Dear Reader


No not love, but a warning. In what many will regard as somewhat ironic, Russia is adopting the concept of transparency in international business structures implying openness, communication and accountability relating to cross border transactions. The Ministry of Finance on 9 April 2014 issued a letter No. 03-00-RZ/16236 with the official clarification of what constitutes the beneficial ownership (or “actual recipient of income”) for the purposes of application of double tax treaties under Russian law (we would like to thank Nadezhda Marchenko of KPMG, Russia for providing us with the English translation of the letter). The letter can be viewed as the most complete compilation and systematisation of approaches of Russian tax authorities to determining beneficial ownership before the introduction of the relevant concept in Russian tax legislation provisionally by the end of Q2 2014.

For example, tax-deductible royalties payable by a Russian licensee to a foreign licensor are taxed at 20%. Under the double tax treaty with Cyprus the withholding tax is reduced to nil and the royalties are only liable to tax in the hands of the licensor. If the Cyprus based sub-licensor then pays the royalties to the head licensor resident in, say, the British Virgin Islands, only a small margin of the royalty income will be subject to tax in Cyprus, while the Russian licensee will have its taxable income substantially reduced.

Certainly, one of the functions of a double tax treaty is to encourage international trade by exempting from tax trading profits which are not created through a local permanent establishment, and minimising withholding tax on passive income such as dividends, interest and royalties. However, another function is to prevent fiscal evasion (indeed this phrase is included in the title of most Conventions). Thus, most modern treaties contain the requirement that residents of contracting States must “beneficially own” dividends, interest or royalties in order to qualify for the reduction or elimination of source jurisdiction withholding tax on those payments.

The above example of the BVI-Cyprus-Russia arrangement may be viewed as a ‘misuse’ of treaties where a person acts through an entity created in another State with the main or sole purpose of obtaining treaty benefits which would not be available directly to such a person. The Letter therefore attempts to address this issue by stating:

* The term “actual recipient (beneficial owner) of income” should not be used in a narrow technical sense, but rather it should be understood in the context and in light of the main principles of the treaties, including the prevention of misuse of provisions of the treaty and substance-over-form concept.

* In order to be recognised as the actual recipient (beneficial owner) of income the entity should not only have the legal right to such income, but should also be an immediate recipient of benefits. This means that the entity should actually benefit from the income received and determine the subsequent economic fate of such income.

* One should also consider the functions performed and the risks undertaken by a foreign legal entity upon determination whether it can be treated as an actual recipient (beneficial owner) of income.

* The favourable provisions of the treaties should not apply if the income received under the transaction (or several transactions) according to which the foreign entity claiming the application of the reduced tax rates on passive income pays directly or indirectly all or nearly all of such income (at any time and in any form) to another entity which would not have the right to apply favourable provisions of treaties in case such income was paid directly to that entity (conduit transactions).

The Letter also provides examples of the most common conduit transactions, such as explained above, and it remains to be seen how the Russian tax authorities will apply the recommendations contained in the Letter.

What is clear is that the Letter parallels many of the recommendations in the OECD Commentaries and the findings of international courts. According to the Commentaries the term “beneficial owner” should not be used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. An agent or nominee who is merely passing the income to the ultimate beneficiary and is not its true owner should be denied the beneficial owner status. Further, an example is made of a conduit company, which although the formal owner of the income, in practice has very narrow powers to dispose of it.

The most recent judgement, in which an international court aimed to establish whether the recipient of the income was its beneficial owner entitled to treaty benefits, is the Canadian case Velcro Canada (Case 2012 TCC 57). The judgement can serve as a useful guidance to the steps that a taxpayer should take to satisfy the beneficial ownership requirements. It concerned the payment of royalties by a Canadian licensee to a Dutch licensor which further paid almost 90% of the royalties to the head licensor resident in the Netherlands Antilles. The Canadian tax authorities questioned the beneficial owner status of the Dutch company which received the royalties virtually free of Canadian withholding tax in accordance with the provisions of the Canadian–Dutch double tax treaty.

In arriving at its decision, the court identified four elements to consider in determining where beneficial ownership lies: possession, use, risk, and control. The court also stated that the corporate veil is not to be pierced unless the corporation has “absolutely no discretion” with regard to the use of the funds. Ultimately the following factors weighed in favour of the Dutch company (and not the Netherlands Antilles head-licensor) being found the beneficial owner of the royalties:

* the Dutch company (and not the Netherlands Antilles company) had the legal right to receive the royalties from the taxpayer;

* the funds paid as royalties were deposited in an account over which the Dutch company had exclusive possession and control;

* such funds were comingled with other monies in its accounts; the Dutch company converted the funds from Canadian to US dollars to pay the Netherlands Antilles company exposing itself to currency risk;

* the money earned interest belonging to the Dutch company;

* the Dutch company did not have to seek instructions in dealing with the funds; and

* the amount of the royalty payments received from the Canadian taxpayer differed from the amount paid by the Dutch Company to Netherlands Antilles company.

Overall, on the basis of these factors the court concluded that the Dutch company had some discretion with respect to the use of the royalties and it was not a mere conduit of the Netherlands Antilles company.

The London branch of the IBSA is holding its first Discussion Group on the topic of Transparency in International Business Structures in the Old Court Room, Lincoln’s Inn at 5.30 pm next Thursday, 15th May – all IBSA Members are invited to join the Discussion Group without charge (details can be found on the IBSA website at (click here). Beneficial Ownership will not be the only topic of discussion: transfer pricing and other issues involving the need for openness, communication and accountability will also be considered.

And on the subject of accountability, the IBSA Conference on 3rd June at the Mandarin Oriental Hyde Park hotel, London, will address the OECD recommendations of how the digital economy will change the basis of the source of profits generated by international companies. IBSA Members and non-Members are invited to attend this day long conference (click here) where the keynote speaker is Raffaele Russo, Head of the BEPS Project of the OECD.

With our best wishes

Roy Saunders & Dmitry Zapol

Roy Saunders, Chairman, IFS and IBSA. IBSA is the network for international business advisors and their clients, bringing together specialist advisors to enable businesses to optimise the structure of their international operation by enhancing resilience in tax planning, mitigating regulatory and market risk and enabling sustainable multi-jurisdiction growth.

Roy Saunders created International Fiscal Services in 1971 which is a niche international tax boutique at 44 Southampton Buildings, London, WC2A 1AP. Website: (click here) Email: (click here)