Russia and Cyprus: the end of the torrid romance?
On 25 March 2020, President of the Russian Federation announced an increase of the withholding tax rates for certain types of cross-border transactions. Subsequently, the Ministry of Finance of the Russian Federation sent an official letter to the Government of Cyprus containing a request to revise the terms of the agreement for the avoidance of double taxation entered into by the two countries (the “Agreement”).
The Russian Federation has proposed to Cyprus to increase the withholding tax rate up to 15% in respect of dividends and interest, but Cyprus unsurprisingly dismissed this proposal. Russia, in the meantime, has notified that failure to comply with its request will lead to the termination of the Agreement.
The termination of the Agreement will trigger major implications for the taxation regime of cross-border structures and for individuals who have personal, family or property ties with Cyprus. Here, we set out the most significant changes:
- Taxation of dividends. There will be changes in tax rate applicable to dividends – payments to Cyprus residents will be subject to standard 15% withholding tax established by Tax Code of the Russian Federation. Now dividends payable from the Russia to Cyprus are taxed at reduced rates of either of 5% 10%, depending on the asset contribution of a Cypriot resident entity to a Russian company.
- Taxation of interest and royalties. The taxation regime for interest and royalties will be changed. Payments of interest and royalties will be subject to 20% withholding tax in the Russian Federation. At present, interest and royalties payable to Cyprus are tax exempt.
- Double tax residence. The criteria used to resolve disputes concerning a person’s tax residence will no longer be in effect. The risk will emerge of such person being treated as a tax resident of both states and, therefore, taxed in both states.
The mutual agreement procedure between the authorized bodies of the Russian Federation and Cyprus will also become unavailable. Such procedure can be used to resolve disputes regarding tax residence or double taxation issues.
- Elimination of double taxation. Individuals will completely lose the option to set off any taxes paid in Cyprus against taxes payable in Russia. Russian companies would not be able to set off Cyprus withholding tax on dividends distributed in favor of Russian companies if Cyprus cancels the zero tax rate on such transactions.
- Exchange of tax information. The termination of the Agreement may lead to a suspension of exchanging tax information between the states. Whereas an obligation to provide such information is also recognized in the Convention on Mutual Administrative Assistance in Tax Matters, its provisions are of a general nature and Cyprus will have greater opportunities to postpone such requests from Russian tax authorities.
Cyprus will also be able to suspend the automatic exchange of tax information with the Russian Federation. This will have a negative impact on currency regulation as Russian residents have been allowed since 1 January 2020 to credit funds payable from non-residents directly to foreign bank accounts in countries that automatically exchange financial information with Russia.
- Permanent establishments. In the absence of the Agreement, the 12-month grace period during which the activity of a Cypriot company on a construction site does not constitute a permanent establishment will be abolished.
- CFC taxation. Russian residents will be unable to exempt a Cypriot CFC’s profits from taxation in Russia in a case where the effective tax rate applicable to such CFC in Cyprus is at least 75% of the Russian rate. It will be necessary to maintain the financial statements of Cypriot CFCs in accordance with Russian accounting standards.
Thus, the termination of the Agreement will have significant negative consequences for businesses structured via Cyprus and for individuals who have personal, family or property ties with both jurisdictions. We recommend conducting a preliminary analysis of the effect that business will bear due to the termination of the Agreement, and developing an action plan in order to minimize the negative impact should the Agreement actually be terminated.
 Agreement between the Government of the Republic of Cyprus and the Government of the Russian Federation for the avoidance of double taxation with respect to taxes on income and on capital (concluded in Nicosia on 5 December 1998)
 Convention on Mutual Administrative Assistance in Tax Matters (concluded in Strasbourg on 25 January 1988)
 The proposal of Vladimir Putin to impose on CFCs a fixed tax in the amount of RUB 5 million per year is not taken into account.
 Russian residents will retain the right to exempt a CFC’s profits from taxation on other grounds provided for by the Russian CFC rules, for example, on the ground that a CFC is an active foreign company (active income constitutes at least 80% of the CFC’s total income).