The development of the business after the change of DTAA with Cyprus

With the development of the economy, globalization, and technological changes, taxation in transactions involving foreign organizations is becoming increasingly important for large, multinational Russian companies. The existing system of tax agreements for the Double Taxation Avoidance Agreement (DTAA) allows Russian businesses to attract new investments, find business partners, and reduce the tax burden. But not all companies use DTAA for legitimate purposes, abusing tax schemes for tax evasion and withdrawal of funds to offshore zones.

Currently, Russia has signed tax agreements with more than 80 countries. Cyprus is considered one of the most attractive countries for business development. Interest in this economic zone is primarily due to the relatively low income tax rate of 12.5 % and the dividend rate of 5 %.

At the moment, this topic is relevant, due to the fact that Russia and Cyprus signed a Protocol to amend the Double Taxation Avoidance Agreement (Government decree No. 2229-R of 02.09.2020). According to the amendments, the tax at the source of payment of dividends and interest is increased to 15 percent. If the Protocol is ratified before the end of the year, the amendments will start working from January 1, 2021.

What decisions will Russian companies with structures in low-tax jurisdictions make in connection with the increase in the tax rate? Let's look at some options:

1. To remain in the jurisdiction of Cyprus;

2. Move to another low-tax jurisdiction;

3. Return the business to special administrative regions in the Russian Federation.

Let's look at each option in more detail.

The Protocol on amendments Double Taxation Avoidance Agreement of the Russian Federation and Cyprus established an increase in the withholding tax rate to 15% for both dividends and interest. Companies will be able to continue their activities, and also at a preferential rate, if they fall under the following categories:

• the company's shares are listed on a registered stock exchange, i.e. it is a public company;
• at least 15% of the company's shares are in free circulation;
• the company holds at least 15% of the capital of a subsidiary that pays dividends or interest for at least 365 days prior to the date of payment.
• Insurance institutions and pension funds;
• Government and local authorities;
• Central bank.

The rates for these parameters are equal to 5% for both dividends and interest.

Exemption from taxation of interest paid from the Russian Federation to Cyprus occurs if the interest is paid:

• in favor of the FPA, which is a Bank, insurance company or pension Fund, Central Bank, Government or its division;
• for outstanding bonds.

The reduced rate is undoubtedly a plus for companies using the DTAA, but the right to use this benefit must be proved, which is not an easy task.

It is necessary to prove that the organization does not just transfer money to offshore companies, but manages its income and bears the corresponding risks.

If the tax authority refuses to apply the benefits, the company's presence in Cyprus may become unnecessarily expensive, which will lead to large expenses.

Another option is to move to another jurisdiction with which the Russian Federation has entered into a tax agreement with preferential rates in the order of redomicilation. But the Cyprus company will have to pay exit tax, which is effective from January 1, 2020.

According to the amendments, Cyprus corporate taxpayers are required to pay income tax in Cyprus for the amount equal to the difference between the market value of the asset at the time of its withdrawal from Cyprus and the tax value of the asset.

This method is quite expensive, but obvious for those payers who have already successfully confirmed to the Russian tax authorities, based on the results of inspections or pre-verification analysis, that companies that pay interest and dividends are not transit layers.

Do not forget about the business goal, moving only out of a desire to save on tax rates at the source will cause questions from the Russian tax authorities and lead to a dispute with them. In addition, there are not many tax-friendly jurisdictions, and Russia is actively negotiating with all of them to change international agreements (Malta, the Netherlands, Luxembourg, etc.)

And option 3 is the transfer of a Cyprus company to a Russian offshore company, to special administrative regions (SAR): Russky island in Vladivostok and Oktyabrsky island in Kaliningrad. Residents of the SAR will be able to apply a rate of 5 percent when paying dividends to foreign companies and individuals until 2029. To do this, a resident of the SAR must:

• have the status of a public international holding company;
• established before 01.01.2018;
• controlling persons of the future MC were controlling persons of a foreign company until 01.01.2017;
• make investments in the territory of the Russian Federation in the amount of at least 50 million rubles within six months.

But we must take into account the risks that may arise in the framework of foreign economic activity. For example, sanctions may be imposed against residents of the SAR.

Summing up, we can say that after the agreement is denounced, it will be unprofitable for Russian holdings to structure a chain of legal entities through Cyprus. A more attractive option is to return to the Russian jurisdiction.

Companies need to use tax planning to assess all possible risks and make the right decision to minimize losses and further develop the company.