On the night of 15th March 2023 amidst the Russia-Ukraine war, the Russian Ministry of Finance and the Ministry of Foreign Affairs joined forces to present a compelling proposal to the President of Russia. Their aim? To halt the operation of double taxation agreements with nations that had unilaterally imposed economic sanctions on Russia. Subsequently, on 8th August 2023, the President of Russia formally introduced Decree No 585, (English Translation) thereby suspending specific clauses within the international tax treaties of the Russian Federation.
This decree wielded the authority to temporarily freeze specific section of the double taxation agreements with 38 nations categorised as “unfriendly”, affecting a range of income types, including dividends, interest, royalties, capital gains, employment income, and fees for board members, subject to various taxation rates like 15% for dividends, 20% for interest payments, royalties, and other profit distributions. This move has a direct and profound impact on Russia’s relationship with these 38 countries, including major players such as the United States, the EU and the United Kingdom. One of the most significant consequences of suspending tax treaties is the partial elimination of double taxation treaty (DTT); an agreement designed to protect individuals or companies by preventing the taxation of the same commodity or income in two different states. Consequently, individuals are now faced with the obligation to pay income taxes both in Russia and one of the 38 affected countries. For instance, a property owner in London who, in the past, could leverage the offsetting of tax on rental income in the UK against their Russian personal income tax is now confronted with the obligation to pay income taxes in both the United Kingdom and Russia. This sudden shift potentially results in a substantial increase in the individual’s overall tax liability to both jurisdictions.
Moreover, starting from August 8, 2023, Russian companies acting as tax agents are required to deduct corporate profits tax in accordance with increased rates when making payments to foreign individuals residing in “unfriendly” countries. This change has negative implications for foreign corporations receiving payments from Russia. It means a reduction in the income they receive due to the increased tax withholding. Conversely, it results in increased tax collection for the Russian government. Further, the absence of tax treaties leads to the application of new withholding taxes on cross-border transactions, impacting transfer pricing (TP) arrangements that previously didn’t incur these charges under the now-suspended double taxation agreements. Corporations from those countries continuing operations in Russia will face increased tax burdens within their TP arrangements. This heightened tax load will prompt more foreign companies to leave Russia due to the sudden rise in operating costs.
This situation also highlights the significant challenges European companies face when it comes to selling or assessing the value of their assets in Russia. Multilateral companies are likely to face heightened insecurity due to the escalation of trade wars with Russia. For instance, Fortum Oyj, a Finnish-owned energy company, cautioned its shareholders about the potential risk of their assets in Russia being subject to takeover or expropriation by the Russian Government. The situation manifested when Russian authorities seized control of Fortum’s assets within Russia. Following this sudden and substantial loss of control, Fortum was compelled to deconsolidate its Russian segment leading to the full write-down of its Russian assets in the second-quarter financial report for 2023. Another corporation significantly affected by the suspension of the Double Taxation Treaty was Heineken, a Dutch brewery, which was compelled to sell its Russian operations to Russia’s Arnest group for a mere symbolic sum of 1 Euro.
A coalition of nations, including the UK, have issued a collective call to the Russian Government, urging them to reconsider their treaty suspension. On August 18, 2023, the UK’s HMRC released an update clarifying that the UK-Russia Convention doesn’t provide a green light for Russia to take unilateral actions of this magnitude. In response, the Russian Ministry of Finance issued a statement citing the Vienna Convention on the Law of Treaties which allows for the suspension of agreements when the rights of a nation have been infringed upon.
The suspension of tax treaties has significant geopolitical implications that extend beyond mere financial considerations. These repercussions can be understood through several interconnected dimensions. From an economic perspective, this action has the potential to trigger significant shifts in the global economic landscape. International enterprises that previously enjoyed favourable tax arrangements in Russia are now leaving the country altogether to protect themselves from potential adverse financial consequences. This includes safeguarding against actions like asset seizures by the Kremlin, which has occurred with subsidiaries of Russian companies such as Danone and the Danish brewer Carlsberg, placing them temporarily under the ownership of the Federal Agency for State Property Management. Other companies like Starbucks, Renault, Maersk and many more have sold their assets and operations at a discounted amount as many Western investors leave.
The Russian Ministry of Finance has also introduced a new law, referred to as the “windfall tax”, aiming to impose additional tax obligations on larger Russian corporations and foreign companies operating within Russia for tax purposes which are expected to contribute to the Russian budget augmentation. Furthermore, this action may also function as a mechanism for the Russian government to manifest its dedication to fortifying the nation’s fiscal well-being. On the upside, the Russian government could see an increase in tax revenue which can be posed as a gain from suspending the treaty, however, the long-term implications could be less favourable if corporations continue their exodus, potentially resulting in a substantial and severe downturn in Russia’s economic landscape. Another downside of this move is Russia’s deteriorating trade relations with the affected countries. In the US, certain senators are advocating for additional sanctions in reaction to Putin’s August announcement to cease tax treaty benefits with the U.S. Moreover, the UK is contemplating potential retaliatory steps against Russia after the suspension of the tax treaty.
Another significant implication of this move is the rise in withholding tax, which is a tax deducted at the source of payment. In the context of international agreements, it refers to the tax withheld by the country where the income is earned before it is paid to a foreign entity or individual. Individuals residing in countries like Latvia and Denmark, where a 10% treaty rate was in place with Russia, will now encounter an extra 5% tax liability to be paid on their Russian-sourced dividend income after the termination of the treaty. Residents of these states will become subject to Russia’s domestic withholding tax rate of 15% on dividends, interest and royalties. Conversely, Russian residents will experience an adjustment, necessitating them to adhere to Denmark’s domestic withholding tax rate of 27% on dividends disbursed by Danish firms, as opposed to the established treaty rate of 10%. This will create an extra burden of paying a larger percent without the possibility to reduce this tax down to a treaty rate.
Lastly, the suspension of DTTs by Russia has also spurred a significant shift in investment dynamics. With many Western companies withdrawing their operations from Russia, this move has paved the way for increased investments from China and other Eastern nations such as India. Notably, the deepening Moscow-Beijing cooperation, especially following the fallout from the Ukraine conflict and subsequent Western sanctions, has propelled Russia towards closer ties with Asia. As a result, China, in particular, has reaped substantial benefits from this pivot, effectively filling the void left by exiting Western companies, particularly in the mining and transportation sectors. The trade turnover between China and Russia has surged, recording a 29% increase in 2022 and a further 40.6% rise in the latter half of 2023. This growing trend of Eastern investments in Russia could potentially foster a scenario of increased polarization between Eastern and Western spheres, emphasizing a shifting global order based on economic ties and strategic alliances in the Eurasian region.
The suspension of tax treaties carries profound geopolitical implications. This reckless decision reverberates across the spectrum of geopolitics, touching various aspects of international affairs and economics. From intricate economic relationships to the delicate threads of diplomatic ties, from the shifting landscape of global competitiveness to the dynamics of international trade and corporate strategies, and even to the pivotal question of government revenues—each facet bears the weight of this transformative policy shift. In this interconnected world, Russia’s actions serve as a stark reminder that geopolitical decisions resonate well beyond borders, transcending fiscal matters to shape the very landscape of global affairs. As nations and corporations navigate this new reality, the impact of this decision will continue to ripple through the complex web of international relations, leaving lasting impressions and challenging the status quo in ways we are only beginning to comprehend.