The Russian President and the Japanese Prime Minister signed the Convention for the Elimination of Double Taxation with respect to Taxes on Income and the Prevention of Tax Evasion and Avoidance (the “Convention”) on 7 September 2017. The Convention will replace the existing treaty signed in 1986 by the Soviet Union and Japan. The Convention will become legally binding after its ratification by both countries. It is expected to go into force on 1 January 2018.
The signing of the new Convention was necessitated by the changes in the countries’ national legislation, as well as the improvement of the rules of international taxation in the framework of the Action Plan on Base Erosion and Profit Shifting (the BEPS Plan).
The Convention’s provisions are based on the OECD Model Tax Convention of 2014. They take into account the minimum standard of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. Russia joined the Multilateral Convention this summer 2017.
The wording of the preamble of the Convention states that governments, while eliminating double taxation, do not intend to create opportunities for non-taxation, reduced taxation through tax evasion or avoidance. All the provisions of the Convention must be interpreted in accordance with this objective.
Also, the new version of the Convention introduces changes to permanent establishments, limitation on benefits, exchange of information, mutual agreement procedure and legalisation requirements.
The Convention has expanded the list of cases where the activity of an enterprise is not recognised as preparatory and auxiliary, and leads to the emergence of a permanent establishment: business activities that are carried on by two enterprises at the same place or by the same enterprise or closely related enterprises at two places, where such activities represent complementary functions that are part of a cohesive business operation, form a permanent representative office.
In addition, the Convention has also expanded the list of cases where the activity of an agent leads to the formation of a permanent establishment. An agent is not independent if it acts solely or almost exclusively on behalf of a closely related enterprise. In this case, the persons/entities are considered closely related when one directly or indirectly holds more than a 50% interest in the other.
Limitation on benefits
The Convention includes extensive provisions on the limitation on benefits, which are aimed at effectively combating its abuses, as well as making the applicable tax regime more predictable to taxpayers.
In accordance with the provisions of the Convention, benefits are granted to the following categories of persons/entities:
- persons/entities are deemed qualified if they are individuals, public authorities, professional securities market participants, pension funds in which at least half of the beneficiaries are individuals and companies, in which half of the shares belong to the abovementioned individuals for at least half of the days of any twelve month period;
- persons/entities that are not qualified, but in which “equivalent beneficiaries” own at least 75% of shares. The Convention defines an “equivalent beneficiary” as a person/entity who would be entitled to benefits under the domestic law, the Convention or any other international instrument;
- persons/entities engaged in a business activity in their state of residence that receive passive income in another contracting state, which is formed or associated with that business activity. For the purposes of implementing the provisions of the Convention, the following activities are not recognised as business:
- holding activities, activities to provide supervision and administration of a group of companies;
- activities to provide group financing;
- making or managing investments (with the exception of bank, insurance companies, professional securities market participants).
When receiving income from related persons/entities, a person is entitled to the benefits if the business activity is “substantial” in relation to the received passive income. The business activities of related persons/entities with respect to a resident are deemed to be carried out by such resident.
If a person is not entitled to tax benefits, the competent authority of the other contracting state can grant the benefits, taking into account the objectives and purposes of the Convention, provided that the resident produces evidence that obtaining benefits is not one of the principal purposes of the transaction at stake. Before responding to such requests from taxpayers, the Convention provides for mutual consultations between the competent authorities.
The Convention has expanded the definition of the term “exchange of information”: information can be exchanged when it can be considered foreseeably relevant for carrying out the provisions of the Convention. The existence of banking secrecy laws cannot be an obstacle to information disclosure, while the information obtained within the framework of the Convention can also be used for non-taxation purposes.
Mutual agreement procedures
The Convention provides for mutual agreement procedures that are necessary to protect the rights of taxpayers if they consider the actions of the contracting states result or will result for it in taxation violating the Convention.
A taxpayer has the right to present its case to the competent authority of any of the contracting states, and not only in its own state. The case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention.
The protocol to the Convention specifies that any document received under the information exchange procedure, including certificates of residence, does not require legalisation or apostille.
Withholding tax rates
The new Convention, unlike the previous one, reduces the tax rates at source for passive income.
The comparative table below shows the withholding tax rates for passive income under the previous version of the 1986 Convention and the 2017 Convention.
Type of passive income
The 1986 Convention
The 2017 Convention
5%, if all the following conditions are met:
- holding of no less than 15% of the voting shares;
- for 365 days; and
- confirmation of beneficial ownership of the income.
15%, if all the following conditions are met:
- at least 50% of the value of shares derives directly or indirectly from immovable property and;
- possession for 365 days.
10% in other cases.
0% for artistic work
10% for patents, trademarks, design, models, secret formula or process
Income from the alienation of property
0% on income from the alienation of property, except for income from the sale of immovable property, ships and aircraft, property of a permanent establishment
0% on income from the alienation of property, except for income from the sale of immovable property, ships and aircraft, property of a permanent establishment, as well as the income from the alienation of shares and interests in companies (funds, trusts), whose assets, directly or indirectly, consist of 50% of immovable property at any time during the 365 days preceding the alienation.
Exceptions are shares traded on a stock exchange, where the resident and persons/entities related to that resident own in the aggregate 5% or less of shares.
The new Convention on the avoidance of double taxation reflects the current trends in international taxation and the efforts to counter tax abuses. These trends and developments must be taken into account when structuring cross-border business operations that involve residents of Russia and Japan.
In general, the entry into force of this Convention should affect positively cross-border transactions of good faith taxpayers since it provides for lower tax rates on the taxes to be withheld at source from passive income, compared to the previous version.
At the same time, the tightening of a number of provisions of the Convention, notably the introduction of provisions on the limitation on benefits, may lead to an additional tax burden for some established cross-border structures.
In this regard, taxpayers are advised to analyse their existing cross-border transactions that fall within the scope of the Convention in order to identify the possible tax risks stemming from the changes in its provisions, as well as the possible ways of tax optimisation. New cross-border transactions should also be implemented in the light of the amended provisions of the Convention, as well as the law enforcement practices that will arise from it.
CMS Russia tax lawyers have the relevant expertise and in-depth experience in providing a full range of services in the fields of international taxation, supporting the creation and operations of international business structures, as well as assisting with international transactions. They will be happy to answer any queries on the changes in the new Convention.