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Russia on the EU blacklist: what are the tax consequences?

Do the test around you: ask those around you to name several tax havens. It's more than likely that Russia doesn't feature on the list of exotic, sulphurous states or financial centres that often immediately spring to mind and (sometimes mistakenly) make the uninitiated nervous. And yet, on February 14, the Council of Europe published its blacklist of uncooperative countries and territories for tax purposes, expressly adding Russia to the list, in addition to the British Virgin Islands, Costa Rica and the Marshall Islands, bringing the total number of countries on the list to 16. Of course, the announcement's coincidence with Valentine's Day is pure coincidence (taxation doesn't bother much with love), but the decision nevertheless marks the (red) iron of disenchantment between Europe and Russia, as we sadly celebrate the first anniversary of the war in Ukraine.

To understand this insertion, it's important to remember that this blacklist sanctions three types of pitfall, defined back in 2016. Firstly, there are states that engage in harmful tax competition, seeking to attract foreign investment through tax incentives that may fall within the scope of other states' anti-abuse measures. Among these are the Marshall Islands, which offer a 0% tax rate and require no substance or nexus to transactions registered on its soil. Secondly, there are the opaque states, which have failed in their duty of transparency towards EU states, most often by preventing information exchange mechanisms, or simply by blocking diplomatic relations. Since 2020, a third category has emerged, sanctioning states or territories that refuse to implement measures stemming from the OECD's BEPS program, aimed precisely at combating the erosion of tax bases and international tax evasion.

The hardening of relations between Russia and the Council, in addition to its 2022 reforms regarding foreign holding companies in response to international sanctions, have precipitated Russia into the second category of tax havens. The Council of Europe thus deplores the fact that the Russian Federation has not honored its commitment to modify the assessment of the treatment of intellectual property income and grandfathering provisions for foreign holding companies.

This announcement is by no means anecdotal. Article 238-0 A, 2 bis of the General Tax Code extends to this blacklist the same tax effects as those reserved for the French list of uncooperative states and territories (ETNC). Without falling into the trap of a "Prévert" list, it is imperative that any taxpayer with capital, economic or financial links with one or more Soviet partners be made aware of a number of issues.

TRANSFER PRICING

Insofar as Russia is now deemed to be a non-cooperative state, any Russian company engaged in transactions with a French company is deemed to be a related company within the meaning of Article 57 of the CGI. This automatically triggers all the relevant obligations, in particular the need to justify the arm's length nature of flows that have become intra-group, in addition to reporting these flows under transfer pricing documentation and form 2257-SD if the financial thresholds are exceeded.

A first incongruity then arises: if the Russian company was until then a true third party, i.e. unrelated within the meaning of articles 57 and 39-12 of the CGI, then its relationship with the French taxpayer was necessarily at arm's length.

Henceforth, this demonstration will have to be reported by means of economic analyses, such as searches for comparables on specialized databases. Given the subjective nature of such analyses, and the current trend in legal and administrative practice towards the use of net margin methods and the median of comparable intervals, it is quite possible that the transaction will be perceived as abnormal, rather than marketable.

A second incongruity arises in the area of documentation. If the Russian company is considered to be a related party, and the thresholds set out in article L13 AA of the LPF are exceeded, the French taxpayer will have to provide full documentation of its transfer prices. Here again, the French taxpayer could find himself in an abstruse situation, where he would be required to produce formal documentation based on the OECD model, not because of the thresholds observed at his level, or that of his shareholders or subsidiaries, but because of the size of his Russian partner.

What's more, administrative doctrine explicitly states that "when transactions of any kind are carried out with one or more associated companies established or incorporated in a non-cooperative state or territory within the meaning of Article 238-0 A of the CGI, the documentation referred to in Article L. 13 AA of the LPF also includes, for each company benefiting from the transfers, additional documentation comprising all the documents required of companies liable for corporate income tax, including the balance sheet and income statement drawn up under the conditions set out in article 102 U of appendix II to the CGI and article 102 V of appendix II to the CGI". This would mean that French taxpayers would also have to produce the accounting and financial information of a third-party company, on pain of incurring penalties.

It is therefore essential to break the automaticity of the arm's length relationship caused by Russia's blacklisting. On this point, we would point out that since the reservation of interpretation by the Constitutional Council in its decision no. 2014-437 (QPC of January 20, 2015), the taxpayer has the option of making use of the safeguard clause to demonstrate the reality of operations carried out in Russia. It is to be hoped that the tax authorities will be pragmatic in this respect, and that as soon as the taxpayer demonstrates the anteriority and characteristics of the transactions carried out up to that point with the Russian third party, the exception relating to the condition of dependence in article 57 will fall by the same token.

WITHHOLDING TAX NOT CHARGED TO CORPORATION TAX

In accordance with the combined provisions of the CGI and administrative doctrine, a legal entity established in France may offset against the corporate income tax due in France the withholding taxes borne by the foreign company or entity on dividends, interest or royalties originating in third countries or territories and taxable in the hands of the French legal entity. However, this possibility is subject to two conditions: the existence of a tax treaty eliminating double taxation; and that the state or territory from which the income originates is not considered as uncooperative within the meaning of Article 238-0 A of the CGI.

Russia's inclusion on the blacklist therefore automatically makes it impossible for the withholding tax borne by the foreign company to be offset against French corporation tax. This results in double taxation of the same income, undoubtedly affecting the profitability of companies and forcing them to review their contractual conditions.

STRICTER DEDUCTIBILITY OF CHARGES IN FRANCE

Finally, there is a third significant consequence of Russia's inclusion on the blacklist. Henceforth, expenses incurred by a French company in respect of sums paid to a Russian partner may no longer be deducted from profits in France, save in exceptional circumstances.

In accordance with the third and fourth paragraphs of Article 238 A of the CGI, the rule applies whether or not the Russian beneficiary is subject to a preferential tax regime.

It should also be noted that the non-deductibility also applies to any payment made into an account held with a financial institution established in Russia.

On this point, it should be noted that the scope of the expenses concerned is broad, covering "interest, arrears and other income from bonds, debts, deposits and guarantees, royalties from the assignment or concession of operating licenses, patents, trademarks, manufacturing processes or formulas and other similar rights, or remuneration for services". However, an exception is made for interest due on loans taken out before March 1, 2010, or taken out on or after that date but treated in the same way as such loans.

For these, the principle of non-deductibility does not apply, and these charges remain deductible under the same conditions as those paid in "cooperative" states or territories.

Here again, however, the taxpayer can apply the safeguard clause and override the non-deductibility rule by providing two types of evidence: firstly, he must prove that the expenses correspond to actual transactions and are not abnormal or exaggerated. Secondly, the taxpayer must demonstrate that the transactions to which the expenses relate do not have the main purpose and effect of enabling the expenses to be localized in an ETNC. While this second condition may seem easy to meet, the first brings back the complexities of transfer pricing discussed above. Indeed, if the Russian partner is now considered a related party within the meaning of Article 57 of the CGI, then the "normal" nature of the transaction will have to be derived from an arm's length analysis.

APPLICABILITY

In accordance with the CGI, the restrictive tax measures newly applicable to Russian interests apply from the first day of the third month following publication of the decree, i.e. in this case, from May 1, 2023. French companies engaged in economic and financial transactions with partners based in Russia urgently need to assess the flows potentially at risk, and the effects of the resulting tax frictions. It remains to be seen what degree of tolerance will be adopted by the tax authorities in assessing situations that come to light during tax audits.

The author would like to thank Alison SERRIERE, student lawyer, for her research assistance.

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