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Cyprus - Russia Double Tax Treaty – Court decision for thin capitalization rules

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Cyprus - Russia Double Tax Treaty – Court decision for thin capitalization rules

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The Russian Supreme Court (the ‘Court’) issued a decision on 6 March 2018 for to the case OJSC SUEK-Kuzbass, related to the application of the Double Tax Treaty between Cyprus and Russia of 1998 as amended in 2010 (the ‘DTT’).

The decision related specifically to the treatment of interest considered as non-tax deductible (and thus considered as deemed dividend) based on thin capitalization rules in Russia.

In particular, the Court ruled on the rate of Withholding Tax (WHT) which should be applied to interest paid by a Russian company to a Cyprus company, taking in to account that such interest was considered as excessive, and thus non-deductible for tax purposes, based on Russian thin capitalisation rules.

The taxpayer’s position was that the WHT rate applicable for dividends based on the DTT, amounting to 5% when the beneficial owner directly invests in the equity capital at least EUR 100,000 or its equivalent in roubles, should be applied. The Russian company applied the 5% rate to the interest payment since it considered the loan provided by the Cyprus company, which exceeded EUR100,000, as a direct investment to its capital. The taxpayer based its position on the Commentaries to article 10 of the OECD Model Tax Convention of 2014 (the ‘OECD Model Treaty’), which states that when income derived from a loan is treated as dividends (deemed dividends), then the loan must be treated as capital and not as a liability for WHT purposes.

The lower courts of the Russian Federation did not support the taxpayer's position, basing their position to the provisions of the Memorandum to the DTT, which defines direct investment to the equity capital as the acquisition of shares under initial or subsequent emissions or the acquisition of shares via the open market or from the previous owner.

However, the Court ruled in favour of the taxpayer, agreeing with the argument of reliance on the Commentaries to the OECD Model Treaty. The Court added that the fact that the Cyprus company is not a shareholder of the Russian company under company law is irrelevant. It further noted that the WHT rate under the DTT may be applied only if the beneficial owner requirement is met.

The case was returned for second review to the Court of First Instance.

Article supplied by the Fiducenter

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