August 2023 Blog

Russia suspends tax treaties with “unfriendly states” – Practical implications for foreign investments and expatriates

By Presidential Decree (“Ukaz”) No. 585 of 8 August 2023, Russia has suspended the application of the main provisions of double taxation treaties (hereinafter referred to as “DTTs”) with what it calls “unfriendly states”, for example Article 5-22 and Article 24 of the DBA between Russia and Germany (hereinafter referred to as “DTT Russia”). The list of unfriendly states is drawn up, regularly reviewed and, where applicable, adjusted by the Russian government. It currently includes all EU Member States and 22 other states.

Payment of dividends / withholding taxes

This means that, under certain conditions, the reduced withholding tax rate of 5% on Russian-sourced dividends may no longer be applicable to German shareholders. In other words, all dividends are subject to Russian withholding tax at a rate of 15%.

Under Article 11 DTT Russia, which Russia has now suspended, the withholding tax payable on dividends to be distributed by Russian companies to German shareholders is reduced to 5%, if the German shareholder holds at least 10% of the registered share capital of the Russian company having a nominal value of at least EUR 80,000.

This is problematic for German companies with Russian subsidiaries because cash transfers from Russia to Germany were strongly restricted even before the suspension of the DTTs.

Restrictions apply, for example, to loan repayments by Russia-based borrowers to foreign lenders in “unfriendly states”, and to payments of dividends to shareholders in “unfriendly states”: Payment obligations exceeding RUB 10m  per month either require the approval of the government commission to be fulfilled or must be fulfilled by payment into a special account with a Russian bank, which is not to be recommended, because the funds would generally not be disbursed to the foreign creditor.

In order to obtain the approval of the government commission for payments of dividends exceeding RUB 10m per month, restrictive conditions must be met, which the Russian government commission summarised as follows in a publication of 7 Juli 2023:

  1. The amount of dividends to be distributed must not exceed 50% of the company’s total net profit for the previous year;
  2. The amount of dividends for previous periods and the procedure for their payment must be considered;
  3. The foreign shareholder must be ready to continue its commercial activities in Russia;
  4. Reports of the relevant authorities and of the Bank of Russia regarding the significance of the company and the effects of its activities for the technological and production sovereignty of the Russian Federation, the social and economic development of the Russian Federation and/or its constituent entities must be obtained and considered;
  5. The company requesting the approval must fulfil certain key performance indicators confirmed by the federal executive authorities or the Bank of Russia;
  6. It must be possible to pay dividends on a quarterly basis, if the key performance indicators are fulfilled.

The entire approval procedure is very complicated and time consuming.

Profit distributions other than dividend payments to recipients in Germany can be taxed only in Germany pursuant to Article 10(4) DTT Russia, but nevertheless they shall henceforth also be subject to 20% withholding tax in Russia.

Interest and licenses

Pursuant to Articles 11 and 12 DTT Russia, interest and licenses originating from Russia, which are, payable to a recipient in Germany can be taxed only in Germany.

Given that the Russian Federation has now ceased to apply these provisions, interest and licences are now subject to Russian withholding tax at a rate of 20%.

Capital gains on disposal

Under the national tax law of Russia, the income of foreign organisations from the sale of shares in Russian companies whose assets include over 50% of real estate located in Russia is subject to 20% withholding tax in Russia. Article 13 DTT Russia provides for an exemption from tax in this regard.

Without the application of Russia’s DTT, this kind of income is subject to Russian withholding tax at a rate of 20%.

Permanent establishments

According to Article 5(3) DTT Russia, which has also been suspended now, a building site, construction or installation project  only qualifies as a permanent establishment; if it lasts longer than twelve months.

In the absence of this tax relief, a foreign company as a general rule must register in Russia for tax purposes, if its activities in Russia exceed 30 calendar days per year (Article 83(4) of the Tax Code of the Russian Federation). Provided that the other requirements are met (fixed place of business of a foreign company in Russia through which the foreign company permanently conducts its business), a permanent establishment is usually assumed to exist, if this period is exceeded. The profit attributable to a permanent establishment in Russia is subject to Russian profit tax at a rate of 20%.

Income (pay) from employment

The income of employees with unrestricted tax liability in Germany who perform part of their employed work activities in Russia can be taxed in Russia according to Article 14 DTT Russia only to the extent that work is actually performed in Russia. Moreover, Russia’s right of taxation is fully excluded, if the following conditions are cumulatively met:

  • The employee remains in Russia no longer than 183 days during a period of 12 months,
  • all remuneration is paid by an employer based in Germany, and
  • the remuneration is not (financially) borne by a permanent establishment or fixed base the German-based employer has in Russia.

This limitation of Russia’s right of taxation ceases to apply and, as a result, pay from employment may be subject to double-taxtion in Germany and Russia.

Surviving provisions

From Russia’s perspective, only the formal provisions of the DTT Russia remain in force, e.g. those on the taxes covered by the Treaty, the definitions, the provisions on the exchange of information and mutual agreement procedures and on the credit of foreign taxes.

Additional measures to support Russian persons are to follow.

Recommendations for action

Companies should review their business relationships or investments with a link to Russia with a view to the potentially higher tax burden and to assessing whether adjustments are needed. For example, changes with regard to tax gross-up clauses may be particularly helpful. Furthermore, it should be examined whether tax relief mechanisms are available in Germany and what conditions need to be fulfilled to use them.

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