International tax developments in RussiaNew Challenge and New Solutions

Chair: Roustam Vakhitov

Panel:

Denis Schekin, Pepeliaev Group, Russia

Nicolas Fermaud, Allen&Overy, Luxembourg

Martin Bergwerff, Hamelink Van den Tooren,

The Netherlands

OUTLINE OF THE PRESENTATION

1. RECENT DEVELOPMENTS: LIMITATION ON DEDUCTIBLE INTEREST

Russia

OpCo

HoldCoInterest

Deductible interest rate

•for loans in Russian currency 1,8 * refinancing rate of the RF Central Bank in 2010 and 2011

•for loans in foreign currency 15% in 2010, 0,8 * refinancing rate (6,4%) in 2011

8

Loan

FinCo

Russian Co

Interest

Cyprus

Russia

HoldCo

Dividends

1. Direct loan from HoldCo to Russian Co would be covered by thin cap rules

2. Loan via foreign sister co does not fall under thin cap limitations

3. Can we re-characterize loan via Hungary FinCo

into direct loan to from HoldCo to Russian Co?

4. Court of first instance – yesCourt of appeal – yesCourt of cassation – no.

Thin capitalization

1. RECENT DEVELOPMENTS: MIRLAND CASE

Hungary

Loan

3 5

Capital Gains:• Alienation of shares deriving more than 50% of their value from property situated in a contracting state may be taxed by the state where the immovable property is situated;• Grace period of 4 years following the entry into force of the Protocol (expected 2016)

Article 6 (income from immovable property):

•income received from real estate investment fund

1. RECENT DEVELOPMENTS: PROTOCOL TO TAX TREATY WITH CYPRUS

Holding

Russian Company

Cyprus

Russia

RussianReal estate

3 6

Article V (Dividends)

• definition of dividends includes payments on shares of mutual investment funds or similar collective investment vehicles and excessive interest under thin cap rules• direct investment of US 100,000 needed to trigger a 5% dividend withholding rate has now been increased to EURO 100,000

Article 27 (Assistance In Collection)Contracting states shall lend assistance to each other for the collection of revenue claims or any other tax penalties and costs of collection

1. RECENT DEVELOPMENTS: PROTOCOL TO TAX TREATY WITH

CYPRUS

7

• RF President and RF Ministry of Finance seek to use this concept to combat treaty shopping

• This concept targets multilayer structures

• How does it work? No treaty benefits (0% or reduced withholding tax rates) apply to income received by

person not qualifying as beneficial owner

• Who is beneficial owner of income (Russian approach)?

- person having formal title on income AND- person detemining «economic destiny of income»

• Beneficial ownership concept does not apply to repatriation of profits from branches/ rep. offices

1. BENEFICIAL OWNERSHIP: RISKS, MINIMIZATION STRATEGIES

1. BENEFICIAL OWNERSHIP: RISKS, MINIMIZATION STRATEGIES

• If DutchCo not considered beneficial owner of dividend income, benefits under the Netherlands – Russia DTT may be denied; • If treaty benefits denied then Russian domestic tax rules should apply;

• The Dutch tax implications (WHT) will not be affected;

• May Germany – Russia DTT apply?

RusCo1

DutchCo

RusCo

GermCo

5% WHT

0%/ 9% WHT15%/ 5% WHT?

100%; EUR 100 000

49%/90%51%/10%

7

• What factors may indicate person is not beneficial owner of income?

- person has no presence in the residence state (no office, no personnel, no bank accounts, no financial reporting obligations etc);

- person has no activities other than those which treaty benefits are claimed for;

- person does not bear normal commercial risks (subsidies from parent company; no adequate margin);

- person assumes legal obligations to distribute income it receives;

- the terms of back - to - back operations are same or similar (e.g.for debt financing: principal amount, currency, interest rate, payment terms etc)

1. BENEFICIAL OWNERSHIP: RISKS, MINIMIZATION STRATEGIES

7

• How could we mitigate the risks? Case by case approach

• General recommendations:

- simplify structures: do not use multilevel structures until necessary;

- substance and presence in residence state: office space, personnel, bank accounts, board and shareholders meetings, bookkeeping and accounting, general overhead expenses etc;

- consolidation of business functions (group financing company; group IP holding company);

- multiple project vehicles;

- arm’s length remuneration (margin);

- sound economic reasons behind use of offshore companies (foreign markets, foreign investors and flexibility of foreign law, statutory requirements under foreign law when making outbound investments)

1. BENEFICIAL OWNERSHIP: RISKS, MINIMIZATION STRATEGIES

7

Head office:preparing integrated product,

management, sales

Decision of Moscow commercial court

Of 08.12.2010 in case № А40-94391/2010

(not appealed):

1. Rep. office of a US company gathered information and prepared news. Considering main office’s functions, this was core activity and not preparatory or ancillary activity.

2. Revenue was defined as all sales in Russia

Rep.office in Russia:

Collection and preparation of news, VAT returns

Russia

US

1. RECENT DEVELOPMENTS: BLOOMBERG CASE

7

Head office:preparing integrated product,

management, sales Possible reasons for negative outcome:

- lack of proper description of functions of personnel and rep. office

- lack of proper allocation of revenues and expenses, attributable to Russian and Head office

Rep.office in Russia:

Collection and preparation of news, VAT returns

Russia

US

1. RECENT DEVELOPMENTS: BLOOMBERG CASE

1. RECENT DEVELOPMENTS: NEW PARTICIPATION EXEMPTION

Foreign

Jurisdiction

Russia

SubHoldCo

HoldCoDividends

1. 50% participation 2. 365 days 3. Dividends should come from

non-blacklisted jurisdictions 4. Investment of at least RUR 500

million

Foreign

Jurisdiction

Russia

SubHoldCo

HoldCoDividends

Participation exemption in 2010 Participation exemption in 2011

10 2: CYPRUS: TAXATION OF DIVIDENDS, INTEREST, ROYALTIES AND CAPITAL GAINS

Taxation of dividends and capital gains 1. Dividends: 5%/10% 2. Capital gains: 0%

Taxation of interest and royalties

1. Exempt from tax in Russia, 2. No explicit BO test3. No special provision on full deductibility

of interest

Russian OpCo

Top oldCo

FinCo

Cyprus

DividendsInterest, royalties

HoldCo

Russia

Cyprus

Low tax jurisdiction

10 2: LUXEMBOURG: TAXATION OF DIVIDENDS, INTEREST, ROYALTIES AND CAPITAL GAINS

Taxation of dividends and capital gains 1. Dividends: 10%/15% 2. Capital gains: 0%

Taxation of interest and royalties

1. Exempt from tax in Russia, 2. No explicit BO test3. No special provision on full deductibility of

interest

Russian OpCo

Top HoldCo

FinCoLux

DividendsInterest, royalties

HoldCo

Russia

Luxembourg

Low tax jurisdiction

Low tax

jurisdiction/

Russian HoldCo

Lux Holding

Company

Russian

Company

Russian

Branch

Tax free after-tax profits by a PE distribution

WHT on dividends: 10%/15%

Zero WHT due to non-discrimination claues?

Distribute profits with low or no dividend withholding tax

2: LUXEMBOURG: INVESTMENT VEHICLES

EU

Company

10 2: THE NETHERLANDS:TAXATION OF DIVIDENDS, INTEREST, ROYALTIES AND CAPITAL GAINS

Taxation of dividends and capital gains 1. Dividends: 5%/15% 2. Capital gains: 0%

Taxation of interest and royalties

1. Exempt from tax in Russia, 2. Explicit BO test for zero WHT on interest

and royalties3. Special provision on full deductibility of

interest

Russian OpCo

TopHoldCo

FinCoNL

DividendsInterest, royalties

HoldCo

Russia

The Netherlands

Low tax jurisdiction

Low tax jurisdiction

Dutch Holding

Company

Russian

Company

Russian

Real Estate

Company

Russian

Branch

Participation exemption on profit distributions and capital gains at the level of the Dutch Holding

(Re)invest international profits or provide financing

Distribute profits with low or no dividend withholding tax

2: THE NETHERLANDS: DUTCH HOLDING COMPANY

Russian

Real Estate Branch

10 BUSINESSES POTENTIALLY INTERESTED IN DUTCH AND LUXEMBOURG SOLUTIONS

• Real estate investment projects • Mutual funds

• Russian groups with outbound investments (Lux)

• Russian subsidiaries with loans in foreign currency with interest rate exceeding 6,4% (NL)

Holding

Russian Company

/Fund

CyprusNL/LUX

Russia

RussianReal estate

12

Roustam Vakhitov

Head of International Section of the Scientific and Expert Council of the Russian Chamber of Tax Advisers

T:+79060598008

E-mail: vakhitov@palata-nk.ru

Roustam Vakhitov specialises in international taxation. Roustam has experience of working in law firms and consulting companies in Russia, the Netherlands and Luxembourg. He is focusing on international tax issues since 2002.

Roustam’s main practice area is advice on Russian international tax structuring involving Benelux countries and tax support of transactions involving financial instruments and capital market projects, including Islamic finance. His clients include large Russian banks and enterprises, as well as investment companies.

Roustam is the Deputy Head of the Russian Branch of the International Fiscal Association and Head of the International Taxation Section of the Research and Expert Council within the Russian Chamber of Tax Advisors and the member of Coordination Council of the Russian Association of Experts in Islamic Finance.

Roustam speaks English and Dutch languages. He is an author/co-author of Russian national IFA branch reports to National Congresses of 2003, 2006, 2008 and 2010. Roustam has authored many publications on international taxation and tax structuring.

ROUSTAM VAKHITOV