The enactment of Russian Federal Law 395-FZ on “The amendment of legislative acts of the Russian Federation in respect of dividends”, together with the consequent change to the Russian Tax Code, is an important development in the Russian tax order.
The Law, which was adopted at the end of December 2010, introduces an exemption from personal income tax for disposals of stock or participation shares in the charter capital of Russian companies, and a zero corporate tax rate on disposals of such shares by companies, subject to the following conditions being met:
- the relevant stock or participation shares must have been held by the taxpayer for more than 5 years without interruption;
- the relevant stock must not have been publicly traded at any time while it was held by the taxpayer concerned. An exception is made for shares of companies active in the high technology sector.
The tax exemption will apply to participations acquired as from 1 January 2011, and so any benefits will not be realised until 2016 at the earliest. The exemption is available only to Russian-resident investors.
The principal purpose of the incentive is to encourage investment in Russian businesses, particularly in the high-technology sector. From a practical viewpoint it is expected to be particularly attractive to potential investors in joint ventures for projects in Russia.
However, the Cyprus-Russia 1998 Agreement for the Avoidance of Double Taxation (“DTT”) already exempts Cyprus companies investing in Russia from tax on disposals of shares. Under the DTT Cyprus has the sole taxing right in respect of the alienation of shares or similar interests held by Cyprus companies in Russian enterprises. Any gains from the alienation of securities are exempt from tax in Cyprus. The term “securities” covers a wide range of financial instruments. In contrast to the relatively limited scope of the exemption under Russian law, gains on disposal of investments through Cyprus enjoy exemption from tax irrespective of the nature of the investment and the holding period.
Moreover, by virtue of Article 10 of the DTT, Russia applies a reduced withholding tax of only 5% on dividends paid by Russian companies to shareholders in Cyprus, subject to a minimum investment of USD 100,000. This, coupled with the fact that such dividends are exempt from Cyprus tax, and that Cyprus imposes no taxes on dividends paid overseas, means that the total tax burden on such dividends is only 5%.
The combination of exemption from tax on disposals and minimal tax on dividends makes Cyprus an ideal location for investment into Russia, with attractive tax planning opportunities. Although the recently-agreed amend