The beneficial ownership of the income

concept (“the

Concept”) is nowadays a

material aspect affecting the eligibility of the taxpayers to claim treaty

benefits.

The

Concept is defined by the OECD, however, it is not very specific leaving room

for Tax Administrations of each jurisdiction to adopt a more relax or strict

approach. In either case the Concept is a weapon to the tax authorities which enables them to attack aggressive tax planning by refusing granting treaty

benefits to the entities that are not beneficial owners of the income. The most

recent example is the new interpretation of the Russian Federal Tax Service

(“FTS”) issued on 12th of April 2018 which followed a strict approach as of the

concept.

Given

the above, clients should examine the position of their companies and take the

necessary measures to comply with the new requirements of Russian Federal Tax

Service. This should not be limited to those clients that obtain treaty

benefits from Russia but to all clients that obtain treaty benefits as the

“concept” can be found in all double tax treaties.

A.    DEFINITION

OF BENEFICIAL OWNERSHIP BY OECD

In the OECD commentary on Article 10

of the Model Convention, it is stated that the term “beneficial owner” should

not be used in the narrow technical sense but should be understood in light of

the object and purposes of the Convention, including avoiding double taxation

and the prevention of fiscal evasion and avoidance.

The Commentary also states that in the

cases of an agent, nominee, Conduit Company acting as a fiduciary or

administrator, the direct recipient of the dividend is not the “beneficial

owner” because that recipient’s right to use and enjoy the dividend is

constrained by a contractual or legal obligation to pass on the payment

received to another person. Such an obligation will normally derive from

relevant legal documents but may also be found to exist on the basis of facts

and circumstances showing that, in substance, the recipient clearly does not

have the right to use and enjoy the income.

The

Commentary stresses that the beneficial ownership concept should be

applied only in relation to passive income such as dividends, royalties

and interest.

B.    DEFINITION

OF BENEFICIAL OWNERSHIP BY RUSSIAN FEDERAL TAX SERVICE

In

an effort to interpret the meaning of actual right to use/or dispose the income

the FTS issued a letter in 2017 [1],

explaining that the beneficial owner of income can be determined through a

limited list of criteria:

Independence of directors in decision-making;

Power to dispose of the

income;

Availability of personnel,

office and related general administrative expenses;

Use of the income in

entrepreneurial activities (enjoying the economic benefits from the

income);

Absence

of any legal or actual obligations to further transfer the income,

including the systemic nature of any transitory (back-to-back) payments;

The

FTS noted that the beneficial ownership concept applies to all types of

income.

2018

In 2018, the FTS provided

further guidance [2] as to the criteria which were initially analysed in 2017 which

has now led to an increase in the requirements for a foreign entity to qualify

as the beneficial owner of the income. The new criteria for the beneficial

owner of income are can be summarised as follows:

Sufficient level of substance

The FTS guidance states that a

foreign company should be in the position to demonstrate the right to use and

dispose the income independently (as per the requirements of the 2017 letter) AND

also to demonstrate that the foreign company operates as an independent

business. If no independent business is performed then it is an indication of a

conduit company. According to the new guidance a conduit company is a company

which has the following characteristics:

Has no independent operating activity.

Absence of non-Russian Income.

Principle purpose is to redirect income to shareholders or group

entities.

The company takes minimum financial and commercial risks.

Its employees perform minimum functions.

Minimum administration costs.

No significant income other than dividends and interest from related

entities.

According to the FTS guidance,

the below do not constitute valid arguments to prove that a company

operates as an independent business:

Holding and financing activities are not considered as operational

activities.

The investing in the shares of a company without involvement in the

operations of the subsidiary do not constitute active business.

Minimal personnel cost doesn’t not evidence the employment of qualified

staff.

The only administration expenses of the company are for the compliance

with the local regulations. This is an indication that the company does not

operate independently.

Genuine business activities

This

approach focuses on the business purpose and nature of the transactions. More

specifically, in order for a company to qualify as the beneficial owner of the income,

the Russian taxpayer has to justify the need for involving a foreign company in

their business structure and operations. Further, evidence should be provided that

the involvement of the foreign company was reasonable and also to present the

associated business risks.

In

case the Russian taxpayer is unable to demonstrate the business rationale for

involving a foreign company the tax authorities have the right to deny treaty

benefits and also to reclassify the payment, for example from debt to equity.

Disclosure Requirements

The new interpretation

enforces extensive disclosure, since the burden of proof in relation to the

qualification of the beneficial ownership concept, has shifted from the Tax

Authorities to the taxpayers, since all the above-mentioned criteria necessary

to be met, should be proved and justified by the taxpayer in order to receive

the treaty benefits.

C.    CONCLUSION

The new approach mainly

focuses on attacking the holding, treasury, licensing, and intermediary group

financing companies in an effort to extinguish all the previously adopted tax

planning practice followed with the purpose of tax avoidance and tax

minimisation.

On top of this, the fact that

this is a change in interpretation rather than a formal amendment to the

Russian Tax Code, means that this approach may apply to transactions for the

past three years that are still open for tax audit.

It is evident through the years,

that the Russian Tax Authorities follow an aggressive approach. Therefore,

there is need for a more in-depth and sophisticated analysis of the existing

structures, in order to reassess the viability and the corresponding tax risks

based on the current tax developments.

Our Tax Department will be able

to prepare a diagnostic review and propose possible solutions to your structure.

D.

HOW KINANIS LLC CAN ASSIST

Kinanis LLC is in a position to assist

you with the provision of the following services:

Reviewing

your existing structures and report with suggestions on the possible risks and

possible solutions based on the new developments

Tax

Advice on possible restructuring

Assistance

in the creation of substance and relocation of personnel to Cyprus

E.

DISCLAIMER

This publication has been prepared as a

general guide and for information purposes only. It is not a substitution for

professional advice. One must not rely on it without receiving independent

advice based on the particular facts of his/her own case. No responsibility can

be accepted by the authors or the publishers for any loss.

November 2018

Authors

MARIOS PALESIS, Manager – Tax Department, [email protected], Kinanis LLC

ARTEMIS KYRIAKOY,  Tax Advisor – Tax Department, [email protected], Kinanis LLC

Our Firm

Kinanis LLC, a law and consulting firm, is one of the leading and largest business law

firms in Cyprus and advises for over 35 years the international investor and private clients on

all aspects of law, tax and accounting.

Kinanis LLC absorbed the business of its

shareholders which are in the legal and consulting profession since 1983, with

local and international dimensions.

Experience and practice over the years brought

forward the need for transformation from a traditional law firm to a more

innovative multidisciplinary firm providing a full range of services combining

law and accounting with the extensive expertise in corporate and tax advice to

ensure that our clients will obtain the best possible spherical advice adopting

the principle as to the services offered "All in one place", so that

the client will find a quick, correct and efficient solution to its daily

legal, accounting and tax issues in a trustworthy environment.

This combination of legal,

accounting and tax services through our well qualified personnel and our

involvement and participation in international transactions over the years,

have established our firm as one of the key players in the field. Our

involvement in international financial transactions has also provided us with

the extensive expertise in representing groups, corporations, funds as well as

the private client.

The

firm is staffed with around 80 young, energetic and ambitious professionals,

including lawyers, accountants and administrators who provide prompt, efficient

and high quality services and who are capable of meeting the current demanding

challenges of the local and international business environment.

We always look to give solutions in a

simple and as possible quick way focusing on the needs of each client trying to

anticipate the issues before becoming a problem.

Kinanis LLC

Lawyers’

Limited Company

12 Egypt Street, 1097, Nicosia

P.O. Box 22303, 1520 Nicosia, Cyprus

Tel: + 357 22 55 88 88 – Fax: + 357 22

66 25 00

E-mail: [email protected]

– Web site: www.kinanis.com

KINANIS is the service mark through

which Kinanis LLC of Cyprus, Kinanis Fiduciaries Limited of Malta and their

affiliated companies are conducting business each of which is a separate legal

entity.

[1] Letter

СА-4-7/9270@ of 17.05.2017

[2] Letter

CA-4-9/8285 @ of 28.04.2018