CY-Russia - Thin Cap Rules

The Russian courts issued a decision on 6 March 2018 (case OJSC SUEK-Kuzbass) on the application of the Double Tax Treaty between Cyprus and Russia of 1998 as amended in 2010 (the ‘DTT’). Based on the decision interest expense was considered as non-tax deductible in accordance with the Russian thin capitalization rules.

  • The case: The Court ruled on the Withholding Tax (WHT) rate which should be applied to interest payment by a Russian company to a Cyprus company. The interest was considered as excessive (thus non-deductible for tax purposes) based on the Russian thin capitalization rules (i.e. the excessive interest payment was considered as deemed dividend payment).
     
  • The taxpayer’s position: the WHT rate of 5% (applicable for dividends) must be applied in line with article 10 (2a) of the double tax treaty (DTT) when the beneficial owner directly invests in the equity capital at least EUR 100.000 or its equivalent in Rubles.

    The Russian company applied the 5% rate to the interest payment since it considered the loan provided by the Cyprus company, which exceeded EUR100.000, as a direct investment to its capital.

    The taxpayer based its position on the Commentaries to article 10 of the OECD Model Tax Convention of 2014 (the ‘OECD Model Treaty’), which states that when income derived from a loan is treated as dividends (deemed dividends), such loan must be treated as capital for WHT purposes.
     
  • Position of the lower court: the position of the taxpayer was not supported. The position of the lower court was based on the Memorandum to the DTT, which defines direct investment to the equity capital as the acquisition of shares under initial or subsequent emissions or the acquisition of shares via the open market or from the previous owner.
     
  • Position of the Supreme Court: the Court ruled in favour of the taxpayer, agreeing with the argument of reliance on the Commentaries to the OECD Model Treaty. According to the Court, the fact that the Cyprus company is not a shareholder of the Russian company under company law is irrelevant.

    It further noted that the WHT rate under the DTT may be applied only if the beneficial owner requirement is met.

The case was returned for second review to the Court of First Instance.

Contacts:

Marios Hadjihannas, Tax Partner

E-mail: [email protected]

Chrysanthos Fotiadis, Tax Manager

E-mail: [email protected]