Beneficial Owner of Income: Whom the Law Refers To
Why this rule was introduced
Russia has concluded double tax treaties with various states, including Cyprus, the United Arab Emirates, Kazakhstan, China and others. In practice, this led some companies to use foreign jurisdictions with applicable double tax treaties as an intermediary link in order to reduce withholding tax in Russia: formally, the income is received by an intermediary company in a country with an effective double tax treaty, but in substance it belongs to another person controlling that company.
It was precisely to prevent such arrangements that the concept of the beneficial owner of income was introduced into Russian tax law.
Who is the beneficial owner of income
The concept of the beneficial owner of income is set out in Clause 2 of Article 7 of the Russian Tax Code. Such person is defined as a person who has the right to independently use and/or dispose of income, as well as a person in whose interests another person is authorized to dispose of income.
The law also expressly requires taking into account the functions and business activities of such person, as well as the risks assumed by that person.
Therefore, the beneficial owner of income is not simply the person to whom the money was formally transferred, but the person who actually controls that income, can independently dispose of it and receives the economic benefit from it.
In simple terms, the main features of the beneficial owner of income are:
independent decision-making in relation to the income received;
absence of an obligation to automatically transfer the income further along the chain;
absence of the role of a mere intermediary and the existence of real business activity.
This approach corresponds to Clauses 2 and 3 of Article 7 of the Russian Tax Code, which separately state that a person is not recognized as having the beneficial ownership of income if that person merely performs intermediary functions, has limited powers to dispose of the income and transfers it further to a person who would not itself be entitled to claim benefits under a double tax treaty.
When confirmation is required
Under Clause 1 of Article 312 of the Russian Tax Code, a foreign company must provide supporting documents to the tax authority precisely when it or its Russian tax agent intends to apply a benefit under a double tax treaty, for example, an exemption from tax in Russia or a reduced tax rate.
It follows that an ordinary payment to a foreign counterparty under a commercial contract does not, in itself, mean that the existence of beneficial ownership of income must be separately proved in every case.
In other words, this rule does not apply automatically to every cross-border payment. It applies when the issue of applying benefits under a double tax treaty arises.
Where mistakes occur in practice
In practice, Russian counterparties often request documents confirming the status of the beneficial owner of income from a foreign company for almost any outbound payment, treating Article 312 of the Russian Tax Code as a universal rule.
This understanding of the rule is too broad. The wording of Clause 1 of Article 312 of the Russian Tax Code shows that confirmation is required specifically for the application of an international treaty, and not for every payment as such.
Therefore, a payment to a foreign company does not in itself mean that the tax agent must always look for a hidden beneficiary.
The main purpose of Article 312 of the Russian Tax Code and Clause 3 of Article 7 of the Russian Tax Code is to prevent the use of intermediary companies to obtain tax benefits.
If the parties do not form a corporate or de facto related structure and are ordinary independent counterparties under a transaction, the concept of the beneficial owner of income should not be automatically applied to their relationship solely because one of the parties is a foreign company.
Why this matters for the Russian payer of income
When a Russian organization pays income to a foreign party, it becomes a tax agent. It is the Russian organization that is responsible for correctly calculating, withholding and remitting tax to the budget.
If the tax agent wrongly applies a benefit under a double tax treaty where the recipient does not have beneficial ownership of the income, this may create tax risks for the tax agent itself.
Under Article 123 of the Russian Tax Code, unlawful failure to withhold or remit tax entails a fine of 20% of the amount that should have been withheld and remitted.
In addition, the tax agent must report such payments and the tax withheld in the calculation submitted to the tax authority.
Therefore, it is important for the tax agent to determine three things: whether a double tax treaty applies in the specific situation, whether the recipient is indeed entitled to independently use and dispose of the income, and whether there are any signs of a transit or intermediary structure referred to in Clause 3 of Article 7 of the Russian Tax Code.
For the foreign taxpayer itself, this means that the issue of beneficial ownership of income should not be resolved formally. It must be assessed taking into account the ownership structure, the functions of the participants, the risks assumed and the further movement of funds.
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