Tax Withholding on Foreign Companies' Income Obtained in Russia

While in the process of concluding negotiations on a contract, questions about tax withholding often come up. Foreign suppliers frequently provide contracts with conditions concerning increases in the price to the amount of Russian taxes. Because of the effect on price, the question of tax withholding of Russian taxes takes on special significance.

There are assets, the acquisition of which implies obligation of tax to the Russian Federation, regardless of the presence or the absence of permanent representation. Earnings from such assets are called "income from sources obtained in the RF" and enumerated in the Article 309 of the RF Tax Code (hereinafter -- the Code).

Taxation of earnings from sources obtained in Russia is only slightly regulated by the Code. An approximate list of earnings stipulated in Article 309 of the Code also contains such different types of earnings as dividends, interest and income from sale of shares, real estate, from international traffic, property lease (leasing), as well as other "similar types of income." So, at first blush, it is not clear how to mark out the essential patterns of such types of earnings and to withhold taxes specifically from those subject to taxation, and not from all sums.

Seeking to decrease risks, taxpayers often appeal to international treaties on double taxation avoidance. However in accordance with the Russian national legislation, the condition which permits international treaties' application is deemed, with the presence of proper form documents, to confirm validity of the correspondent treaty in favor of foreign company.

The question is whether all the peculiarities of Russian legislation are used by taxpayers.

Judicial practice analysis, as well as certain official explanations from the Finance Ministry, confirms that the broad interpretation of taxable income list is incorrect and as a rule is not supported by the Courts.

Important summaries for taxpayers are cited in the RF Supreme Arbitration Court (SAC) presidium resolution from 08.07.08 № 3770/08 where the dispute concerned income from services provided by foreign organizations on selection of range numbers (IP-addresses of the Internet). The SAC indicated that types of income, enumerated in clause 1 of Article 309 of the Code, from which tax is withheld, shall not be in connection with entrepreneurial activity. Therefore if a foreign company renders services, within the limits of its usual entrepreneurial activity, a company that obtained its services is not obliged to withhold and enumerate taxes from such services.

In fact, clause 2 of Article 309 of the Code provides a release from taxation of foreign companies' income from certain types of activity within the territory of the RF: sale of goods and other properties, as well as property rights, performance of work, rendering of services that do not result in formation of permanent representation. Apart from that, if the activity on performance of work and rendering of services is carried out outside the RF, income from such activity is not taxable in Russia as well, because the source of such income shall be considered activity outside Russia.

Nevertheless, clause 1 of Article 309 of the Code mentions in the capacity of taxable income, for instance, receiving loan interest or payments for intellectual property objects, though their receipt might be in the result of performance of activity outside Russia.

What is the difference between receiving interest, loan, royalty and other similar payments and sale of goods, performance of work, rendering of services, assignation of property rights? It is logical to suppose that such a difference in the method of approach is caused by vital difference in such types of activity. Firstly, the selling nature of activity on sale of goods (works, services, property rights) as opposed to income receiving in the form of interest, dividends, royalty, penalties.

In accordance with the abovementioned facts, the conclusion can be drawn that the standards of the Code, as a rule, release such income obtained from the activity of sale of goods, performance of work, rendering of services, assignation of property rights carried out inside and outside Russia from taxation. And on the contrary, income obtained from the activity without sale of goods, performance of work, rendering of services, assignation of property rights are subject to taxation regardless of business location.

Of course exceptions may exist. They are directly indicated in clause 1 and 2 of Article 309 of the Code: sale of stocks (shares) of Russian issuers, real estate sale, located in Russia, and in addition, property lease (sublease, leasing) in Russia and transportation, is carried out inside and outside Russia.