Vague Description of a Vague Idea

Despite the fact that the ‘beneficial owner of income’ institution was introduced into the Tax Code of the Russian Federation only in 2015, international double taxation agreements previously provided for the possibility to use the benefits of double taxation agreements (including reduced rates) only for the persons/entities:

  • Having the actual right to such income (interest, dividends, royalties);
  • Whose/which main purpose or one of the main purposes of establishment or existence was not the receipt of benefits under the agreement.

The concept of beneficial owner of income has been around for quite some time and has been successfully applied in other countries (including in Switzerland, Austria, Germany, the Netherlands, etc.). In this regard, it is impossible to blame the regulatory authorities, the courts and our legislator for ‘inventing’ something new while trying to make life difficult for taxpayers by refusing to apply benefits or preferences in some cases with the sole purpose of replenishing the budget with new taxes. As a matter of fact, they drew our attention to the method of applying preferences of tax agreements in bad time letting their foreign colleagues tread this thorny path.

In April 2018, the Federal Tax Service issued a letter making it possible to monitor the major directions of judicial practice development as well as the approach of the tax authority in forming evidentiary basis on disputes related to improper use of preferential provisions stipulated in international double taxation agreements by taxpayers and tax agents1.

Thus, taxpayers must substantiate their need to make transactions in a certain form as well as the involvement of foreign companies in the business structure and provide evidence of reasonableness of the choice made and its economic feasibility.

The companies serving only the interests of their own group and parties affiliated with it enjoy advantages of international double taxation agreements in cases where their income is not economically feasible.

In practice, new approaches have emerged both to the list of criteria indicating the company’s ‘conduity’ and to the assessment of the evidence provided by taxpayers of the fact that that the company receiving income was the actual beneficiary.

A foreign company is recognized as a technical company with signs of ‘conduity’ if:

  • The activities of the foreign company have no signs of a separate part of the business (business goal);
  • There are no operations that cause economic activity;
  • The payments are of ‘transit’ nature;
  • The activities of the foreign company are not associated with financial and other risks that are normal for business activities;
  • The company does not receive benefits from the income disposal (use);
  • The company’s employees exercise virtually no control and management functions concerning the company2.

In addition to the circumstances of creating a foreign company, analysing the available material, immaterial, labour resources, investigating cash flows from the point of view of the ‘transit’ nature of payments and exercising powers on independent management of the income received, special attention is paid to assessing the financial and economic activities of a foreign company and the nature of such activities. The lack of business activities by the foreign company is one of the signs of the technical nature of such company.

In this case, the activities carried out only in the form of investments and financing of the group (holding) companies or interdependent affiliated companies is not indicative of independent business activities.

Conclusions about the lack of independent business activities by a foreign company are also confirmed by the following circumstances:

  • The main profit of a foreign organization which is the income recipient is formed mainly by income transferred from the Russian Federation;
  • The primary activities of the company are mostly associated with redirection of income further down the chain to the founders or companies in the group;
  • The activities which are not related to receipt of dividends are not carried out;
  • The company has no significant financial, commercial risks; there are no payments characteristic of normal economic activities or the volume of operating expenses is insignificant and the company bears only administrative expenses due to formal fulfillment of requirements of the country of incorporation.

Thus, each of the evidence of a foreign organization’s activities submitted by taxpayers should indicate that the company carries out independent business activities, uses the income received to create an economic profit center in a foreign jurisdiction or to attract foreign capital to the Russian economy.

The position formed by the courts on the case of Neftservisholding, LLC3 и Auction Company ‘Soyuzpushnina’, LLC4 is noteworthy. The position of the courts comes down to the fact that the following types of income are considered insignificant:

  • Income from provision of information and consulting services,
  • Income in the form of foreign exchange gain from purchase and sale of foreign currency,
  • One-time purchase of preferred shares,
  • Ownership of shares and interest in affiliated companies.

Acquisition of shares of various companies is not recognized as confirmation of investment activities in the event that a foreign company does not participate in the activities of the acquired companies, they do not carry out any actual activities, they do not generate any income and the acquisition of shares was formal. The establishment of subsidiaries does not indicate the actual implementation of independent business activities if decisions to establish the subsidiaries are actually not made by the foreign organization. Minutes of the meeting of the board of directors are not recognized as evidence of active investment and business activities of a foreign company if they lack specific business goals and objectives related to commercial activities of this foreign company, and only general issues are specified.

Bearing of expenses by a foreign organization should also not be formal but only ensuring the registration and maintenance of the office in a foreign jurisdiction.

The case of Shakhta Polosukhinskaya, OJSC5 provides that insignificant expenses for salary payments and social benefits indicate the absence of personnel of a foreign company that could allow the company to efficiently manage its assets; provision of invoices for accounting services is also not indicative of vigorous activities due to the fact that these expenses are necessary expenses for maintaining the formal existence of the organization.

In the light of the above, all Russian companies engaged in money transactions with foreign counterparties should be prepared for close attention and audit by the inspection bodies in enjoying the benefits of tax agreements. The key points that inspection bodies pay attention to in such cases and the arguments on which they base their reasons are reflected in the court cases considered. Therefore, in order to at least somehow minimize the risks considered, we recommend studying the information on them to avoid similar mistakes.

In addition, to minimize the risks considered, it seems appropriate to adhere to the requirements necessary for recognition of the foreign company acting as the counterparty of a Russian organization as beneficial owner of income. Of course, these recommendations cannot be considered exhaustive and completely eliminating this risk. However, the implementation of such recommendations is a mandatory minimum, the absence of which will unequivocally put the mentioned operations involving foreign companies in jeopardy.

  1. Decision of the Moscow Arbitration Court dated 08.05.2015 on the case No. А40-12815/15.
  2. Decision of the Perm Territory Arbitration Court dated 31.07.2018 on the case No. А50-9233/2018.
  3. Decree of the Ural District Arbitration Court dated 16.07.2018 No. Ф09-3559/18 on the case No. А50-29761/2017.
  4. Decree of the Moscow District Arbitration Court dated 05.04.2018 No. Ф05-3523/2018 on the case No. А40-73573/2017.
  5. Decree of the West Siberian District Arbitration Court No. Ф04-2998/2018 dated 07.08.2018 on the case No. А27-27287/2016.
Anna Senchenko, LL. M.

Leading Lawyer

Tax and Legal Practice

Korpus Prava (Russia)

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