (DTA) provisions. Notably, in 2021, the agreement with the Netherlands was terminated due to their refusal to abolish preferential rates on dividends and interest from Russian companies. Cyprus, Malta, and Luxembourg adjusted their rates to 15%, aligning them with Russian tax law, and the agreements were amended bilaterally.
Prospects
It should be added that according to Article 57 of the Vienna Convention on the Law of Treaties (1969), suspending the operation of a treaty either entirely or towards a particular party requires either agreement as per the treaty's provisions or consensus of all parties after consulting other contracting states. Double taxation agreements don't have provisions for unilateral suspension. Therefore, parties must either negotiate changes (as with Cyprus, Malta, and Luxembourg) or a state can denounce the treaty unilaterally.
This unilateral suspension of DTAs is legally questionable and may lead to treaty denunciation. However, ot should be noted that in 2022, Latvia unilaterally suspended the DTAA with Russia, which resulted in its denunciation by RF. The agreement with Ukraine was also denounced in 2022.
The decision taken by the President of the RF may entail both a mass denunciation of agreements, which will affect more people and will complicate the lives of those who have relocated. In such a case, it would be unclear how to resolve disputes regarding dual tax residency. However, it's assumed that other countries are unlikely to reciprocate the suspension.
Summarizing the above and given the current situation, we can say that these measures aimed at suspending certain provisions of DTAs are rather political and are retaliatory against EU sanctions. The overall impact depends on how other countries respond, but a significant deterioration in the global economic situation is not anticipated. The worst-case scenario could be a complete breakdown in tax cooperation with "unfriendly" countries.
