Russian Federation: A Russian Court Ruling On Permanent Establishments Confirms The Importance Of Careful Planning

On 8 December 2010 the Moscow State Commercial Court decided that the collection of information by Bloomberg LP's representative office in Moscow resulted in the creation of a permanent establishment under Russian law and the double tax treaty between Russia and the United States.

The taxpayer, Bloomberg LP, produces information products, including analytical databases. Between 2006 and 2007 it maintained a representative office in Moscow, where a number of employees gathered information which was incorporated into its databases.

The main question which concerned the tax office and the court was whether activities related to information gathering result in an entity creating a permanent establishment, given that under the US - Russia tax treaty the collection of information as a preparatory and auxiliary activity is excluded from the general definition of the activities of a permanent establishment. There was a secondary question concerning the attribution of the profits to Russia, but that is not considered in detail here.

The tax authorities' view was that a permanent establishment existed since the activities carried out by the employees in Russia were an integral part of the taxpayer's core activities given the nature of the taxpayer's business (which is connected with the collection and trading of valuable information) rather than being an auxiliary or preparatory activity.

Bloomberg's position was that the collection of information is mentioned in the list of exclusions from the general definition of the term "permanent establishment" under the relevant tax treaty. As this activity was auxiliary and preparatory in nature the fact of collecting the information should not, in Bloomberg's view, create a permanent establishment.

The court ruled that the activities of collecting information and selling products based on such information in fact fall within the ambit of Bloomberg's core business. The Russian office's activities could not be regarded as auxiliary or preparatory; therefore the taxpayer had a permanent establishment in Russia in 2006 and 2007. The court which decided the matter was a first instance court and no appeal was filed.

It is also significant that on this point the court referred to the Organisation for Economic Cooperation and Development (OECD) Commentary to the Model Tax Treaty, despite the fact that Russia is not an OECD member. This does not mean that the court considers itself bound by the OECD Commentary in any specific way: rather, it will decide each time on a case by case basis.

While the case in question concerned the application of the US-Russia double tax treaty, the underlying principles and issues examined are highly relevant and important in the context of Cyprus, since substantial investments are channelled through Cyprus into Russia either through the establishment of subsidiaries or through the use of branches or representative offices. Careful planning should be made in structuring investments, taking account of the relevant provisions of the 1998 Cyprus – Russia double tax treaty (the "RCDTT") to ensure that no permanent establishment in Russia is created unless this is specifically intended.

The provisions set out in the RCDTT (including the respective PE provisions) are to a large extent also based on the OECD model treaty. In addition, the provisions contained in the Protocol amending the 1998 treaty which was signed during 2010 but which has not yet been ratified by Russia and Cyprus ("the 2010 Protocol") are largely based on the OECD model.

This, together with the fact that the Russian authorities have for the first time examined the issues in such depth and made such detailed reference to the OECD Commentary, suggests that the Russian tax authorities may be losing some of their previous reluctance to refer to the OECD Commentary in order to resolve disputes with taxpayers. This development may promote and ensure stability and consistency given the comprehensiveness of the OECD Commentary on the interpretation of complex double tax treaty provisions.

Articles 5(4) (d) and (e) of the RCDTT contain similar provisions to those included in the US-Russia treaty to the extent that activities such as collecting information or the carrying out of any other activity of a preparatory or an auxiliary character do not constitute a permanent establishment. However, the definition of a permanent establishment is extended by the 2010 Protocol to include, subject to certain conditions, the provision of services in one country by a resident of another country through one or more individuals who are present in the first country for more than 183 days in any 12-month period. Care should be taken that the representatives of the company in Russia will not be treated as falling within this category, or otherwise a taxable permanent establishment will be created in Russia for tax purposes.

In view of the outcome of the Bloomberg case as well as the wider definition of "permanent establishment" in the 2010 Protocol, the activities of Cyprus companies in Russia through a representative office should be re-assessed carefully. In particular, investors should:

  • re-examine the structure and scope of activities carried out by Cyprus companies in Russia without a registered branch in Russia;
  • take action to mitigate the risk that activities that the Cyprus company regards as auxiliary and preparatory might be considered as giving rise to classification as a permanent establishment;
  • ensure that such an entity is properly registered if its activities may meet the standard for being classified as a permanent establishment; and
  • undertake a thorough, detailed examination of the accounts of the Cyprus company as well as the profits attributed to its Russian permanent establishment, and be prepared to justify or substantiate the profit attribution if required to do so.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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