International taxation

International Taxation, part 3 of 3 15.01.2021 International Taxation (part#3) Borisov Oleg, PhD, associate professor, Department of Taxes and Tax Administration Multinational enterprise’s tax strategy • A first step in devising a global tax strategy and plan is to (1) make an assessment of the MNE's ETR relative to its peers, or similar companies, and (2) evaluate the factors driving the enterprise's profit and related tax burden Profit and tax drivers • The appropriate benchmarks are typically ETR and cash tax rate. FINANCIAL PROFIT DRIVERS • relate to financial risk • include the return on inventory risks, accounts receivable risks, warranty risks, foreign exchange risks, the return from internal deployment of capital and other income-producing assets (e.g. intangibles) • negative tax rate drivers are intangible profits in high-tax jurisdictions and capital deployed in high-tax jurisdictions FUNCTIONAL PROFIT DRIVERS • relate to the critical business functions of the company and where those functions take place • accrue from the physical functions of the company such as manufacturing, distribution, marketing, sales, services and R&D • negative tax rate driver is establishing and maintaining core functions and the related risk in high-tax jurisdictions Borisov O.I., oborisov@fa.ru 1 International Taxation, part 3 of 3 15.01.2021 Key Triggers Drivers BUSINESS DRIVERS Profitable growth Globalization Better customer service Lower costs Shareholder value TAX DRIVERS High domestic effective tax rates Transfer pricing audits Tax Incentives More aggressive tax authorities Trapped tax losses Actions Benefits Centralization of planning and mgmt Lower effective tax rate Shared services Less transfer pricing risk Integrated supply chain management More stable effective tax rate Global/regional business units Higher earnings Improved cash flow Alignment of tax & business structure Centralized Tax Structure Optimized supply chains Introduction to International Tax Planning International Tax Planning – a regular, legal and legitimate use of existing tax provisions with the objective of minimizing the overall tax burden (“acceptable tax avoidance”) SUBSTANTIVE TAX PLANNING Aggressive tax planning – OECD Action Plan on Base Erosion and Profit Shifting (BEPS) FORMAL TAX PLANNING seeks to change substantially an economic activity or give it up entirely to save taxes seeks to keep the tax on a given structure of economic activity as low as possible has a negative impact on both investment and employment reduces tax revenues and has no impact on the level of investment Example: restructuring of assets or whole production parts to a lower taxed foreign country without releasing hidden reserves Example: debt financing of subsidiaries located in high-taxed countries in order to benefit from the deductibility of interest payments from taxable income in the source state Borisov O.I., oborisov@fa.ru 2 International Taxation, part 3 of 3 15.01.2021 Introduction to International Tax Planning International Tax Planning can lead to TEMPORARY TAX SAVINGS PERMANENT TAX SAVINGS only postpone tax payments to future periods and follow from a deferral of taxable income: the longer the period of deferral, the greater is the benefit of the tax planning reduce the overall tax burden of the international investor so that tax payments are reduced or completely avoided Examples: the retention of profits at the level of a foreign subsidiary or the high depreciation rates available under domestic tax law for certain assets Examples: the permanent use of a lower foreign tax rate or ‘white income’ which is taxed in neither state of residence nor of source Example The manufacturing company X has the following financial key data: - sales = EUR 1,000 Mio - profit before taxes = 10% of sales = EUR 100 Mio - outstanding shares = 20 Mio The relevant tax rate is 30%  profit after taxes = EUR 70 Mio. 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝐸𝑈𝑅 70,000,000 = 𝐸𝑈𝑅 3,5 𝐸𝑈𝑅 20,000,000 In order to increase the EPS ratio by EUR 0,25 to EUR 3,75 (which equals 7,14%), several alternatives exist: sales can be increased by EUR 71,4 Mio (and thus profits by EUR 7,14 Mio): 𝐸𝑃𝑆 = 𝐸𝑈𝑅 107,140,000 × (1 − 30%) = 𝐸𝑈𝑅 20,000,000 = 𝐸𝑈𝑅 3,75 Borisov O.I., oborisov@fa.ru the relevant tax rate is reduced by 5% to 25%: 𝐸𝑃𝑆 = 𝐸𝑈𝑅 100,000,000 × (1 − 25%) = 𝐸𝑈𝑅 20,000,000 = 𝐸𝑈𝑅 3,75 3 International Taxation, part 3 of 3 15.01.2021 Main objective of international tax planning MAIN OBJECTIVE OF INTERNATIONAL TAX PLANNING AVOIDING OR REDUCTION OF DOUBLE TAXATION AVOIDING OR REDUCTION OF SINGLE TAXATION NEGATIVE TAXATION depends on the effective application of the tax relief method in the state of residence (the credit or the exemption method) the goal is ‘(double) nontaxation’ whereby neither the state of residence nor that of source levy any taxes on the taxpayer Examples: the installment of ‘mixer companies’, use of reduced withholding taxes on dividends, interest payments and royalties, the application of cross-border loss compensation Examples: (1) the use of international tax rate differences, tax-efficient profit distributions; (2) avoidance of taxable transfers of assets, the avoidance of taxable intragroup transactions and transaction taxes, the taxefficient use of transfer pricing implies a tax refund higher than the tax previously paid by the multinational investor Example of Negative taxation (1)  The parent company X, resident in country A, has a foreign subsidiary in country B completely financed by equity.  The foreign subsidiary earns a pre-tax profit of 100 which is distributed as dividend to X  To refinance the equity contribution, X takes up a loan lending to tax deductible interest payments of 80  The relevant tax rate in country A is 40%, in country B – 20%. There are no withholding taxes. (i) Country A exempts foreign dividends from taxation at corporate level (ii) Country A applies the credit method on dividend income or deductible interest is allocated to country B Tax Net Income Total Tax (i) Exemption in A B (CIT 20%) 100 -20 80 -20 A (CIT 40%) -80 +32 -48 +32 Total +12 (ii) Credit in A B (CIT 20%) 100 -20 80 -20 A (CIT 40%) (100-80)=20 (8-8)=0 Total Borisov O.I., oborisov@fa.ru -20 Country A Parent company X loan interest 80 dividend 80 Taxable Profit Subsidiary company income 100 Country B 4 International Taxation, part 3 of 3 15.01.2021 Example of Negative taxation (2)  The parent company X, resident in country A, has a foreign subsidiary in country B completely financed by equity.  The foreign subsidiary earns a pre-tax profit of 100 which is distributed as dividend to X  Subsidiary takes up a loan lending to tax deductible interest payments of 80  The relevant tax rate in country A is 40%, in country B – 20%. Country A applies. There are no withholding taxes. Taxable Profit Tax Net Income Total Tax B (CIT 20%) (100-80)=20 -4 16 -4 A (CIT 40%) Country A Parent company X Total dividend 16 Exemption in A -4 Credit in A B (CIT 20%) (100-80)=20 -4 16 -4 A (CIT 40%) 20 (-8+4)=-4 12 -4 Total -8 Subsidiary company Country B loan interest 80 income 100 Integrated global structure Borisov O.I., oborisov@fa.ru 5 International Taxation, part 3 of 3 15.01.2021 Tax avoidance and abusive practices Tax avoidance is the circumvention of a taxing rule resulting from a friction between form and substance that unduly prevents the application of such rule. Tax avoidance can also occur in the form of undue entitlement to a preferential treatment, tax advantage or exemption Three elements characterize tax avoidance: 1. 2. 3. Friction between form and substance to obtain tax advantage (causal link with internal inconsistency) Purely artificial transactions lacking valid economic reasons Intention to avoid tax duly reflected in objective elements Generally tax avoidance reflects the existence of abusive practices. However, its actual positive legal dimension partly depends on how a legal order reacts to it Borisov O.I., oborisov@fa.ru 6 International Taxation, part 3 of 3 15.01.2021 Blurred line between Tax Evasion and Tax Avoidance Tax Avoidance • • • • Legal Freedom versus morality International planning opportunities (harmful) tax competition Tax Evasion • • • Illegal: Tax Fraud Criminal offence Mounting international exchange of information and coordination From a conceptual perspective, tax avoidance IS Abuse of tax law or fraus legis Since the taxpayer escapes the application of a taxing rule by exploiting the friction between form and substance Borisov O.I., oborisov@fa.ru IS NOT Sham Since the taxpayer does not generate an appearance (which would lead to tax evasion), but an actual substance. 7 International Taxation, part 3 of 3 15.01.2021 Tax avoidance and aggressive tax planning Tax avoidance Aggressive tax planning Three elements: Three elements: 1. Friction between form and substance to obtain tax advantage (causal link with internal inconsistency) 2. Purely artificial transactions lacking valid economic reasons 1. Exploitation of cross-border tax disparities to obtain bilateral tax advantages (causal link with external inconsistency) 3. Intention to avoid tax duly reflected in objective elements Generally reflecting existence of abusive practices 2. Misalignment between taxing powers and value creation 3. Unintended tax advantages from double non-taxation No abusive practice in one tax system Global Tax Avoidance Damage Borisov O.I., oborisov@fa.ru 8 International Taxation, part 3 of 3 15.01.2021 State Aid and Tax Avoidance (1) • EU Commission: Luxembourg has granted selective tax advantages to Fiat's financing company and the Netherlands to Starbucks' coffee roasting company. A tax ruling issued by the respective national tax authority artificially lowered the tax paid by the company. • Tax rulings as such are perfectly legal. They are comfort letters issued by tax authorities to give a company clarity on how its corporate tax will be calculated or on the use of special tax provisions. • The two tax rulings endorsed artificial and complex methods to establish taxable profits for the companies. They do not reflect economic reality. This is done by setting prices for goods and services sold between companies of the Fiat and Starbucks groups (so-called "transfer prices") that do not correspond to market conditions. • As a result, most of the profits of Starbucks' coffee roasting company are shifted abroad, where they are also not taxed, and Fiat's financing company only paid taxes on underestimated profits. • This is illegal under EU state aid rules: Tax rulings cannot use methodologies, no matter how complex, to establish transfer prices with no economic justification and which unduly shift profits to reduce the taxes paid by the company. It would give that company an unfair competitive advantage over other companies (typically SMEs) that are taxed on their actual profits because they pay market prices for the goods and services they use. State Aid and Tax Avoidance (2) Borisov O.I., oborisov@fa.ru 9 International Taxation, part 3 of 3 15.01.2021 State Aid and Tax Avoidance (3) State Aid and Tax Avoidance (4) A B Borisov O.I., oborisov@fa.ru 10 International Taxation, part 3 of 3 15.01.2021 State Aid and Tax Avoidance (5) • • Tax structure allowed McDonald's to divert revenue for years, costing European countries over €1 billion in lost taxes between 2009 and 2013 Between 2009 and 2013, the Luxembourg-based structure, which employs 13 people, registered a cumulative revenue of €3,7 billion, on which it reported a meager €16 million in tax. State Aid and Tax Avoidance (6) • Luxembourg gave illegal tax benefits to ENGIEgroup. • On certain profits in Lux, Engie paid an effective corporate tax rate of 0,3%. • Unpaid taxes of €120 mio has to be paid and tax to be paid in the future Borisov O.I., oborisov@fa.ru 11 International Taxation, part 3 of 3 15.01.2021 State Aid and Tax Avoidance (7) • IKEA has received illegal tax benefits and an impermissible leg up on the competition in the Netherlands • Ikea paid a significant part of its revenue as an annual licence fee to a Luxembourg subsidiary, which owned some of the intellectual property rights State Aid and Tax Avoidance (8) • • France’s fifth-largest company, utility Engie, is accused of having dodged at least €300 million in corporate taxes by employing a complex system of subsidiaries and taking advantage of an tax agreement brokered with the government of Luxembourg The group paid no tax at all on profits of €1.1 billion ($1.17 billion) between 2011 and 2015 Borisov O.I., oborisov@fa.ru 12 International Taxation, part 3 of 3 15.01.2021 ‘Double Irish Dutch Sandwich’ Borisov O.I., oborisov@fa.ru 13 International Taxation, part 3 of 3 15.01.2021 Google: structure Google Inc. ① IP transfer USA ⑧ dividends (deferred) BM Google Ireland Holdings (*) ⑦ royalties ② license Google NL Holding B.V. IE NL ③ sublicense Google Ireland Ltd. ④ online promotion clients ⑥ royalties ⑤ fees DE *) The Google Ireland Holdings was founded in Ireland, but the place of management is in Bermuda. Google: tax avoidance • USA: • Google Inc.: US CIT on dividends (but deferral in Bermuda) and no CFC taxation (active income from Irish subsidiaries) • Google Ireland Holdings: intangible assets transferred via cost sharing arrangement (APA) from the USA to Bermuda (no super royalty rule) • Google Ireland Ltd. / Google NL Holding B.V.: • no tax resident (both companies are not incorporated in the USA) • no CFC taxation (check-the-box-election  active revenues from Irish subs) • Bermuda: Google Ireland Holdings: no CIT and no withholding tax (tax haven) • Netherlands: • Google Ireland Holdings: no withholding tax on royalties outgoing (local tax code) • Google NL Holding B.V.: ruling on royalty net income (handling fee) • Ireland: • Google Ireland Holdings: no tax resident (no place of management in Ireland) • Google NL Holding B.V.: no withholding tax (Council Directive 2003/49/EC)  Google Ireland Ltd.: CIT = 12,5%, but low net income (high TP on royalties) • Germany: Google Ireland Ltd.: no CIT (no permanent establishment) Borisov O.I., oborisov@fa.ru 14 International Taxation, part 3 of 3 15.01.2021 Apple: Structure Apple Inc. IE Apple „OpCo“ International ① IP transfer Apple Sales International USA TW Apple OpCo Europe Foxconn DE Apple Distribution Int. ② sale clients Apple Retail Holding Europe ③ sale Apple Retail Germany ④ sale Apple: tax avoidance • USA: • Apple Inc.: • no CFC taxation (active income from disregarded “Irish” sub-subsidiaries) • Apple OpCo International / Apple OpCo Europe / Apple Sales International: • incorporated in IE, but have no tax residency in Ireland (no employees, no PE) and in the USA (ghost company) – board meetings in CA! • intangible assets transferred via cost sharing arrangement from the USA • no CFC taxation (check-the-box-election  sales income of Irish subsidiaries is active income of AOI) • Ireland: • Apple OpCo International / Apple OpCo Europe / Apple Sales International: • subject to non-resident taxation, but special tax rate of 2% • Apple Distribution International / Apple Retail Holding Europe: • tax resident, but low net income (TP: low risk distributor) • Germany:  Apple Distribution International: no CIT (no permanent establishment)  Apple Retail Germany: tax resident, but low net income (TP: low risk distributor) • Taiwan: Foxconn: tax resident, but low net income (TP: low risk distributor) Borisov O.I., oborisov@fa.ru 15 International Taxation, part 3 of 3 15.01.2021 Types of anti-avoidance rules  Anti-avoidance rules (AAR) typically apply by focusing on the substance of a transaction or arrangement.  When insufficient substance is present, AAR may allow the tax authority to change the tax result of a transaction or of steps within the transaction that it finds objectionable. GENERAL antiavoidance rule (GAAR) ANTIAVOIDANCE RULES Borisov O.I., oborisov@fa.ru a set of broad principles-based rules within a country’s tax code designed to counteract the perceived avoidance of tax a concept within law that provides the taxing authority a mechanism to deny the tax benefits of transactions or arrangements believed not to have any commercial substance or purpose other than to generate the tax benefit(s) obtained TARGETED antiavoidance rules (TAAR) many (if not all) of the characteristics of a GAAR regime but is limited to a specific set or type of transactions SPECIFIC antiavoidance rules (SAAR) tax law designed to deal with particular transactions of concern 16 International Taxation, part 3 of 3 15.01.2021 General anti-avoidance rules Domestic tax systems contain general anti-avoidance rules in the form of an express provision incorporated into the tax code in the form of a general principle of abuse of law, generally developed by local judges in domestic case law the development of the local economy the know-how of the local tax authorities the approach of domestic courts vital factors in order to evaluate the risk incurred by multinational groups General anti-avoidance rules Objectives of a GAAR Codify judicial rulings on what governments feel constitutes avoidance or abuse Target transactions that may comply with a technical interpretation of the law but that generate tax benefits the government considers to be unintended or inconsistent with the spirit of the law Define what constitutes an artificial scheme, transaction or arrangement that has been concocted to extract a tax benefit Apply some type of substance or purpose test as a filter for determining whether a transaction is legitimate Provide the tax authority a mechanism to recharacterize or disregard a transaction or otherwise eliminate the tax benefits claimed Allow the imposition of special assessments, penalties and interest where violations are determined Provide the taxpayer with reconstructive relief so they pay only the new tax or penalties assessed by the authority (i.e., they avoid domestic double taxation on a transaction), although this would not necessarily provide relief in a cross-border situation Borisov O.I., oborisov@fa.ru 17 International Taxation, part 3 of 3 15.01.2021 Classification of anti-avoidance clauses  Substance over form and factual recharacterisation: Cyprus, Czech Republic, Estonia, Finland, Hungary, Netherlands, Poland, Romania, Slovakia, Sweden  Abuse of law GAAR: Austria, Belgium, Bulgaria, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Portugal, Spain, UK  Fraus legis GAAR: Croatia, Netherlands (judicial + richtige heffing)  No GAAR, but application of civil law: Latvia, Lithuania, Slovenia  Judicial approach prevailing: France, Netherlands GAAR/SAAR in Russian tax legislation • Russian doesn’t have a GAAR, but it does have a series of SAAR in specific areas of legislation that aim to prevent tax avoidance. • The Russian tax authorities apply the concept of “unjustified tax benefit” UNJUSTIFIED TAX BENEFIT – a reduction of the amount of a tax liability resulting from a reduction of the tax base, the receipt of a tax deduction or tax concession (incentive) or the application of a lower tax rate, and the receipt of a right to a refund (offset) or reimbursement of tax from the budget • Substance-over-form principle • “Mala fide taxpayer” concept • “Unjustified tax benefit” concept Borisov O.I., oborisov@fa.ru apply to companies, not to individuals 18 International Taxation, part 3 of 3 15.01.2021 General anti-avoidance rules General anti-avoidance rules are domestic rules that allow the tax authorities to recharacterize a transaction or a series of transactions that have been entered with the purpose of obtaining undue tax benefits A deduction, relief, rebate or refund A reduction, avoidance or deferral of income A reduction, avoidance or deferral of tax or other amount that would be payable but for a tax treaty tax benefit An increase in a deduction, rebate or refund of tax or other amount An increase in a refund of tax or other amount as a result of a tax treaty A reduction in tax base, including an increase in loss, in the relevant financial year or any other financial year Unjustified tax savings concept  Taxpayer’s right to achieve tax savings is recognized • presumption of good faith of taxpayers and economical justification of taxpayer’s actions • burden of proof lies with the tax authorities • possibility of receiving the same economic results, but with lesser tax benefits … is not a basis for finding tax benefits unjustified  On the other hand: • tax savings are unjustified – if received with no connection to actual economic activities or as the only/main “business goal” • if the form of transaction differs from the substance, taxpayer’s rights and obligations should be determined based on the actual economic substance  Can treaty benefits be questioned based on “tax savings” doctrine? Borisov O.I., oborisov@fa.ru 19 International Taxation, part 3 of 3 15.01.2021 Purpose test In the UNITED STATES, the economic substance doctrine provides that a transaction will be treated as not having economic substance unless the taxpayer can show that: In AUSTRALIA, the test requires an objective analysis of eight factors to determine whether the scheme was entered into or carried out for the “dominant purpose” of enabling the taxpayer to obtain the tax benefit(s). Those factors include: The transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer’s economic position i. Manner in which the scheme was carried out The taxpayer has a substantial purpose (apart from federal income tax effects) for entering into the transaction ii. Form and substance of the scheme iii. Timing of the scheme and length/duration of the scheme iv. The result that would otherwise be achieved by the scheme v. Change in financial position of the taxpayer as a result of the scheme vi. Any change in the financial position of any person connected with the relevant taxpayer as a result of the scheme vii. Any other consequences for the relevant taxpayer or any person referred in part vi. above, as a result of the scheme being carried out viii. The nature of any connection between the relevant taxpayer and any person referred to in point vi. Upon whom is the burden of proof? Tax authority Taxpayer Belgium France Italy Japan Mexico The Netherlands India United Kingdom Australia Brazil China Ireland RUSSIA Shared Borisov O.I., oborisov@fa.ru Singapore South Korea Sweden United States Canada Germany Indonesia Poland South Africa Switzerland Turkey 20 International Taxation, part 3 of 3 15.01.2021 Avoidance of Non-taxation Actions to avoid non-taxation UNILATERAL ACTIONS - CFC-legislation - Activity clauses - Thin capitalization rules - Anti-treaty shopping-/anti-directive shopping-/anti-abuse provisions - Subject-to-tax-/switch-over-clauses * Residence and/or source country; * Avoidance of profit shifting Non-taxation is said to occur if there are unjustified tax benefits, either from exploiting international tax rate differentials without matching the economic interests, or from taking advantage of a miss match of tax laws leading to a qualification conflict BILATERAL ACTIONS - Activity clauses - Subject-to-tax-/switch-over clauses - Exchange of information provision - Anti-treaty-shopping-provisions (e.g. LOB-clause in Art.28 US-DE TT) Avoidance of qualification conflicts by incongruent profit apportionment of the contracting states Other SAARs ANTI-DEBT CREATION RULES • Several countries have rules to prevent the introduction of leverage into the country concerned through an intragroup transfer of a shareholding. • Example: Under German domestic law, interest expense on a borrowing taken out from a related party to finance the purchase of shares from the same or another related party are not deductible for tax purposes. • Example: French domestic law prevents the deductibility of interest expenses where a French company purchases another French company and the acquired company then joins the acquirer's consolidated tax group. ANTI-DUAL RESIDENT AND ANTI-HYBRID RULES • Several states have rules to prevent double utilization of losses, often through dual resident companies. • Example: The United States has similar rules that, broadly, prevent the deductibility of losses in the United States when the same losses have already been deducted in another jurisdiction. • Some states have introduced rules to counter the use of hybrid instruments and hybrid entities. Specifically, the United Kingdom has introduced a complex set of rules, which, inter alia, can deny relief for any expense arising as part of a scheme involving hybrid entities or hybrid instruments. ANTI-TAX HAVEN RULES • Several domestic tax systems contain legislation to prevent the use of tax haven jurisdictions. • Specifically, costs and expenses are not deductible if they arise from transactions with entities located in a listed tax haven. The deduction is generally allowed if the resident company can prove that the non-resident company actually and mostly carries on a business activity and/or that the transactions have a business purpose and have in fact been concluded. Examples of rules of this type can be found in Italy and Spain. • Along the same lines, some countries impose higher withholding taxes when payments (generally in the form of dividends, interest, royalties or service fees) are made to entities located in tax havens. Borisov O.I., oborisov@fa.ru 21 International Taxation, part 3 of 3 15.01.2021 OECD’s approach to the concept of the beneficial owner The term «beneficial owner» isn’t to be used in a narrow technical sense, rather, it should be understood in light of the object and purposes of the Convention, including the prevention of fiscal evasion and avoidance. (§ 12 par. 2 Comments to Art. 10 OECD Model Convention). OECD is still reviewing the wording of the criteria for determining the beneficial owner, that specifies the importance of this issue. Borisov O.I., oborisov@fa.ru 22 International Taxation, part 3 of 3 Borisov O.I., oborisov@fa.ru 15.01.2021 23 International Taxation, part 3 of 3 15.01.2021 The Finance Ministry Approach to defining the beneficial owner The term “factual recipient of the income" should be understood: - not in a narrow technical sense; - In light of the basic principles of contracts: prevention of fiscal evasion and avoidance, substance-over-form approach. Foreign company is to be treated as the beneficial owner of income provided the following conditions are met: 1) there is legal basis to receive an income, verified by the civil contracts; 2) a foreign recipient does not act as an agent or nominee on behalf of another person who actually benefits from the income; 3) a foreign recipient is a direct recipient of the income, i.e. «economically or factually has the power to control the attribution of the income». (The Letters of the Finance Ministry dated September 26, 2012, № 03-08-05 (interest); dated December 30,.2011, № 03-08-13 / 1 (Eurobonds); dated October 15,.2007, № 03-08-05 (income from trust management); dated April 21, 2006, № 03-08-02 (income American Depositary Receipt)). Borisov O.I., oborisov@fa.ru 24 International Taxation, part 3 of 3 Borisov O.I., oborisov@fa.ru 15.01.2021 25 International Taxation, part 3 of 3 Borisov O.I., oborisov@fa.ru 15.01.2021 26 International Taxation, part 3 of 3 15.01.2021 The concept of ”the beneficial owner" is important to distinguish from the term “beneficial holder" of the company. The “beneficial owner" means the individual who directly or indirectly owns or has the power to control it. (the term is introduced by the law dated June 28, 2013, № 134 –FL, in the Federal Law dated August 07, 2001, No 115-FL "On countering legalization of proceeds from crime ...") To date it is not clear how the current laws on the requirement of disclosing the beneficial owner will relate to the mechanism of applying the beneficial owner concept, which is proposed to be introduced into the Russian tax legislation. The concept of the beneficial owner is one of the main treaty anti-abuse rules in the world. The above said makes it clear that the question of providing a mechanism of this concept application in the Russian tax legislation is important and difficult to implement. Example of the Beneficial Ownership Concept in Treaty Law (article 11 RU-CY TT) X WHT = 20% Financial intermediary Tax haven country Borisov O.I., oborisov@fa.ru Cyprus Securities WHT = 0% But: Art.11 (1) RU-CY TT Russia 27 International Taxation, part 3 of 3 15.01.2021 Example considering the Implementation of the Beneficial Ownership Concept Sole trader B (BS) Sole trader A (AW) N-B.V. (NL) WHT 25% WHT 25% WHT 0% 100% holding D-GmbH (DE) Example of a Unilateral Switch-Over Clause Sole trader A (DE) Sole trader B (DE) C-SNC (BE) Borisov O.I., oborisov@fa.ru 28 International Taxation, part 3 of 3 15.01.2021 Thin capitalisation rules What is Thin capitalisation: It is a situation in which a company is financed through a relatively high level of debt compared to equity. Thinly capitalized companies are sometimes referred to as ―highly leveraged or highly geared. Debt Equity Other party resources (loan) Own resources Interest expense is tax deductible No tax deduction on payment of dividend Lower tax incidence on nonresident investor/ lender- Treaty benefits Dividend tax implications might arise in some jurisdictions Why is Thin capitalisation significant: Country tax rules typically allow a deduction for interest paid or payable in arriving at the tax measure of profit. The higher the level of debt in a company, and thus amount of interest it pays, the lower will be its taxable profit. Aim of framing Thin capitalisation rules : To limit an entity’s debt-to-equity ratio to control highly leveraged financing structures Borisov O.I., oborisov@fa.ru 29 International Taxation, part 3 of 3 15.01.2021 Different approaches to thin capitalisation Approaches Excessive debt approach Earnings stripping approach Method Arm’s length approach Description • Maximum amount of “allowable” debt - Debt that an independent lender would be willing to lend to the entity i.e. the amount of debt that a borrower could borrow from an arm’s length lender • Typically considers the specific attributes of the entity in determining its borrowing capacity (i.e. the amount of debt that entity would be able to obtain from independent lenders) Ratio approach • Maximum amount of “allowable” debt – Debt on which interest may be deducted for tax purposes is established by a pre-determined ratio, such as the ratio of debt to equity Fixed ratio rule • Limits entity’s net deductions for interest and payments economically equivalent to interest to a percentage of its earnings before interest, taxes, depreciation and amortization (EBITDA) Group ratio rule • Allows an entity with net interest expense above a country’s fixed ratio to deduct interest up to the level of the net interest/EBITDA ratio of its worldwide group Approaches discussed in action plan 4 (BEPS) Fixed Ratio • Limit net interest deduction to a fixed percentage of EBITDA • The percentage to be somewhere between 10% to 30% Group Ratio • Group ratio is to supplement the fixed ratio rule • Entity with net interest expense above the fixed ratio could be allowed to deduct such interest up to the interest/EBITDA ratio of the worldwide group to which it belongs • The same can also be capped at additional 10% from the fixed ratio Other recommendations • Adopting an equity escape rule which allows interest expense so long as an entity's Debt : Equity ratio does not exceed that of the group • Providing for carry forward and/or carry back of disallowed interest expense, within limits • Providing exclusions for interest paid to third party lenders on loans used to fund public benefit projects Borisov O.I., oborisov@fa.ru 30 International Taxation, part 3 of 3 15.01.2021 Thin capitalisation in different countries Jurisdiction Approach/Method Canada Excessive debt Debt included Related party debt Additional information • Permissible Debt : Equity ratio is 2:1 • Interest paid to related parties, if the interest in the hands of the recipient is not taxed, is disallowed United States of America Earning stripping and excessive debt Both Internal and External debt China Ratio method Related party debt • However, it provides flexibility of the ratio when the taxpayer is able to justify the high ratio United Kingdom Arms length method Related party debts • Focuses on special relationship and whether the loan would have been accorded had there been no special relationship Germany and Italy Fixed ratio All debts • Limits the deductibility to 30% of EBITDA India Fixed ratio All debts • Limits the deductibility to 30% of EBITDA Indonesia Excessive Debt All interest bearing debts and Interest bearing Trade Payables • Permissible Debt : Equity Ratio of 4:1 Malaysia Fixed ratio Related party debt • Limits the deductibility to 20% of EBITDA • Applicable to corporations having Debt : Equity ratio exceeding 1.5:1 and when such corporation has excess interest expense Thin capitalization rules • Thin capitalization rules are aimed at disallowing the deduction of certain interest expenses at the level of the payer, when the debt to equity ratio of the debtor exceeds certain thresholds. • Key points to be taken into account when analysing thin capitalization rules are: (i) the (subjective and objective) scope of the provisions; (ii) the determination of the debt to equity ratio; (iii) the effects of the application of the provisions; and (iv) the existence of safeguard clauses. Borisov O.I., oborisov@fa.ru 31 International Taxation, part 3 of 3 15.01.2021 Determining the Existence of Thin Capitalization (1) FLE has 30% in RLE. FLE gives a RLE a loan. (2) FLE has 60% in RLE-1. RLE-1 has 50% in RLE-2. FLE gives a loan to RLE-2. FLE 30% FLE FLE loan 40% 60% RLE-1 RLE loan 50% (4) FLE has more than 25% (directly or indirectly) in the capital of RLE. It pledges a guarantee for repayment of a loan taken by RLE from any source. Indirect ownership share is 30% (60% × 50%) FLE loan 60% RLE-1 loan RLE-2 RLE-2 30% RLE (3) FLE has 40% in RLE-1 and 60% in RLE-2. RLE-1 provides a loan to RLE-2. Direct ownership of 60% is taken into consideration and the loan will prima facie be considered as controlled. However, an exemption is available for loans between RLEs if there are no further loan relationships with the FLE so it can be shown that no tax benefit arises. RLE Compare the amount of controlled debt with the amount of equity capital M=P/K M – maximum amount of interest that can be considered deductible; P – overall sum of the amount of interest paid on the particular controlled debt; C – "capitalization coefficient", is calculated as follows: K = N / C * S / 3 (12.5) N – amount of outstanding controlled debt; C – capitalization of the borrowing organization; S – share held in the borrowing organization by the lending organization Borisov O.I., oborisov@fa.ru 32 International Taxation, part 3 of 3 ASSETS 20 000 mln. 15.01.2021 LIABILITIES debt instruments, всего incl. the amount of outstanding controlled debt equity capital overall sum of the amount of interest paid on the particular controlled debt 19 000 mln. 16 000 mln. 1 000 mln. 16 000 × 24% × 28 + 31 = 619,02 366 "capitalization coefficient" 16 000 1 × = 4,267 1 000 × 30% 12,5 maximum amount of interest that can be considered deductible 619,02 =145,07 4,267 Borisov O.I., oborisov@fa.ru 33 International Taxation, part 3 of 3 15.01.2021 Typical Structure Shareholder Trust 78,5% 21,5% Holding company Other company 100% BVI company 100% Company 1 Company 2 50% 50% Company 3 100% Russian company CFC legislation • Controlled foreign corporation (CFC) legislations – rules that empower a state to tax its resident taxpayers on income derived by foreign entities controlled by them Resident taxpayers may divert profits to CFC that are subject to a favourable tax treatment on the income received. This allows taxpayers to defer their tax liability until the profits of the foreign company are finally repatriated to them (dividend/capital gain). Borisov O.I., oborisov@fa.ru Domestic tax systems contain rules that allow the tax authorities to tax the income derived through the controlled foreign company at yearend and therefore eliminate the benefit derived from the deferral 34 International Taxation, part 3 of 3 15.01.2021 How do CFC Rules work? • When a domestic parent company establishes a CFC in a low-tax country, it relocates certain activities and resources – and therefore a part of its tax substrate - to the low-tax country. • The CFC generates income. • If the domestic tax authority wants to tax the CFC's income, it can't do so because the CFC is domiciled in another country. Foreign Country = e.g. Domestic Country = e.g. Switzerland Germany • • Activities Resources Domestic Tax Authorities CFC Domestic Parent Company Shielding Effect How do CFC Rules work? • Only when the CFC distributes its profits to the parent company, the domestic tax authority can subject these to taxation. • But because the parent company rules the CFC by definition, it can decide when the CFC shall distribute its profits. As long as it retains the profits in the CFC, it can achieve a tax deferral through this primary shielding effect. A tax deferral can get the domestic parent company an interest gain and a liquidity advantage. • Under certain circumstances, it can be possible to return the profits to the CFC taxfree in a country of residence. In such a case, the secondary shielding effect takes effect, whereby the tax deferral achieved by the primary shielding effect is transformed into a definitive non-taxation. Foreign Country = e.g. Domestic Country = e.g. Switzerland Germany Domestic Tax Authorities CFC Domestic Parent Company Shielding Effect Borisov O.I., oborisov@fa.ru 35 International Taxation, part 3 of 3 15.01.2021 How do CFC Rules work? • To prevent this, countries are introducing CFC rules. The CFC regulation cancels the shielding effect and adds the CFC's profit as a fictional profit to the domestic parent company's profit already before the actual profit distribution. • The profit added on can be domestically taxed according to the domestic tax level. That way, the tax deferral resulting from the shielding effect can be reduced or cancelled. Foreign Country = e.g. Domestic Country = e.g. Switzerland Germany Domestic Tax Authorites CFC Domestic Parent Company Shielding Effect Tax deferral vs. CFC rules USA USA Inc. Inc. EBT no dividend ./. 0 CIT profit OpCo active income 100 EBT IE Borisov O.I., oborisov@fa.ru no dividend EBT ./. 35 CIT + 12,5 FTC 100 EBT ./. 12,5 CIT 87,5 profit -22,5 loss CFC ./. 12,5 CIT 87,5 profit passive income IE 36 International Taxation, part 3 of 3 15.01.2021 Comparison tax credit method exemption method tax deferral CFC-rules IE-OpCo 100 EBT ./. 12,5 CIT (IE) = 87,5 profit IE-OpCo 100 EBT ./. 12,5 CIT (IE) = 87,5 profit IE-OpCo 100 EBT ./. 12,5 CIT (IE) = 87,5 profit IE-OpCo 100 EBT ./. 12,5 CIT (IE) = 87,5 profit US-Inc. 87,5 EBT=dividend DE-AG 87,5 EBT=dividend US-Inc. US-Inc. [+ 12,5 gross up] [./. ./. + = 35 CIT (US) 12,5 tax credit 65 profit affiliated group = 65 profit ./. = EBT=dividend 87,5 exemption method] ./. CIT (IE) 1,3 CIT (DE) 86,2 profit = profit affiliated group = 86,2 profit affiliated group = 87,5 profit EBT=dividend [+ 100 ./. + = 35 CIT (US) 12,5 tax credit - 22,5 loss CFC-income] affiliated group = 65 profit How do CFC Rules work? (1) A «Controlled Foreign Company» is a: 1. Company 2. Domiciled abroad 3. That is being "ruled" by a domestically domiciled corporation • Also called base- or intermediate company in English usage. • A company designated as CFC is being accused of having been established abroad with the sole purpose of obtaining fiscal advantages. Therefore, CFCs usually meet two other criteria: 4. The CFC is domiciled in a low-tax country 5. And typically pursues a passive activity. Borisov O.I., oborisov@fa.ru 37 International Taxation, part 3 of 3 15.01.2021 How do CFC Rules work? (2) • CFC Regulations are unilateral rules of individual states against the migration of tax substrate, which are applied without mutual national agreement. • These days, there is a vast, hardly manageable variety of CFC Rules and the conditions of when an add-back taxation is applied vary heavily: • In principal, all domestic individuals and legal entities fully liable to tax are possible tax subject of the CFC Regulations. • Control: the domestic parent company has to be able to influence the CFC in such a manner, so that it can determine the time of the profit distribution. According to the country, various formal and/or factual criteria must be met. • Low Taxation global or jurisdictional approach • Passive Activities = Activities that can be easily relocated und therefore exhibit a high location-flexibility. E.g. Interest-, dividend- and rental income, license earnings and capital gain. transactional or entity approach • Some CFC Legislations stipulate exemptions and discharges. CFC rules CFC rules can be classified under two broad categories THE DESIGNATED-JURISDICTION APPROACH THE EFFECTIVE-TAX-RATE APPROACH states restrict their CFC rules to investments made in certain jurisdictions that provide general or specific tax benefits CFC rules apply to companies that pay less than a specified effective tax rate it is possible to apply to a subsidiary company in a high-tax jurisdiction, if the system of reliefs and exemptions in the country of the subsidiary is different from that in the home country Borisov O.I., oborisov@fa.ru 38 International Taxation, part 3 of 3 15.01.2021 Russian CFC legislation Individual – RF resident 100% BVI company / JV / Trust / etc. Interest/dividends 100% Cyprus company • The aim of the CFC Rules is that the taxes on the income of passive non‐Russian companies and structures that are controlled by Russian resident companies and individuals are paid to the Russian budget. • Disclosure requirements will likely also apply to uncontrolled participations of more than 10% in equity, as well as in relation to settlement of foreign structures that are not legal entities (e.g., trusts); the question of whether beneficiaries should file notifications is yet to be determined. Operating companies Borisov O.I., oborisov@fa.ru 39 International Taxation, part 3 of 3 15.01.2021 Controlled Foreign Companies (CFCs) Controlled Foreign Company Controlled Foreign Structure (p.1 art. 25.13 RF Tax Code) (p. 2 art. 11 RF Tax Code)  Shall NOT be RF Tax Resident  Is controlled by RF Tax Resident All foreign companies controlled by Russian tax residents are treated as CFCs and must be disclosed as such, even though profits of certain types of companies are exempt from profit tax in Russia  Is not a legal entity (trust, fund, partnership, foreign company, etc.)  Is established under the foreign legislation  Is entitled to carry out income generating activity  Is controlled by RF Tax Resident Key Definitions – Control Criterion – Relevant for the control criterion are: – Voting rights; – Stake in the company’s equity – Influence on decisions (e.g. through shareholder agreement). Dividend rights should not be taken into account with regard to the control criterion (see structuring options in the case studies). Borisov O.I., oborisov@fa.ru 40 International Taxation, part 3 of 3 15.01.2021 Key Definitions – Control Criterion – A controlling person is: – A person whose direct and/or indirect participating interest in the company in conjunction with his spouse and/or minor‐age children and other dependent persons is more than 25%. – A person (as defined above) that directly and /or indirectly owns over 10% of a company, where all Russian tax residents (in conjunction with his spouse and/or minor‐age children and other dependent persons ) have an aggregated direct and/or indirect interest of over 50%. – Equity ownership is calculated taking into account participation held via structures, including trusts, in relation to which a Russian individual is a controlling person; courts may take into account other circumstances. Cyprus International Trusts (CIT) Key parties to a trust: Settlor: Key CIT features:  governed exclusively by Cyprus law;  may exist in perpetuity;  powerful asset protection mechanism;  a trustee has unlimited investment powers.  establishes a trust by transferring assets to it;  may have some reserved powers (e.g. to revoke or amend trust terms, give directions for making payments, etc.); Trustee: holds assets of the trust for the beneficiaries’ benefit; Beneficiary: is entitled to receive income and/or capital of the trust; Protector: exercises oversight over trustees on settlor’s behalf; Enforcer: enforcers a trust made for a specific purpose. Borisov O.I., oborisov@fa.ru 41 International Taxation, part 3 of 3 15.01.2021 Typical Structure Shareholder Trust 78,5% 21,5% Holding company Other company 100% BVI company 100% Company 1 Company 2 50% 50% Company 3 100% Russian company Criteria for Considering a Trust as CFC The relevant trust can be treated as CFC if one the following conditions are met (para. 5, p. 7 art. 25.13 RF Tax Code):  founder of the trust is entitled to receive assets of this trust in his property;  settlor’s rights can be transferred to another person;  founder is entitled to receive directly/indirectly (via an affiliate) any profit of the trust distributed among all its participants (shareholders, trustees or other persons);  possibility to distribute its profit among all its participants (shareholders, trustees or other persons). Borisov O.I., oborisov@fa.ru 42 International Taxation, part 3 of 3 15.01.2021 Foundations Founder (does not participate in management) Key Features of appoints Foundations: establishes Protector FOUNDATION a legal entity controls  separate legal entity (not a trust);  closely regulated by statutory rules;  only statutes of Foundation shall be registered;  civil law rules on forced heirship can apply to foundations formed in such jurisdictions;  cannot undertake certain activities, e.g. commercial activities. in favor of Council Members Beneficiary (s) Investment Funds Monetary Authority/Regulator (Cayman Islands, Jersey, Cyprus) No formal obligation of RF Tax resident to notify RF tax authorities on controlled participation in the Fund – if portfolio is less than 10%; Managing company No obligation on notifying RF tax authorities on foreign account and activity on it; Fund Borisov O.I., oborisov@fa.ru Potentially is not a CFC. Portfolio 1 Portfolio 2 Client 1 Client2 43 International Taxation, part 3 of 3 15.01.2021 Insurance Wrappers (1) nominates Policy holder (non-Russian person/entity) Life policy Life insurance company SPV Beneficiary (non-Russian person/entity) Life assured person (RF tax resident) Investment Manager manages assets appoints Insurance Wrappers (2) Insurance: Investment: Life assured person (Russian tax resident):  not a founder/settlor/establisher of the SPV;  not a controlling person or beneficiary of the SPV;  cannot withdraw, surrender, pledge the policy or take up advantages on the policy. Investment manager:  has to manage the assets according to the agreed investment strategy, in line with the risk profile of the Policyholder and rules of the regulator  cannot dispose of assets  cannot withdraw or surrender the policy Policyholder:  can withdraw or surrender the policy Life assured person (Russian tax resident):  not a founder/settlor/establisher of SPV;  not a controlling person or beneficiary of SPV; Borisov O.I., oborisov@fa.ru 44 International Taxation, part 3 of 3 15.01.2021 Exemption from Taxation – Legal Entities Profits of a CFC are exempt from taxation in Russia if: The CFC is a tax resident in a treaty state (except for those treaty states that do not exchange information with the Russian tax authorities); and If the effective tax rate is at least 75% of the average weighted rate (operational corporate income tax rate: 20%; dividend income rate: 9% (in future: 13%)) or If the company’s share of income from passive activities is not more than 20%. Structures which are not legal entities (“corporations”) might be exempt if, in addition to other requirements, this structure does not have the capacity to distribute profits among its participants or other persons according to its personal law and constituting documents. Calculating the Profit of a CFC A CFC’s profits are determined: – In accordance with its financial statements subject to audit provided the CFC is located in a treaty jurisdiction (in this case, CFC will not have to recalculate its profits under Russian tax rules); – According to Chapter 25 of the Russian Tax Code for all other instances. Borisov O.I., oborisov@fa.ru 45 International Taxation, part 3 of 3 15.01.2021 CFC Rules Liquidation Payments and Sales of Shares – A foreign company is not a tax resident if a decision has been made to liquidate the company and the liquidation procedure is completed by 1 January 2017 – Similar to liquidation proceeds, the Draft Law exempts income that a CFC earns from sales of certain securities and/or property rights to a company that qualifies as a controlling entity or to its Russian related party. – This provision applies if there has been a decision to liquidate the CFC and the liquidation procedure is completed by 1 January 2017. This is a transitional provision to provide an incentive for the restructuring of Russian groups to eliminate companies which would otherwise give rise to tax liabilities under the new CFC rules. Case Study I Reorganisation of an existing Structure Current structure: Target structure: Swiss Foundation BVI HoldCo 50% (25%) HoldCo CH OpCos (Russia) Borisov O.I., oborisov@fa.ru OpCos (Russia) 46 International Taxation, part 3 of 3 15.01.2021 Reorganisation of an existing Structure Restructuring steps: 5. 3. 1. Swiss Foundation BVI 2. • Step 1: Establishment of Swiss Foundation, HoldCo and HoldCo CH by BVI • Step 2: Donation of HoldCo shares from BVI to Swiss foundation • Step 3: Liquidation of BVI • Step 4: Liquidation of Cyprus HoldCo • Step 5: Transfer of 50% (25%) of the shares in HoldCo CH to Russian individual (?) HoldCo 1. HoldCo CH 4. OpCos (Russia) Case Study I Corporate Foundations  According to Swiss law, the foundation is a legally independent purpose fund. To establish a Swiss foundation an endowment of assets for a particular purpose is required. The foundation is established by public deed or by testamentary disposition. Further, an entry into the commercial register is required.  Corporate foundations («Unternehmensstiftungen») are neither regulated nor mentioned in the Swiss foundation law but are a very common feature in practice.  A corporate foundation is considered nonprofit provided that the interest in maintaining the company serves a nonprofit purpose and if the foundation does not carry out management activities.  Participation exemption is not applicable but depending on the canton the effective tax rate is very low (e.g. 4.98% in the canton of Nidwalden or 7.7% in the canton of Lucerne). Borisov O.I., oborisov@fa.ru 47 International Taxation, part 3 of 3 15.01.2021 Case Study II Set up of a new Structure Current situation: Target structure: Independent Swiss individual 51% Voting Rights 30% Dividend rights Russian Individual 49% Voting Rights 70% Dividend rights HoldCo CH HoldCo CH HoldCo CH OpCos (Russia) Loans Equity: 30% Debt: 70% Case Study II Shares with Privileged Voting Rights – According to Swiss corporate law, a disproportionate voting power can be achieved via issuing two classes of shares with equal voting rights, but different nominal values (so called shares with privileged voting rights). – The highest nominal value may not be more than ten times than the lowest. – Each share grants to its holder a right to a portion of dividend and liquidation proceeds proportional to its nominal value. Borisov O.I., oborisov@fa.ru 48 International Taxation, part 3 of 3 15.01.2021 Case Study II Shares with Privileged Voting Rights Example: If a shareholder owns 100 shares with a nominal value of CHF 10.– and another shareholder owns 100 shares with a nominal value of CHF 1.–, they would each have the same number of votes (namely 100) at the general shareholders' meeting. They would also each have the same influence on the company, even if the second shareholder held a stake in the company's equity that was ten times smaller than the first shareholder. However, the dividend payment to the first shareholder is ten times higher than to the second shareholder. Case Study II Participation Certificates  Swiss corporate law does not permit non voting shares, but participation certificates can be issued.  In principle, the holders of participation certificates have the same financial rights as the holders of shares but no voting rights.  The articles of association can, however, grant certain social rights to the holders of participation certificates (such as the right to call a general meeting or the right to information).  The holders of participation certificates have the right to challenge the resolutions of the general meeting that violate the law or the articles of association and to initiate liability suits against the organs of the company for breach of their fiduciary duties. Borisov O.I., oborisov@fa.ru 49 International Taxation, part 3 of 3 15.01.2021 US tax reporting & collection system Specific Issues Addressed • High profile situations where Foreign Financial Institutions (FFI) were used to shield US taxpayers’ identities from the Internal Revenue Service (IRS) • Foreign banking privacy laws in certain tax havens were difficult to overcome and became a practical impediment to detecting tax evasion Response • Legislation that creates a new withholding and reporting regime intended to provide the IRS with additional tools which: - require FFIs to perform a more exhaustive search for US persons; and - require non-financial foreign entities (NFFEs) to disclose direct and indirect substantial US owner Borisov O.I., oborisov@fa.ru 50 International Taxation, part 3 of 3 15.01.2021 Scope of FATCA • FATCA stands for “Foreign Account Tax Compliance Act” • US tax law enacted March 18, 2010, Effective as from July 1st, 2014 • The objective of FATCA is to increase the ability to detect US tax evaders hiding their money in accounts at financial institutions (banks/investment vehicles) outside the US • FATCA requires financial institutions to identify and report US customers • In order to comply with FATCA Financial Institutions will have to: - Identify on US customers - Report to the IRS on US customers and improve processes to manage customer information (e.g., KYC, on-boarding data) - Withhold taxes as deemed necessary Worldwide increased transparency US regulation EU regulation FATCA enables the Internal Revenue Service (IRS) to collect tax income from sources previously hidden (US tax evaders) EU Savings Directive provides for a reporting regime 7 million US persons live outside the US – only 10% file a US tax return. Revenue is estimated at approximately $10 billion over 10 years Increases transparency on the hidden assets of EU residents FATCA encourages Foreign Financial Institutions to enter into an agreement with US tax authority to comply with documentation, reporting, verification and withholding procedures The widening of the scope is under discussion 30% withholding tax on “passthru payments” (US and certain non-US income) in case of noncompliance Borisov O.I., oborisov@fa.ru 51 International Taxation, part 3 of 3 15.01.2021 An overview of payment and information flows What is an FFI? Borisov O.I., oborisov@fa.ru 52 International Taxation, part 3 of 3 15.01.2021 FATCA – Agreement with the IRS FATCA strongly encourages Foreign Financial Institution to enter into an agreement (“contract”) with the IRS e.g. to: • Obtain information from each account holder (and investor) as necessary to determine which accounts are “US accounts”; • Comply with verifications and due diligence procedures; • Report annually certain information (incl. name of investor, investment volume, income paid etc.) to the US tax authorities; • Under certain conditions 30% withholding tax on “withholdable payments”; • Provide IRS with further information upon request; and • Attempt to obtain a waiver in any case in which foreign law (e.g. Luxembourg banking secrecy) would prevent reporting of such information. US Account = A U.S. account is any financial account maintained by an FFI that is held by one or more US persons (US citizen or US resident) or “USowned foreign entity”, i.e. corporations, partnerships or trust in which a specified US individual owns directly or indirectly more than 10% of the stock (by vote or value), interest, profits or capital (10% is reduced to 0% for most investment vehicles). FATCA MODEL 1 IGAs USA Department of the Treasury Internal Revenue Service Bilateral Tax Treaty / Convention on Mutual Administrative Assistance in Tax Matters / Tax Information Exchange Agreement in force FATCA MODEL 1 IGA Foreign Contracting State Minister of Public Finance Tax Administration Report US accounts Legislative Branch Ratifies- Enacts domestic law incorporating FATCA MODEL 1 IGA provisions U.S. Withholding Agents Borisov O.I., oborisov@fa.ru FFIs NFFEs Certify if US or not 53 International Taxation, part 3 of 3 15.01.2021 MODEL 2 IGAs USA Department of the Treasury Internal Revenue Service Bilateral Tax Treaty / Convention on Mutual Administrative Assistance in Tax Matters / Tax Information FATCA MODEL 2 IGA FFI Report US accounts Foreign Contracting State Minister of Public Finance Tax Administration Legislative Branch Ratifies- Enacts domestic law incorporating FATCA MODEL 2 IGA provisions U.S. Withholding Agents Certify if US or not NFFEs Q&A Suggestions, comments and questions very welcome! Borisov O.I., oborisov@fa.ru 54