Executive summary

Recently there has been an increase in questions raised by taxpayers about withholding tax on services rendered by foreign companies in connection with the transportation of goods. Challenges encountered by importers, exporters and logistics companies in paying for services of foreign carriers include:

• How can it be verified that a foreign company is entitled to treaty benefits, and is it necessary to obtain confirmation of the company's beneficial ownership of income received?
• Are freight forwarding services subject to withholding tax and is there a need to collect documents to support the application of tax treaty benefits for such services?
• What is the tax treatment of income from the leasing of assets used in international transportation?

Recent explanations issued by the Finance Ministry and developments in arbitration case law in this area address the issues faced by many companies that pay for the services of foreign carriers.

As a general rule, when a foreign company receives income from Russia with respect to international transportation services, that income is subject to withholding tax.¹ Tax must be withheld at the rate of 10%² unless more favorable treatment is provided in a tax treaty.

Detailed discussion

Relief under tax treaties

Withholding tax can generally be avoided if the carrier is a foreign company from a country with which Russia has a tax treaty. This is because tax treaties usually provide that income from international transportation services should be taxed only in the country of which the company providing the services is a resident.³

Thus, under a tax treaty exemption, income from international transportation services may not be subject to withholding tax. To benefit from this exemption, correct and timely confirmation of the tax residence of the foreign carrier is required. Confirmation of the foreign company's residence in a foreign state (known as a "tax residence certificate") must be provided before income is paid.⁴

In addition, the beneficial ownership rules⁵ introduced in Russia's tax law from 1 January 2015 provide that, where a foreign company is not the final link in a chain of payments, but transfers income to another person and has limited functions and assets, that company cannot claim tax treaty benefits. As from 1 January 2017, foreign companies that receive income from Russian sources are required to provide the Russian tax agent with confirmation that they are the beneficial owners of the income. Like the residence certificate, the confirmation must be provided by the foreign company before the date on which the income is paid.⁶

The question arises as to whether it is necessary to confirm the beneficial ownership status of foreign companies that receive income from Russia for international transportation services. The Tax Code does not make any special exceptions for transportation services. However, the term "beneficial ownership" in tax treaties is generally found only in articles relating to dividends, interest and royalties, but not in relation to international transportation.

The Finance Ministry has taken the position that the requirement to confirm beneficial ownership applies to international transportation.⁷

It is important to note that various challenges arise in practice in confirming eligibility for tax treaty relief. In particular:

• There is no standard form of confirmation, and explanations issued by the Finance Ministry do not provide a complete list of information and documents that may be used to confirm beneficial ownership.
• Obtaining detailed information (such as financial statements, information on disposal of income, staff size, etc.) from international carriers, and indeed any independent business partners, can be extremely problematic owing to the confidential nature of the information. This makes it difficult to prepare a detailed confirmation or to assess the risk of beneficial ownership being challenged.
• Amounts paid to carriers are often fairly small (for example, a few hundred euros). It may be economically impractical to prepare a special confirmation in such cases, and even a residence certificate is not always easily obtainable.

In view of the above, it is often important in practice to determine whether services provided in a particular situation constitute international transportation or other services that are by default not assessable to withholding tax.⁸

Freight forwarding services

The Ministry of Finance has consistently maintained that freight forwarding services should not be taxed at source in Russia since they are not international transportation services and therefore have the same non-taxable status as other services.⁹ This greatly simplifies matters, since if there is no withholding tax, there is no need to confirm eligibility for tax treaty benefits, i.e., to obtain a residence certificate and confirmation of beneficial ownership from the foreign forwarding company.

It should be pointed out that the Ministry was less categorical about this in a recent letter,¹⁰ in which it stated that it is important to take into account the volume and nature of the freight forwarding services, and if there are grounds to classify those services as international transportation, then the rules laid down in the Tax Code and the relevant tax treaty should be followed.

The nature of an agreement with a foreign carrier (international transportation or freight forwarding) for withholding tax purposes has also been the subject of analysis in arbitration cases. For example, in the case involving AR Karton AO,¹¹ the court concluded that the company had entered into forwarding agreements with foreign companies, and that income of those foreign companies, given that they did not have a permanent establishment in Russia, was therefore not taxable at source.

Leasing of equipment and transport for international transport operations

A withholding tax issue also arises in situations where a foreign company does not engage in carriage independently, but leases means of transport or equipment (such as containers) for this purpose. In this case, the question arises as to which rate of withholding tax should be applied: the special 10% rate (subsection 2 of clause 2 of Article 284 of the Tax Code) or the standard 20% rate (subsection 1 of clause 2 of Article 284). The position taken by the Finance Ministry in a number of explanatory letters¹² is that the rate depends on the nature of the transportation. Where equipment is leased for use in international transportation, where either the departure or destination point is in Russia, the 10% rate applies. If both points are in Russia, withholding tax should be charged at 20%.

Payments for the lease of equipment may also qualify for tax treaty relief. Depending on the situation, such income may come under various categories for treaty purposes (for example, "Business profits" or "Royalties"), making it non-taxable at source or taxable at reduced rates. In any case, a residence certificate and confirmation that the foreign company is the beneficial owner of the income would need to be obtained in order for the reliefs to be applied.

Implications

In addition to the challenges set forth above regarding the withholding tax treatment of international transportation services, there are additional issues to consider, such as:

• How would income be taxed where a foreign company has (or there is a risk of it being deemed to have) a permanent establishment in Russia?
• How should tax treaty relief be applied in situations where carriage is effected by a mode of transport not specified in Article 8 "Income from international transportation" (or an equivalent article) of the relevant treaty?
• Can "non-tax" international agreements regarding cooperation in the transportation sector be applied?¹³
• How should other payments related to international transportation (such as demurrage and despatch) be taxed?
• Are services classified as international transportation where carriage takes place between points outside Russia but re-fueling or preparation of a vessel occurs in Russia?

In order to address potential issues, plan tax strategies for international transport operations and support the use of reduced rates under tax treaties, taxpayers should consult with their local tax professional to:

• Analyze existing and planned agreements with foreign carriers in order to determine the nature of the agreements (first and foremost, whether they constitute forwarding agreements or international transportation).
• Check in relation to past payments subject to withholding tax whether residence certificates were received and, if payments occurred after 1 January 2017, whether confirmations of beneficial ownership were received.
• Make appropriate adjustments to agreements being concluded to avoid ambiguity and where possible ensure that services are classified as freight forwarding.
• Prepare explanations for a business partner regarding the need to request a residence certificate, a confirmation of beneficial ownership and supporting documents in situations where a service is subject to withholding tax (international carriage, transport leasing, etc.).
• Analyze risks that may arise as a result of a foreign transport company being deemed to have a permanent establishment in Russia.
• Check whether statements of income paid to foreign companies and taxes withheld have been properly prepared and prepare for the filing of the next statements together with the profits tax declaration for 2017.¹⁴

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ENDNOTES

¹ Subsection 8 of clause 1 of Article 309 of the Tax Code. International transportation means any transportation other than between points situated outside Russia.

² Clause 1 of Article 310 of the Tax Code.

³ Article 8 of the Organisation for Economic Co-operation and Development Model Tax Convention.

⁴ Clause 1 of Article 312 of the Tax Code.

⁵ Clause 1 of Article 312 of the Tax Code.

⁶ Clause 1 of Article 312 of the Tax Code as amended by Federal Law No. 32-FZ of 15 February 2016.

⁷ Confirmation of beneficial ownership in the context of international transport operations is mentioned, in particular, in Ministry of Finance Letters No. 03-08-05/38921 of 4 July 2016 and No. SD-4-3/24561 of 21 December 2016.

⁸ Clause 2 of Article 312 of the Tax Code.

⁹ See, for example, Ministry of Finance Letters No. 03-08-05/7196 of 20 February 2014, No. 03-08-05/15428 of 7 April 2014, No. 03-08-05/51478 of 13 October 2014, No. 03-08-05/66584 of 23 December 2014, No. 03-08-05/46308 of 8 August 2016 and No. 03-08-05/10881 of 27 February 2017.

10. Ministry of Finance Letter No. 03-08-05/51807 of 11 August 2017.

¹¹ Ruling No. F08-1995/2016 of the Arbitration Court of the North Caucasus District of 11 May 2016 on Case No. ?32-7642/2015.

¹² Ministry of Finance Letters No. 03-08-05/64556 and No. 03-08-05/64673 of 4 October 2017.

¹³ For example, the Agreement between the Government of the Russian Federation and the Government of the Estonian Republic on the Principles of Co-Operation and the Conditions of Mutual Relations in the Area of Transport of 21 September 1992.

¹⁴ The form is provided for in clause 4 of Article 310 of the Tax Code and was approved by Order No. MMV-7-3/115 3/115 3/115 3/115 3/115 of the Federal Tax Service of 2 March 2016.

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CONTACTS

For additional information with respect to this Alert, please contact the following:

Ernst & Young (CIS) B.V., International Tax Services, Moscow

• Victor Kalgin
  victor.kalgin@ru.ey.com
• Svyatoslav Vaytsekhovskiy
  svyatoslav.vaytsekhovskiy@ru.ey.com

Ernst & Young LLP, Russian Tax Desk, New York

• Kirill Lukyanets
  kirill.v.lukyanets1@ey.com

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ATTACHMENT

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