The Russian Federal Tax Service ("FTS") has adjusted requirements for foreign holding companies to be treated as beneficial owners and to apply tax treaty benefits1. To get the treaty exemptions and the reduced withholding tax rates under tax treaties, holding companies are no longer required to demonstrate active business operations to the Russian tax authorities. It is now sufficient for a company to show that its arrangements are not artificial and are business-driven.
What has changed?
If a foreign company within a multinational group performs solely holding or investment functions, this should no longer automatically preclude its beneficial ownership status or imply an absence of business operations. Thus, the FTS no longer requires foreign holding companies to demonstrate active business operations (e.g., manufacturing or sales) to apply tax treaty benefits.
This is a departure from the position stated in an earlier FTS letter that pure holding and treasury activities for the benefit of a company's affiliates are insufficient for claiming tax treaty benefits (see Legal Alert dated June 2018). Since these functions were typical for many foreign companies receiving Russian source income, the business community had strongly criticized the FTS's previous statements.
Under the new approach, the FTS encourages the Russian tax authorities to check whether foreign recipients are artificial companies and lack decision-making authority with respect to assets and income.
The new test actually confirms the applicability of tax treaty benefits in structures with no nominal shareholders (interposed companies with no commercial justification) and in the absence of tax avoidance. This approach is closer to the black letter of the Russian Tax Code and to international practice.
Initially, the FTS may take an overly conservative approach to identifying artificial cross-border arrangements and analyzing the discretion of managers in holding and treasury companies. Therefore, uncertainty remains for foreign recipients of income. However, the risks may be substantially mitigated if the taxpayer can promptly provide relevant supporting documents at the request of the tax authorities. Counsels having both tax and corporate law expertise may be helpful in preparing a so-called "defense file". In our experience, such projects require deep understanding not only of international business, but also of the specific features of the particular multinationals.
Actions to consider
Taxpayers may want to consider the following:
- reviewing their group structure and identifying companies that solely or mostly perform holding and intragroup investment functions, and checking whether such companies are the beneficial owners of Russian source income in light of the new clarifications;
- identifying and collecting additional supporting documents that show the genuine business purpose and independent decision-making of foreign companies;
- analyzing whether the direct recipient is the beneficial owner or may be "looked through" so that a higher-tier company or ultimate shareholders with more substance can claim tax treaty protection (considering all relevant complications and tax implications in other jurisdictions);
- examining further restructuring opportunities to mitigate withholding tax risks in Russia.
1 Letter of the Russian Federal Tax Service No. ED-4-13/15696@, dated August 8, 2019 ("Letter").