How do Double Taxation Treaties work in Russia?
What international treaties are being discussed?
If income is received by a resident of one country from another country, such income could be taxed twice: in the country where income is received and in the country where income is paid.
International treaties signed by various countries allow avoiding such double taxation as they have priority over national tax laws.
The text of the treaties between Russia and other countries is, as a rule, in line with the single model developed by the Organization for Economic Cooperation and Development (OECD). Although this unified approach to the drafting of text of treaties makes it easier to apply them, certain rules set out in the treaties of various countries are still interpreted differently.
Double taxation is eliminated by full or partial tax exemption in the country where payment is made or by deducting the tax paid abroad when declaring taxes at home.
Taxation of profit made by companies
The general principle of profit taxation sets out that the profit derived by companies from their entrepreneurial activities may be taxed in another country if such activities give rise to a permanent establishment.
What is a permanent establishment?
Permanent establishment is a fiscal term which should not be confused with the legal forms available for establishment of companies in a foreign country.
Permanent business activity through a division gives rise to a permanent establishment in another country and thereby to taxation under the laws of that country.
So, if a foreign company has an office in Russia and regularly provides services in Russia, such activity will most likely give rise to the obligation to pay Russian tax on the profit derived from such activity. As a rule, foreign companies are entitled to deduct from their taxable income the expenses incurred for profit making, including by transferring some of the expenses incurred abroad.
But will construction or assembly facilities, for example, be deemed a permanent establishment?
Construction sites or assembly facilities are subject to a special procedure for qualification as permanent establishment. As a rule, Double Taxation Treaties set out the time periods for construction or installation works in another country during which such activity will not give rise to a permanent establishment, and consequently, during which companies engaged in such activity will not be required to pay tax.
For example, the Double Taxation Treaty between Russia and Finland provides that when industrial buildings are constructed by Finnish companies in Russia, Finnish companies are not subject to Russian profit tax provided such construction is completed within 18 months. Finnish companies engaged in such projects pay tax only in Finland.
What about the payment of passive income?
Most Double Taxation Treaties provide for preferential taxation of passive income.
For example, interest on debt obligations payable abroad may be fully exempted from tax in Russia. In such case, we should bear in mind that thin capitalization rules apply in Russia so, if the borrower’s funds are insufficient, interest may be re-qualified as dividends subject to 15% profit tax in Russia or other rates specified in the relevant Double Taxation Treaties.
The payment of royalties is another example of full or partial tax exemption. The Russian Tax Code provides that royalties payable abroad are subject to 20% profit tax. However, a number of Double Taxation Treaties between Russia and other countries provide for a reduced tax rate or full exemption from Russian profit tax.
When is a Russian company entitled to apply a Double Taxation Treaty?
Russian companies paying income to foreign companies may apply the benefits conferred by such treaties if they have received the following 2 documents before payment of income:
- Proof of actual right to income;
- Confirmation of residency in the country with which Russia has signed a Double Taxation Treaty.
If the above documents are not available, then the amounts paid to foreign companies will be subject to Russian tax at the rates provided by Russian law.
What do we offer?
We provide advice on application of Double Taxation Treaties. We monitor the latest trends in the interpretation of the provisions of these treaties and closely study how each treaty is applied to specific transactions.
Our experts help plan transactions with non-residents so that your company enjoys without risk the benefits it is entitled to upon transfer of income from one country to another.