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The beneficial ownership of the income
concept (“the
Concept”) is nowadays a
material aspect affecting the eligibility of the taxpayers to claim treaty
benefits.
The
Concept is defined by the OECD, however, it is not very specific leaving room
for Tax Administrations of each jurisdiction to adopt a more relax or strict
approach. In either case the Concept is a weapon to the tax authorities which enables them to attack aggressive tax planning by refusing granting treaty
benefits to the entities that are not beneficial owners of the income. The most
recent example is the new interpretation of the Russian Federal Tax Service
(“FTS”) issued on 12th of April 2018 which followed a strict approach as of the
concept.
Given
the above, clients should examine the position of their companies and take the
necessary measures to comply with the new requirements of Russian Federal Tax
Service. This should not be limited to those clients that obtain treaty
benefits from Russia but to all clients that obtain treaty benefits as the
“concept” can be found in all double tax treaties.
A. DEFINITION
OF BENEFICIAL OWNERSHIP BY OECD
In the OECD commentary on Article 10
of the Model Convention, it is stated that the term “beneficial owner” should
not be used in the narrow technical sense but should be understood in light of
the object and purposes of the Convention, including avoiding double taxation
and the prevention of fiscal evasion and avoidance.
The Commentary also states that in the
cases of an agent, nominee, Conduit Company acting as a fiduciary or
administrator, the direct recipient of the dividend is not the “beneficial
owner” because that recipient’s right to use and enjoy the dividend is
constrained by a contractual or legal obligation to pass on the payment
received to another person. Such an obligation will normally derive from
relevant legal documents but may also be found to exist on the basis of facts
and circumstances showing that, in substance, the recipient clearly does not
have the right to use and enjoy the income.
The
Commentary stresses that the beneficial ownership concept should be
applied only in relation to passive income such as dividends, royalties
and interest.
B. DEFINITION
OF BENEFICIAL OWNERSHIP BY RUSSIAN FEDERAL TAX SERVICE
In
an effort to interpret the meaning of actual right to use/or dispose the income
the FTS issued a letter in 2017 [1],
explaining that the beneficial owner of income can be determined through a
limited list of criteria:
-
Independence of directors in decision-making;
-
Power to dispose of the
income; -
-
Availability of personnel,
office and related general administrative expenses; -
Use of the income in
entrepreneurial activities (enjoying the economic benefits from the
income); -
Absence
of any legal or actual obligations to further transfer the income,
including the systemic nature of any transitory (back-to-back) payments;The
FTS noted that the beneficial ownership concept applies to all types of
income.
2018
In 2018, the FTS provided
further guidance [2] as to the criteria which were initially analysed in 2017 which
has now led to an increase in the requirements for a foreign entity to qualify
as the beneficial owner of the income. The new criteria for the beneficial
owner of income are can be summarised as follows:
-
Sufficient level of substance
The FTS guidance states that a
foreign company should be in the position to demonstrate the right to use and
dispose the income independently (as per the requirements of the 2017 letter) AND
also to demonstrate that the foreign company operates as an independent
business. If no independent business is performed then it is an indication of a
conduit company. According to the new guidance a conduit company is a company
which has the following characteristics:
-
Has no independent operating activity.
-
Absence of non-Russian Income.
-
Principle purpose is to redirect income to shareholders or group
entities. -
The company takes minimum financial and commercial risks.
-
Its employees perform minimum functions.
-
Minimum administration costs.
-
No significant income other than dividends and interest from related
entities.
According to the FTS guidance,
the below do not constitute valid arguments to prove that a company
operates as an independent business:
-
Holding and financing activities are not considered as operational
activities. -
The investing in the shares of a company without involvement in the
operations of the subsidiary do not constitute active business. -
Minimal personnel cost doesn’t not evidence the employment of qualified
staff. -
The only administration expenses of the company are for the compliance
with the local regulations. This is an indication that the company does not
operate independently.
-
Genuine business activities
This
approach focuses on the business purpose and nature of the transactions. More
specifically, in order for a company to qualify as the beneficial owner of the income,
the Russian taxpayer has to justify the need for involving a foreign company in
their business structure and operations. Further, evidence should be provided that
the involvement of the foreign company was reasonable and also to present the
associated business risks.
In
case the Russian taxpayer is unable to demonstrate the business rationale for
involving a foreign company the tax authorities have the right to deny treaty
benefits and also to reclassify the payment, for example from debt to equity.
-
Disclosure Requirements
The new interpretation
enforces extensive disclosure, since the burden of proof in relation to the
qualification of the beneficial ownership concept, has shifted from the Tax
Authorities to the taxpayers, since all the above-mentioned criteria necessary
to be met, should be proved and justified by the taxpayer in order to receive
the treaty benefits.
C. CONCLUSION
The new approach mainly
focuses on attacking the holding, treasury, licensing, and intermediary group
financing companies in an effort to extinguish all the previously adopted tax
planning practice followed with the purpose of tax avoidance and tax
minimisation.
On top of this, the fact that
this is a change in interpretation rather than a formal amendment to the
Russian Tax Code, means that this approach may apply to transactions for the
past three years that are still open for tax audit.
It is evident through the years,
that the Russian Tax Authorities follow an aggressive approach. Therefore,
there is need for a more in-depth and sophisticated analysis of the existing
structures, in order to reassess the viability and the corresponding tax risks
based on the current tax developments.
Our Tax Department will be able
to prepare a diagnostic review and propose possible solutions to your structure.
D.
HOW KINANIS LLC CAN ASSIST
Kinanis LLC is in a position to assist
you with the provision of the following services:
-
Reviewing
your existing structures and report with suggestions on the possible risks and
possible solutions based on the new developments -
Tax
Advice on possible restructuring -
Assistance
in the creation of substance and relocation of personnel to Cyprus
E.
DISCLAIMER
This publication has been prepared as a
general guide and for information purposes only. It is not a substitution for
professional advice. One must not rely on it without receiving independent
advice based on the particular facts of his/her own case. No responsibility can
be accepted by the authors or the publishers for any loss.
November 2018
Authors
MARIOS PALESIS, Manager – Tax Department, tax@kinanis.com, Kinanis LLC
ARTEMIS KYRIAKOY, Tax Advisor – Tax Department, tax@kinanis.com, Kinanis LLC
Our Firm
Kinanis LLC, a law and consulting firm, is one of the leading and largest business law
firms in Cyprus and advises for over 35 years the international investor and private clients on
all aspects of law, tax and accounting.
Kinanis LLC absorbed the business of its
shareholders which are in the legal and consulting profession since 1983, with
local and international dimensions.
Experience and practice over the years brought
forward the need for transformation from a traditional law firm to a more
innovative multidisciplinary firm providing a full range of services combining
law and accounting with the extensive expertise in corporate and tax advice to
ensure that our clients will obtain the best possible spherical advice adopting
the principle as to the services offered "All in one place", so that
the client will find a quick, correct and efficient solution to its daily
legal, accounting and tax issues in a trustworthy environment.
This combination of legal,
accounting and tax services through our well qualified personnel and our
involvement and participation in international transactions over the years,
have established our firm as one of the key players in the field. Our
involvement in international financial transactions has also provided us with
the extensive expertise in representing groups, corporations, funds as well as
the private client.
The
firm is staffed with around 80 young, energetic and ambitious professionals,
including lawyers, accountants and administrators who provide prompt, efficient
and high quality services and who are capable of meeting the current demanding
challenges of the local and international business environment.
We always look to give solutions in a
simple and as possible quick way focusing on the needs of each client trying to
anticipate the issues before becoming a problem.
Kinanis LLC
Lawyers’
Limited Company
12 Egypt Street, 1097, Nicosia
P.O. Box 22303, 1520 Nicosia, Cyprus
Tel: + 357 22 55 88 88 – Fax: + 357 22
66 25 00
E-mail: KinanisLLC@kinanis.com
– Web site: www.kinanis.com
KINANIS is the service mark through
which Kinanis LLC of Cyprus, Kinanis Fiduciaries Limited of Malta and their
affiliated companies are conducting business each of which is a separate legal
entity.
[1] Letter
СА-4-7/9270@ of 17.05.2017
[2] Letter
CA-4-9/8285 @ of 28.04.2018