Russian Arbitration Court rules in case of first impression on beneficial ownership rules with respect to capital gains

Arbitration Court
Arbitration Court of Vladimirskaya region

(Article by: Ernst & Young.)

In January 2017 the Russian Arbitration Court of the Vladimir Province1 issued a decision on the application of the “actual right to income” (“beneficial ownership”) rules.2

The beneficial ownership rules introduced by the “deoffshorization” amendments to tax law have been in effect in Russia since 1 January 2015.

The rules prevent lower withholding tax rates provided for in Russian treaties from being applied when a foreign company receiving income acts as a conduit.

A court recently considered a situation in which the rules were applied to the taxation of capital gains.

As in a number of other recent decisions on the application of the beneficial ownership concept,3 the court came down on the side of the tax authorities. However, the case was the first time a court had considered the application of the concept in relation to capital gains.

The tax inspectorate succeeded in demonstrating that a Russian company purchasing an interest in another Russian company from a Cypriot company did not have the right to benefit from the provisions of the Russia-Cyprus tax treaty due to the fact that the Cypriot company was not the actual recipient of income from the sale. It followed that since more than 50% of the Russian company’s assets consisted of immovable property, withholding tax should have been charged at 20%. The trial court supported this conclusion.

Although the decision may still be reviewed by an appellate court, it is significant from the point of view of the development of practice in the application of the beneficial ownership rules.

Detailed discussion

In May 2011, a Russian company sold a 100% interest in the capital of its subsidiary, EnergoServis OOO, more than 50% of whose assets consisted of Russian immovable property, to the Cypriot company Mosslow Limited for 100 million rubles.

In September of the same year, Mosslow Limited resold that Russian company for 900 million rubles to Vladimirskaya Energosbytovaya Kompaniya PAO.

Following an on-site tax audit of the purchasing company, the inspectorate ordered it to pay additional withholding tax owing to its failure to fulfill tax agent obligations. The inspectorate took the view that income from the sale of the interest did not qualify for the withholding tax exemption provided for in the Russia-Cyprus tax treaty4 due to the fact that the Cypriot company did not have an actual right to the income.

The inspectorate cited the following points for its conclusion, which was supported by the court:

  • All the companies involved in the equity purchase-sale transactions are affiliated entities
  • The Cypriot company transferred the funds received as dividends to its sole shareholder, Ronix Ltd., which is registered in the BVI
  • Both equity purchase-sale transactions took place within a short period of time
  • The Cypriot company did not carry on other activities besides the receipt and transfer of the income in question
  • The Cypriot company did not have any staff or, according to its balance sheet, any assets since its incorporation (except for its participation interest in EnergoServis OOO
  • It is clear from the Cypriot company’s cash-flow reports that the transaction with the Russian company was the only income-bearing operation
  • The Cypriot company’s reports showed that it did not incur any payroll costs
  • Over the period of the Cypriot company’s existence (2009-2012) it had no tax obligations in Cyprus
  • The Cypriot company had a corporate director and secretary represented by Christabel Directors Ltd
  • The above-mentioned factors in the Cypriot company’s activities indicate the artificial (conduit) nature of the company

In defense of its position, the taxpayer asserted that:

  • The Commentaries on the Organisation for Economic Co-operation and Development Model Convention are not a source of law.
  • Russian tax law in effect during the period in which the transactions in question took place did not make it a requirement for a company to have an actual right to income in order for international treaties concluded by the Russian Federation to be applied.

The tax authorities undertook an extensive process of evidence gathering and analysis, including inquiries of the Cypriot tax authorities, reflecting the steadily growing competence of tax inspectors in the field of international taxation.

Whether the “actual right to income” concept is applicable in relation to the taxation of capital gains may be questionable.

Also it should be noted that in the present court case, as in the earlier cases, the taxpayer failed to dispute the approach that a tax agent has an obligation to examine the “actual right to income” criterion in relation to periods prior to the entry into force of the deoffshorization law.


This decision is the latest in a series of adverse rulings on the application of the “actual right to income” concept.5

In the light of this case, it is advisable for companies that pay dividends, interest, royalties and other income and apply lower rates of withholding tax:

  • To analyze existing structures and assess their susceptibility to the “actual right to income” concept
  • To gather evidence (documents, reports, transaction records) that foreign recipients of income are the actual owners of the income, so as to be in a good position to defend the application of lower withholding tax rates if questions arise during an audit
  • If necessary, to carry out restructuring in order to minimize future risk
  • To request foreign recipients of income to provide documentary confirmation of their status as the actual recipients of income. Clause 1 of Article 312 of the Tax Code now makes it a requirement for such confirmation to be obtained before income is paid


1. Decision of the Arbitration Court of the Vladimir Province of 17 January 2017 on Case No. А11-6602/2016.

2. Clauses 2 to 4 of Article 7 and clauses 1 to 1.4 of Article 312 of the Tax Code of the Russian Federation.

3. See our Alerts dated 28 March , 20 July  and 3 November 2016 .

4. Treaty between the Government of the Russian Federation and the Government of the Republic of Cyprus for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital of 5 December 1998 (as worded before 1 January 2017).

5. The TD Petelino OOO case (Ruling No. 09AP-28112/2015 of the Ninth Arbitration Appeal Court of 4 August 2015 on Case No. А40-12815/15); the MDM Bank PAO case (Ruling of the Ninth Arbitration Appeal Court of 9 February 2016 on Case No. А40-116746/15); the Bank Intesa AO case (Decision of the Moscow Arbitration Court of 3 March 2016 on Case No. А40-241361/15-115-195) and a number of other cases.

Be the first to comment

Leave a Reply

Your email address will not be published.