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Denunciation of DTT with Cyprus: a farewell or an ultimatum?

05.08.2020
4 min read
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Pepeliaev Group advises that the Russian Finance Ministry has announced on its official website the launch of the unilateral denunciation of the double tax treaty with the Republic Cyprus.

According to the Ministry’s website, during negotiations on amending the double tax treaty (DTT) provisions with respect to the taxation of dividend and interest income, the parties failed to reach a compromise, as the solution offered by Cyprus is not in line with the position of the Russian Finance Ministry[1] and is an attempt to erode, to the greatest extent possible, the effect of the Russian pro-treasury initiative by means of various exceptions.

The ministry underlined that in response to the suggestions from Cyprus the Russian party presented a compromise solution and suggested holding face-to-face negotiations in Cyprus without delay, but received a negative answer.

In response to this statement, the Finance Ministry of Cyprus also published on its official website the information that the final round of negotiations is scheduled for 10-11 August and the delegation of Cyprus will be headed by the Minister of Finance, Constantinos Petrides.

Therefore, the destiny of the treaty remains uncertain until the final decision is adopted further to negotiations.

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The termination of the DTT with Cyprus will have a significant impact on the business relationships of Russian companies conducting cross-border activities. Firstly, it will result in the income from sources in Russia paid to a Cyprus company being taxed at the rate of 15% for dividends and 20% for other income.

Moreover, Russian persons will no longer benefit from the tools for eliminating double taxation that are provided for by the DTT, such as the offset of tax paid in the Republic of Cyprus.

Another benefit under threat is the possibility to apply the so-called ‘pass-through approach’ that allows a Russian person that is the beneficial owner of income to tax the income paid to Cyprus at the rate of 0% or 13%. Although since the spring of 2020 the Finance Ministry has been holding at gunpoint the rule allowing for income to be taxed at the rate of 0% within the ‘pass-through’ approachthe revision of this rule has been postponed until 2024.

Yet, if the DTT is denounced, the use of the ‘pass-through’ approach will remain at risk, as Cyprus may be included in the Federal Tax Service’s ‘black/offshore list’. According to the amendments suggested by the Russian Finance Ministry to article 312 of the Tax Code, this will directly prohibit the use of the ‘pas-through’ approach by Russian entities.

In a similar way, with the DTT being terminated and Cyprus blacklisted, the rules on controlled foreign companies ('CFCs') may also be affected, as the controlling person will no longer be eligible for part of the benefits provided for by article 25.13-1 of the Tax Code, and the expenses connected with filing reports with Russian tax authorities will considerably increase.

In view of the risk of presumed denunciation, companies whose business is connected with Russia may start to migrate from Cyprus either to Russian special administrative districts, or to other tax jurisdictions. In the event of such migration, however, companies should not forget that from 1 January 2021 the provisions of the Multilateral Instrument (MLI) will start to apply whereby every transaction (including a restructuring of holding companies) will have to be tested for business purpose (i.e., will be checked in terms of whether the main or one of the main purposes of such a transaction was to reduce the tax burden).

We note that the risk of denunciation of similar treaties with countries that have also been mentioned by the Russian Finance Ministry on a number of occasions or that raise concerns in the business community (such as Malta, Luxembourg and Netherlands) is unlikely now, as according to these treaties they may be officially denounced no later than six months before the start of the new tax period.

But then again, the denunciation statement in relation to Cyprus itself may only be a way to affect the negotiations, an ultimatum of a sort, a statement that it is unacceptable in principle to preserve the DTT in its current form or even with the amendments suggested by the Cyprus party. We believe that the treaty, albeit significantly changed, is quite likely to remain in force. The way we see it, the denunciation of the DTT with its extensive and far reaching consequences is not in the interests of either party.

What to think about and what to do

As the government agencies of the two states have not reached an agreement yet, at this point Russian companies paying out income to contracting parties in Cyprus and holding companies with membership interest in Cyprus entities are advised to analyse possible risks and consequences of the DTT with Cyprus being denounced, as well as all possible options for the reorganisation and/or restructuring of the business assets.

Help from your adviser

Pepeliaev Group will keep the clients updated on all the developments, and offers assistance with adjusting corporate structures to the changes in Russia’s tax treaties with other countries.



[1] The Ministry pronounced its position earlier in Letter No. 03-08-05/35110 dated 29 April 2020.

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