Russia challenges beneficial ownership Cypriot holding company

Recently the Arbitrage Court of Appeal of Moscow issued a decision (Decision No. А40-66788/18, March 4, 2019) on the Russian requirements for beneficial ownership of dividends for foreign companies. The question concerned was if dividends paid by a Russian company to its parent company, based in Cyprus, qualify for the partial exemption of withholding tax of 5% provided under article 10(2) of the DTAA Cyprus - Russia.

In order to answer this question the court had to consider the role of the Cypriot parent company and in particular whether it is perceived as the beneficial owner of the shares in the Russian company as well as the corresponding dividends. In determining the beneficial ownership of the Cypriot parent company the court set criteria to establish whether a foreign company is the beneficial owner of Russian-sourced income. The criteria in this case comprise the following:

• The parent company has a permanent location and a real economic presence in Cyprus (it had seven employees and incurred substantial costs for the rent of office space, accounting and auditing services);
• The parent company was engaged in managing foreign investments in several subsidiaries in different countries and controlling the results;
• The parent company received dividends resulting from its investments;
• The parent company makes use of the income in entrepreneurial activities (it enjoyed the economic benefits from the income);
• The parent company had sufficient own capital, and also invested part of the income received in acquiring other investments.

Based on the above the court decided that the Cypriot parent company in the present case was the beneficial owner of the dividends received. According to the court the Cypriot holding company was not a mere intermediary because it was able to independently determine the economic fate of the received dividends.

Despite the fact that this decision relates to beneficial ownership of Russian-sourced income, it clearly provides points of reference which criteria, from a beneficial ownership perspective, should be taken into consideration when determining taxpayer’s entitlement to benefits under a double tax treaty from the perspective of Russia.

Comparison Cypriot structure Russian case vs. the February 26, 2019 (C-117/16) CJEU decision

Recently the CJEU considered a similar issue in respect of withholding tax on dividend distributions from a Danish company to its Cypriot parent company (C-117/16). In this case the CJEU found that the Cypriot parent company acted as a mere intermediary and was not the beneficial owner of the dividends received.

The CJEU denied the assumption of real economic presence in Cyprus. The activities of the Cypriot parent company (corporate and treasury management), the lack of personnel and the limited expenses (directors fee of appr. € 1.000) were not considered sufficient for assuming an economic nexus. Hence, the Cypriot company was not entitled to the benefits of the EC Parent-Subsidiary Directive.

Observing the significant differences in terms of Cypriot substance (for instance no personnel vs. seven employees) between the CJEU case and the Russian Arbitrage Court of Appeal the decision seems reasonable. In this respect it is noteworthy that the Russian Tax Authorities challenged the beneficial ownership of a Cypriot holding company that employed seven employees and incurred substantial costs for the rent of office space, accounting and auditing services.

Some takeaways

MNE’s that hold subsidiaries in Russia with intermediate holding companies for instance in Luxembourg, Cyprus or the Netherlands should monitor these developments. In respect of the Netherlands we note that article 10(2) of the DTAA Netherlands – Russia states that 5% dividend withholding tax can be withheld from the beneficial owner of the dividends if it is a company which holds (among other requirements) 25% of the capital of the company paying the dividends. The beneficial ownership clause in article 10(2) of the DTAA Netherlands – Russia is in principle comparable to the beneficial ownership clause in the DTAA Russia – Cyprus.

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