Multilateral Convention MLI

Newsletter on the beginning of the MLY application by the Russian Federation (Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, "Multilateral Instrument" or "MLI").

1. MLI was developed by the Organization for Economic Cooperation and Development (OECD) as an "add-in" to DTT (double taxation treaties). The purpose of MLI is to limit abuse (double non-taxation, treaty shopping) by the provisions of international DTTs.

2. MLI changes or clarifies certain provisions of the current DTTs (without replacing the DTTs themselves). The MLI text contains options – different legal solutions to certain issues of cross-border taxation. Such options are applied subject to the reservations that states can make when ratifying MLI. (The reservations made by the Russian Federation can be found in the Federal Law of 01.05.2019 No. 79-FZ "On the ratification of the multilateral Convention to implement tax treaty related measures in order to prevent tax base erosion and profit shifting ").

3. According to the Information Notice of the Ministry of Finance of the Russian Federation ("On the entry into force of the multilateral "Convention to implement tax treaty related measures in order to prevent tax base erosion... ", Date of publication: 20.12.2019) MLI contains the following minimum standard requirements that will apply to DTTs:

• replacement of existing preambles to the treaties;

• application of rules limiting abuse of the provisions of the treaties (the Russian Federation has chosen the principal purpose test, supplemented by a simplified limitation of benefits);

• rules on mutual agreement procedures;

• requirements on adjustments to profits of associated enterprises.

4. As mentioned above, Russia has chosen a combination of two schemes for limiting benefits provided for by MLI:

1. principal purpose test (PPT). The Principal Purpose Test allows national tax authorities to deny the application of DTT benefits, if the application of such benefits was not only the principal, but also one of the principal purposes of deal structuring.

2. simplified limitation on benefits (S-LOB). This scheme involves the requirements for the recipient of income to meet strict, formally defined criteria with the possibility of granting benefits to other persons claiming tax benefits by the competent authority only on the condition that it is proved that such persons not fulfilling the formal criteria do not have the principal purpose of obtaining benefits according to DTT.

5. Important: Most countries for agreements with Russia have chosen a principal purpose test, therefore the scheme of simplified limitation on benefits with such countries will not be applied.

6. To assess whether the rules for taxation of cross-border transactions between a resident of the Russian Federation and a resident of another country change, it is necessary to determine whether MLI has entered into force for this state and what reservations were made upon its ratification in relation to DTT of this country with Russia. In this regard, the Ministry of Finance of the Russian Federation issued and posted on its official website another Information Notice ("On the beginning of the application of the Multilateral Convention to implement tax treaty related measures in order to prevent tax base erosion and profit shifting ", publication date: 20.01. 2021), where listed the countries, when making payments to which it is necessary to check with MLI, which complicates the application of benefits. So, from January 1, 2021, the MLI convention must be applied:

1. for taxes in full when working with contractors from 27 states. Among them are the Netherlands, Luxembourg, popular for business (see Annex 1 for a complete list of 27 countries);

2. for withholding taxes when working with partners from 7 countries: Cyprus, Czech Republic, Indonesia, Kazakhstan, Korea, Portugal and Saudi Arabia (for other taxes, the convention will be applied to residents of these countries from 2022).

7. The OECD, for its part, offers MLI support materials (short link - oe.cd/mli), including a matrix for checking the MLI status and its separate provisions.

There is conditions matching table by countries at: https://www.oecd.org/tax/treaties/mli-matching-database.htm.

OECD recommends that countries re-publish the existing DTTs, taking into account the changes introduced by MLI, for that it offers instructions.

8. Key to MLI are provisions on the limitation of tax benefits provided for by DTT, in particular, this applies to withholding tax exemptions and reduced tax rates in relation to taxable payments (dividends, interest, royalties, etc.).

9. Simplified Limitation on Benefits Provision represents a formal set of requirements for a person claiming benefits under DTT - benefits must be provided to so-called “qualified persons” (individuals, the state or its political subdivision, persons whose principal class of shares is traded on the stock exchange , some non-profit organizations, etc.).

In addition to qualified persons, benefits can be applied by persons engaged in active conduct of a business. It should be noted that the Convention directly excludes the activities of holdings (operating as holding companies), providing group financing (including cash pooling), making or managing investments (with the exception of professional market participants) from “active conduct of a business”. If a resident is not a “qualified person” and is not entitled to benefits on other grounds (provided for by MLI), then the competent authority of a contracting state is entitled to grant benefits under DTT if such a resident proves that neither its creation (acquisition or maintenance in a group), nor the operations execution had one of their principal purposes of obtaining preferences under DTT.

10. For the purpose of applying lower tax rates to dividends, MLI introduces a requirement for an uninterrupted tenure in the organization for 365 calendar days. This rule supplements, but does not cancel, the terms and conditions in force in DTT.

11. MLI introduces significant changes to the taxation of a permanent establishment:

a)    MLI narrows the definition of “preparatory and other supporting activities”. If the tax authorities identify abuses in the actions of the taxpayer in the form of structuring a single business in such a way when each of the business units performs separate operations that are of a preparatory or supporting nature and separately do not lead to the creation of a permanent establishment, then such a structure as a whole can be recognized as permanent establishment for tax purposes.

b)    MLI limits the benefits associated with permanent establishments (absence of permanent establishment):

• if a dependent agent not only regularly signs contracts on behalf of the company, but also plays a major role in their conclusion, then such activity creates a permanent establishment;

• the types of activities specified in the treaties and activities that are of a preparatory or supporting nature do not lead to the creation of a permanent establishment. In other cases, a permanent establishment is created and its income is taxed;

• it is prohibited to divide contracts by time in order to avoid the creation of a permanent establishment. Russia made a reservation that these rules would not be applicable to it in a number of DTTs related to the exploration and production of natural resources (in particular, DTTs with Norway and the Netherlands).

• the country of source of income is entitled to receive tax from a permanent establishment located in a third country. The rule is applied when such income is taxed at reduced rates in a third country and is exempt from taxation in the country of residence of the head office. MLI provides for the waiver of DTT benefits when income is paid to a resident of a DTT country from another DTT country if the first country assigns this income to a permanent establishment in a third country (where such income is subject to reduced tax).

12. Individuals with double tax residency

To determine the tax liabilities of persons with a double tax residence, Russia will apply mutual agreement procedures, but not the test of “effective management place”.

13. Mutual agreement procedures

All disputes between Russian and foreign competent authorities can be resolved only within the framework of a mutual agreement procedure.

14. Risk Disclosure and Recommendations

In view of the above, we inform you that:

а) earlier tax-free transactions in the Russian Federation with your foreign counterparties:

1. can be recognized as subject to income (profit) tax;

2. can become an object for self-payment of VAT by a permanent establishment if conditions for its occurrence arise;

б) the reduced rates of income tax established by DTT may prove to be inapplicable.

We recommend you, together with your counterparties, to assess to what extent the change in the rules of taxation of cross-border transactions under DTT affects your relationship. Foreign counterparties must, among other things:

1. determine whether MLI has entered into force for the state of their incorporation and what reservations were made upon its ratification in relation to DTT with Russia;

2. check its activities for the creation of a permanent establishment in the Russian Federation, taking into account new MLI approaches;

3. test the principal purpose in accordance with the MLI provisions.

The RF Ministry of Finance (in a Letter dated July 28, 2020 No. 03-08-05/65902) indicates that the legislator does not limit taxpayers to any list of documents required to confirm compliance with the principal purpose test for the purpose of applying tax benefits under DTT, giving preference to meaningful pieces of information. In this case, for such confirmation, documents may be submitted containing, among other things, the following information:

1. on the availability and amount of tax benefits from the application of an international treaty, expected by the taxpayer when making the transaction (operation);
   

2. on the presence and assessment of commercial (business) benefits expected by the taxpayer when making the transaction (operation);
   

3. on the ratio of the amount of the expected tax benefit from the application of benefits under an international treaty and the expected commercial (business) benefit from the transaction (operation);
   

4. documents proving the residence in one of the Contracting States, reflecting the ownership structure and changes to it, the nature and scope of activities in the country of residence.
   

Taking into account the absence of any practical explanations of the Ministry of Finance on the application of MLI, we recommend that on questions raising doubts, to send written requests to the Ministry of Finance of the Russian Federation, and receive advice from several sources.

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