Recently the Russian Supreme Court agreed with the recognition of the loan as a capital contribution for the purposes of application of thin capitalization rules and calculation of the Russian withholding tax to interests reclassified to dividends. (paragraph 14 of the Review of the practice of courts considering cases involving application of certain provisions of Section V.1 and Article 269 of the Tax Code of the Russian Federation of 16/02/2012). In that dispute, the loan was received from a foreign parent company.
Now the Russian Supreme Court has developed its own view on this issue, and considered loans from foreign companies that do not have direct participation in the capital of Russian borrowers, as investments in capital.
- Definition of the Russian Supreme Court dated March 6, 2018 No 304-KG17-8961 (case No A27-25564 / 2015)
The Russian company received a loan from a Cypriot company that has indirect participation in the Russian company's capital through another Russian company (a foreign grandmother). The company deducted interest accrued under the loan for the Russian profits tax purposes.
The Russian tax authorities applied thin capitalization rules, challenged the deduction of a part of interest and additionally charged withholding tax at the rate of 10% according to the provisions of the Russia-Cyprus DTT. As part of the claim, the company insisted on applying a reduced rate of 5%.
During the court hearings, courts of all three instances supported the position of the tax authorities, pointing out that there were no grounds for applying a reduced 5% withholding tax rate since the Cypriot creditor does not have a "direct investment" in the company's capital.
- Definition of the Russian Supreme Court dated April 5, 2018 No 305-KG17-20231 (case No A40-176513 / 2016)
The Russian borrower attracted a loan from an Austrian sister company. As in the previous case, the tax authorities applied thin capitalization rules, challenged the deduction of accrued interest for tax purposes and charged additional withholding tax at the rate of 15% in accordance with the provisions of the Russia-Austria DTT.
Similar to the previous case, the courts of all three instances supported the position of the tax authorities, citing the fact that the taxpayer had no grounds for applying a reduced withholding tax rate, since the foreign lender (sister company) did not fulfill the criterion of direct participation in the capital of the Russian company.
The position of the Russian Supreme Court in both cases indicates that, the absence between a borrower and a lender of registered shareholder relations can not be grounds for depriving a foreign person of the right to apply a reduced withholding tax rate on dividends established for persons who made direct investments in the capital of a Russian companies in a certain amount.
Both cases were forwarded by the Russian Supreme Court for a new consideration, pointing out that the right to apply a reduced withholding tax rate depends not only on the amount of capital invested, but also on the carrying out of the said investment by a person who has an actual right to such income in the form of dividends. In this regard, it seems that the issue of beneficial ownership will be a key aspect in the new proceedings of these cases.
We will keep you posted on any developments of court practice on this topic.