Unlimited Deduction of Expenses in Russia

8/14/2019 Unlimited Deduction of Expenses in Russia

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SEVERALRECENTCOURTRULINGSMAY INDICATEA

NEW TREND IN COURT PRACTICE THAT ENVISAGES

OPPORTUNITIESFORTHEUNLIMITEDDEDUCTIBILITY

OFINTERESTONLOANSFORCORPORATEPROFITTAX

PURPOSES, BASEDON DOUBLE TAX TREATIESWITHA

NON-DISCRIMINATIONCLAUSE.

16 November 2009

The law firm Pepeliaev, Goltsblat & Partners hereby informs you that recently

two second highest Russian courts have issued court decisions that enabled

Russian companies with foreign participation to deduct interest expense in

excess of limitation imposed by Russian thin cap rules. The court decisions

were based on the provisions of Double Tax Treaties containing a

non-discrimination clause.

1. Russian Double Tax Treaties with some countries (for example with Germany and the Nether-

lands) contain special clauses on the unlimited deductibility of expenses, for example interest,

when determining the tax base of Russian subsidiaries controlled by German or Dutch residents, re-

spectively. On several occasions the courts confirmed the unlimited deductibility of these expenses.

These are in particular the following cases: Resolution of the Federal Arbitration Court for the Mos-

cow District No. KA- F40/6616-05, dated 25 July 2005, on the case involving Ferrotek, Resolution

of the Federal Arbitration Court for the North Western District No. A56-19578/2006, dated 9 April

2007, on the case involving Swedwood Tikhvin, Resolution of the Federal Arbitration Court for the

Moscow District No. KA-F40/4279-08-P, dated 26 May 2008, on the case involving J.T.I., sup-ported by Ruling No. 14163/05 of the Supreme Arbitration Court of the Russian Federation, dated 6

October 2008.

When issuing these decisions, the courts were governed primarily by the fact that the Protocols to

specific Treaties (with Germany and the Netherlands) directly stipulate the ability for unlimited de-

ductibility of interest for corporate profit tax purposes. Accordingly, Russian thin capitalisation rules

are not applicable, as they contradict the provisions of the international treaty, which has greater le-

gal force than the provisions of the Tax Code of the Russian Federation (hereinafter the Tax

Code). Moreover, an additional argument was used in the Resolutions on the cases of Ferrotek and

Swedwood Tikhvin: application of Russian thin capitalisation rules violates the relevant provisions

of Treaties on the non-discrimination of Russian companies controlled by foreign shareholders com-

pared to Russian companies controlled by other Russian companies. It should also be noted, how-

ever, that the argument on non-discrimination was not the major argument in these court decisions.


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A taxpayer also sought to apply the provisions on non-discrimination under the Double Tax Treaty

between Russia and the USA in another court dispute in order to limit the applicability of Russian

thin capitalisation rules. In this case, however, the Moscow Arbitration Court in its decision on caseNo. A40-33678/06-117-246 involving CPC-R (Caspian Pipeline Consortium), dated 22 September

2006, deemed that the taxpayers position was unsubstantiated and ruled in favour of the tax au-

thority.

2. However, on 23 September 2009 the Federal Arbitration Courts of two districts (Moscow and

North Western District) issued similar decisions on the permissibility of the unlimited deduction of

interest in respect of Double Tax Treaties with two countries (Cyprus and Finland), where full de-

ductibility of interest has NOTbeen directly stipulated. In these cases the application of provisions

on non-discrimination served as the fundamental argument.

For example, in Resolution of the Federal Arbitration Court for the Moscow District No. KA-

A40/9453-09-2, dated 23 September 2009, on the case involving Field Invest the court applied theprovisions of clauses 3 and 4 of article 24 of the Double Tax Treaty with Cyprus. According to these

provisions, firstly, the income payable by a Russian company to a company registered in Cyprus for

the purpose of determining the taxable profit of the Russian company should, as a rule, be deducted

on the same terms as if this income had been paid to another Russian company. Secondly, Russian

companies, whose capital is fully or partially, directly or indirectly owned by one or several Cypriot

companies, should not be subject to a different tax regime or more onerous taxation in Russia than

the tax regime that is or may be applied to other similar Russian companies. As clause 2 of article

269 of the Tax Code is only applied to Russian companies with direct or indirect foreign participa-

tion, the court reached the following conclusion: Therefore,taking into account the provisions of

said Treaty, interest payable under the loan agreement with the foreign company EVA INVEST-

MENTS SERVICE LTD,registered in the Republic of Cyprus, is deductible for corporate profit tax

purposes in accordance with Russian legislation on taxes and levies clause 1, article 269 of the

Tax Code.

The courts were justified in their decisions to dismiss the reference of the tax authority to clause 1,

article 9 of the Treaty, as evidence that terms had been established that differed from the terms

that could have existed between unrelated parties, which could have been used by the company to

reduce taxable income, was not presented by the tax authorities and the tax inspectorates have

not referred to the existence of such evidence and facts.

In the Resolution of the Federal Arbitration Court for the North Western District No. 26-

6967/2008, dated 23 September 2009, on the case involving AEK the court referred to similar provi-

sions of clause 4, article 23 of the Double Tax Treaty with Finland regarding non-discrimination and

concluded that proceeding from systematic analysis of the relevant provisions and taking into ac-

count the priority of the rules of international treaties over legislative acts of the Russian Federation

on taxes and levies, the courts established thatthe Treaty established other rules in respect of the

taxation of interest on debt instruments that differ from the rules specified in the legislative acts of

the Russian Federation.

3. In addition to the provisions on non-discrimination in the decision on AEKs case, the court

used a third argument regarding the inapplicability of thin capitalisation rules to the taxation of inter-

est exceeding established limits as dividends. This argument is based on the fact that Double Tax

Treaties may establish specific definitions of such types of income as dividends or interest, which

may differ from the definition of the relevant terms stipulated by Russian legislation. In the opinion


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CONTACT INFORMATION

Sergey Sosnovsky

Head of Tax Practice, St. Petersburg

Pepeliaev, Goltsblat & Partners

Tel.: (495) 967-00-07

Fax: (495) 967-00-08

[email protected]

Andrey Tereschenko

PartnerPepeliaev, Goltsblat & Partners

Tel.: (495) 967-00-07

Fax: (495) 967-00-08

[email protected]

Alexey Markov

Junior attorney


Tel.: (495) 967-00-07

Fax: (495) 967-00-08

[email protected]

Roustam Vakhitov

Senior tax managerof the Group for

International Taxation


Tel.: (495) 967-00-07

Fax: (495) 967-00-08

[email protected]

of the courts, interest paid by the Company under the loan agreement to the foreign legal entity,

which is a resident of Finland, complies with the definition of interest cited in article 11 of the

Treaty. The tax authorities mistakenly followed the presumption that interest under the loan agree-

ment may be classified as dividends in accordance with the provisions of the Treaty.

It could be asserted that the court also used this argument indirectly, in a reference to the definition

of interest, in the case involving Field Invest based on the Double Tax Treaty with Cyprus. How-

ever, with respect to Cyprus, it should be borne in mind that the Protocol to the Treaty with Cyprus

initialled on 16 April 2009 stipulates amendments to the definitions of dividends and interest. There-

fore, if the Protocol is signed, ratified and enters into force, interest reclassified as dividends, in par-

ticular as a result of the application of Russian thin capitalisation rules, will comply with the defini-

tion of dividends specified by this Treaty.

4. Notwithstanding the importance of the above decisions, please note that it might be premature

to state that the Russian courts have a well-established opinion on the inapplicability of Russian thin

capitalisation rules to the Russian subsidiaries of residents of countries with which Russia has con-

cluded Double Tax Treaties that contain a provision on the non-discrimination of such subsidiaries,

until the Supreme Arbitration Court has decided on this issue.

At the same time, all the aforementioned decisions noted that the tax authorities had failed to prove

the existence of the terms of transactions that differed from the terms of transactions existing be-

tween unrelated parties. It is clear that if there is evidence that such deviating terms exist, the likeli-

hood of a ruling in favour of the taxpayer will diminish.

At the same time, however, the decisions analysed above indicate that it might be possible to deduct

interest in full amount in certain cases even if such full deduction is not directly stipulated by the

relevant Double Tax Treaty. Therefore, careful analysis of the specific situation of the taxpayer may

disclose that it is possible to fully deduct interest in cases where the taxpayer had not initially

planned to fully deduct such interest.

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Zdorovets at [email protected]

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Unlimited Deduction of Expenses in Russia