Tighter Control Over the Taxation of Dividends Paid to French Companies

Tax & Legal 30 March, 2020

LT in Focus Tighter control over the taxation of dividends paid to French companies

As widely expected, the oversight on taxpayers with foreign participation tightened after the creation of the Largest Taxpayers Inter-Regional Inspectorate No. 1 and the Largest Inter-District Inspectorates No. 1 and No. 2, which are responsible for the tax administration of major multinational enterprises. The inspectorates launched regular tax reassessments and have Current situation started charging additional taxes on intra-group payments. They have also refused to recognize some expenses for tax purposes, Expert opinion reclassified contractual payments as dividends and disputed the companies’ right being beneficial owners of income, as a fact. Conclusions In addition to generic claims against the majority of multinational enterprises, tax authorities set to challenge the country-specific requirements established for tax residents of individual countries. This means that French-owned companies will face increased tax scrutiny when using the reduced dividend tax rate of 5% in accordance with Article 10 of the France - Russia Double Taxation Treaty1 (hereafter — the DTT).

Current situation

According to the DTT, the reduced tax rate of 5% shall apply if the beneficial owner is a company which: 1) made the investment into a company paying the dividends, irrespective of the form or the nature of such investment, of a cumulative amount of not less than 500,000 French francs or an equivalent amount in any other currency, provided that the value of each investment is estimated on the date the investment is made; 2) shall be taxed by profits tax according to the regime of common law provided by the laws of a contracting state of which it is a resident; 3) is exempted from that tax in respect of such dividends2.

1 The Convention between the Government of the Russian Federation and the Government of the Republic of France for the avoidance of double taxation and the prevention of fiscal evasion and fraud with respect to taxes on income and on capital dated 26 November 1996.

2 Sub-paragraph (a) of paragraph 2 of Article 10 of the DTT. The reason for disputes

Issues with the application of the DTT arose from the fact that, back in 1996 (when the DTT was signed), the full amount of dividends derived by French companies from Russian entities was fiscally transparent for income tax purposes in France. However, French legislation was later amended to introduce several taxation regimes under which some dividends (5% or 1%)3 derived by French companies became subject to CIT. Russian tax authorities used the partial nature and insignificant scale of dividend taxation in France to argue that French recipients are not exempt from paying the tax in France on dividends derived from Russian entities and, therefore, are not entitled to the 5% reduced withholding tax rate in Russia in accordance with the DTT.

French tax authorities

The competent French authorities do not view the above-mentioned changes to French legislation as a reason for canceling the application of the 5% reduced tax rate to dividends in accordance with the DTT. The competent state authorities of the two countries discussed this issue back in 20014 and signed a memorandum (hereafter — the Memorandum) to confirm the right to apply the 5% reduced tax rate to dividend payments, even if the dividends were partially non-deductible.

The opinion of the Russian tax authorities

Until recently, the Russian tax inspectorates that administered taxation of multinational enterprises were either unaware of the Memorandum signed in 2001 that upheld the right to apply the 5% tax rate, or ignored it. However, after the issuance of Letter No. 03-08-05/96196 of the Russian Finance Ministry dated 10 December 2019 in response to an inquiry prepared jointly with Deloitte, tax authorities cannot ignore the agreement reached by the competent authorities of France and Russia. That said, the tax inspectorates still try to challenge the application of the reduced tax rate with respect to dividends derived by French companies indirectly via a string of subholding companies.

Expert opinion

In our opinion, the case for applying the 5% tax rate can also be defended if French companies participate indirectly in the capital of Russian entities. In contrast to many other double taxation treaties, the DTT does not stipulate direct investments as a precondition for the reduced dividend tax rate. Furthermore, the court rulings5 available as of today and commentaries on the articles of the OECD Model Tax Convention are based on the assumption that the concept of “capital” in the context of cross-border dividend taxation comprises all nuances applicable to the capital in accordance with civil (corporate) legislation, including issued loans. Another intergovernmental regulation, Council Directive 2011/96/EU of 30 November 2011 (hereafter — the Directive)6, was incorporated into French national legislation and must be applied in this case.

3 Articles 145, 216, 223, 223А, 223А-bis of the French Tax Code (Code général des impôts). 4 https://bofip.impots.gouv.fr/bofip/2454-PGP.html 5 The Ruling of the Judicial Chamber on Economic Disputes of the Russian Supreme Court of 6 March 2018 and the Decision of the Commercial Court of Kemerovo Region in case No. А27-25564/2015, the Ruling of the Judicial Chamber on Economic Disputes of the Russian Supreme Court of 6 March 2018 and the Decision of the Moscow Commercial Court in case No. А40- 176513/2016. 2 6 https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32011L0096&from=EN According to Article 5 of the Directive, dividends distributed by subsidiaries to their parent companies registered in the EU Member States are exempt from withholding tax. Thus, if a French company makes an investment, the beneficial ownership of stakes in the capital of a Russian entity via a subholding company based in Cyprus or the Netherlands gives grounds to apply the 5% tax rate when EU tax benefits apply. The fact that the cash dividends are derived by an intermediary subholding company should not be an obstacle to applying the reduced tax rate under DTT’s provisions. For Russian withholding tax purposes, if a French company (and not an intermediary subholding company) is the beneficial owner of dividends derived from Russia, any use of the dividends by the subholding company on behalf of the beneficial owner can be treated as the receipt of dividends by a French beneficial owner.

3 Contacts

Tax & Legal

Anton Zykov Tatiana Kofanova Partner Partner Tax & Legal Tax & Legal +7(495) 787 06 00 +7(495) 787 06 00 ext. 1778 ext. 5210 [email protected] [email protected]

Oxana Kozhina Evgenia Baranova Director Senior Manager Tax & Legal Tax & Legal +7(495) 787 06 00 +7(495) 787 06 00 ext. 5163 ext. 8031 [email protected] [email protected]

Irina Bakaeva Alexei Sergeev Senior Manager Senior Manager Tax & Legal Tax & Legal +7(495) 787 06 00 +7(495) 787 06 00 ext. 8153 ext. 3402 [email protected] [email protected]

Pavel Baranov Anastasia Puchenkina Manager Manager Tax & Legal Tax & Legal +7(495) 787 06 00 +7(495) 787 06 00 ext. 5328 ext. 8283 [email protected] [email protected]

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