On the 8th of September 2020, the Republic of Cyprus and the Russian Federation signed a protocol amending the Double Tax Treaty (“DTT”) between the two states. The revised DTT becomes effective from the 1st of January 2021.
In April 2020, the Russian Federation initiated negotiations to review the minimum withholding tax (“WHT”) rates applicable within the DTT. The newly agreed protocol (the “2020 Protocol”) is the result of these discussions. Russia has sent similar proposals to amend its double tax treaties with other countries such as Malta, Luxembourg and the Netherlands. Importantly, the negotiations with Cyprus are the first to have been successfully concluded.
In fact, Cyprus and Russia have a history of cooperation on fiscal matters. Both countries first signed a protocol amending the DTT in 2010 (the “2010 Protocol”). The 2010 Protocol was key to an effort made by the Cyprus Government to be excluded from Russia's blacklist of "Offshore Jurisdictions". It made important amendments to 10 existing articles and introduced a new one (Limitation of Benefits of the DTT), which proved very advantageous for business activities between Russia and Cyprus. The key changes made were aimed at aligning the DTT with OECD standards ensuring that existing and new structures in Cyprus display and conform with the well-known and globally accepted “substance” requirements. Specifically, the definitions of “dividend” and “interest” were revised according to the OECD Model Treaty and the definition of “permanent establishment” was aligned. The 2010 Protocol also improved the exchange of information between the two states and enabled tax authorities from either jurisdiction to deny any benefits arising from the DTT if it were determined that one of the main purposes of a company utilizing the DTT was to obtain a tax advantage.
The 2020 Protocol is mainly characterized by an increase in the WHT rate for outbound dividend and interest payments. The rest of the DTT remains much the same and the amendments do not relate to highly sensitive matters such as tax residency requirements or those pertaining to permanent establishment (headquartering related matters), which were satisfactorily dealt with under the 2010 Protocol.
From 1 January 2021, dividends paid to beneficial owners resident in the other contracting state will be taxed at no more than 15 percent of the gross amount. The rate previously applicable being 5 percent or 10 percent (the latter subject to conditions).
The increase will not be uniformly applied. The previous rate of 5 percent will still be applicable if the beneficial owner is an insurance undertaking, a pension fund, a government entity, or a Central Bank of one of the contracting states.
The 5 percent rate will also continue to apply to companies with shares listed on a registered stock exchange and which meet the following criteria:
- No less than 15 percent of their voting shares must be in free float; and
- They must hold a minimum of 15 percent of the capital of the company paying the dividends for a period of 365 days including the day of payment.
In addition to the increase in WHT for dividend payments, the 2020 Protocol introduces a higher WHT on interest. From 1 January 2021, interest payments made to beneficial owners of the other contracting state will be subject to a WHT rate not exceeding 15 percent.
Similar exemptions that apply to dividend payments will also apply to interest (see above). The 5 percent WHT rate will thus be applicable to insurance institutions, pension funds, specific governmental bodies, and banks. Additionally, certain securities traded on registered stock exchanges will be exempt. The following securities will be taxed at the lower 5 percent rate:
- Corporate bonds;
- Government bonds; and
Agreement on a new protocol is good news for both Cyprus and Russia considering that a termination of the DTT would have had adverse effects in both contracting states. Additionally, whilst the 2020 Protocol does increase WHT rates, it also contains several positive features.
Significant positives include the various exemptions provided for within the text. The most noteworthy being the exemption granted to corporate bonds, the exemption towards various regulated entities, and the continued zero percent WHT rate for royalty payments. It is possible that these may act as a springboard for corporate bond issuers, the Cyprus Stock Exchange, and the new Cyprus IP Regime, respectively.
Furthermore, it should be noted that while foreign tax credit will not be applicable in relation to dividend income because such income is not subject to tax in Cyprus, it may apply to interest payments received by a Cypriot company from a Russian based entity, since interest income is subject to tax.
Despite the different exemptions, the key benefit behind the 2020 Protocol is the certainty it provides. In this regard, Cyprus has effectively obtained a first-mover advantage compared to other jurisdictions. In a time defined by Covid-19 and volatility this is to be welcomed. It is considered that businesses will not be able to “shop around” for jurisdictions with pre 2020 Protocol benefits since Russia is seeking to implement similar amendments to its DTTs with other contracting states. Russia has also expressed a willingness to end DTTs where the other contracting state will not agree to the new WHT rates.
The existence of a DTT with Russia is just one of the factors influencing the decision of companies to base themselves in Cyprus. Besides the abovementioned benefits, Cyprus provides a litany of other advantages including, among others, convenient EMEA access and time zone, low corporate tax, an English common law background, a high degree of asset protection, employment income related incentives for employees relocating to Cyprus, a new IP regime that can be combined in a compelling manner with the zero percent WHT rate on royalties, and low operational costs.
Quite importantly, the decision to satisfy the conditions for participation in the Cyprus tax system should not, in any event, be a purely tax driven exercise. Cyprus was among the first jurisdictions to ratify the MLI and to adopt its minimum standards (Action 6 - clarifying the purpose of its existing DTTs, Action 7 – adopting a general anti-abuse rule based on the principal purpose test (“PPT”), and Action 14 - making dispute resolution mechanisms more effective). Considerations such as the particulars of each investment project, type of company, thresholds on investment amounts, sectors oriented as well as conditions and exemptions are among many of the considerations that a taxpayer or business entity should address before embarking upon any transaction or investment.
Nevertheless, countries are compelled to analyse their tax systems with a view to adjust their fiscal environment for foreign investment. Cyprus, in conjunction to ensuring proper legal and regulatory standards, has positioned itself as a global strategic partner for multi-nationals and other entities, which are looking for a strategy that places no reliance on any specific country.
Businesses in Cyprus that will be subject to the 2020 Protocol are advised to review their corporate structures and assess what impact, if any, the DTT changes will have on their overall effective tax exposure. Any potential reorganization should properly adhere to corporate governance and the arm's length principle.
Originally published by IFLR1000.
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