When thinking of the factors that may affect one’s ability to recover excess withholding tax, war is not usually one that springs to mind. However, in a world as complexly intertwined as ours, socio-political events have widespread ramifications. The recent, major escalation of the Russo – Ukrainian War stands testament to this. Alongside the extensive humanitarian consequences the military predicament has wreaked on the region and the world, diminished withholding tax recovery may be another unfortunate side-effect of the changing political landscape.
The Role of Tax Treaties in Times of Political Tension
Although the primary aims of Double Taxations Treaties (DTTs) include encouraging international investment, facilitating and promoting the inbound transference of skills and technology by residents of other countries, and reducing cross-border tax avoidance and evasion, DTTs are not confined by these objectives. DTTs are also entered into for diplomatic reasons, with the aim of fostering positive bilateral relations. Conversely, during times of contention, the governments of two countries may elect to terminate a treaty (though terminations do occur at other intervals for a variety of reasons).
One significant historical example of how DTTs can come into play during times of political tension is the United States’ commitment in terminating the then 40 year old tax treaty between the US and South Africa that formed part of the US’s anti-apartheid sanctions during the 1980s. A new tax treaty was later negotiated between the countries which took effect on 1 January 1994, after South Africa had met the conditions for the elimination of the US’s various anti-apartheid sanctions (including the release of all political prisoners and lifting of the ban on political parties).
The Tax Implications of the Russia-Ukraine Conflict
Following Russia’s invasion and occupation of parts of Ukraine which took place over a year ago on 24 February 2022, the rest of the world has responded with various methods to condemn Russia’s actions.
As the termination of a DTT constitutes one of the various political tools used to make a statement or impose a political agenda at a state’s disposal, in the current Russo-Ukrainian situation it is unsurprising that Ukraine notified Russia in a letter dated 20 June 2022 of its decision to terminate the tax treaty that had been in place between the two nations since 1995. The Russian government consequently sent a notice to the Ukrainian government to confirm the termination on 23 August 2022. The termination of the treaty became effective as of 1 January 2023.
Ukraine further terminated its treaty with Russia’s ally Belarus on 16 November 2022, with an effective date of termination of 1 January 2024.
Denmark elected to terminate its treaty with Russia, following the Danish parliament’s approval on 2 June 2023 of a bill to terminate the treaty. Latvia similarly announced the termination of its treaty with Russia on 27 March 2023, with Russia responding with a similar decision to terminate the treaty via a notice published April 13 by the Russian Ministry of Finance. Both aforementioned treaties will be terminated with an effective date of 1 January 2024.
Most recently, following announcements in March 2023, Russia began considering the suspension of tax treaties with countries that have introduced unilateral economic restrictions against itself. The Ministry of Foreign Affairs of Russia and the Ministry of Finance of Russia proposed that the President of the Russian Federation issue an executive order on suspending DTTs with all countries deemed to be “unfriendly” towards the state.
Following on the above, earlier this month (August 2023), the President of Russia signed a decree which suspended various DTT provisions affecting 38 tax treaties to which Russia is a party with, the list of which includes:
Australia, Austria, Albania, Belgium, Bulgaria, United Kingdom, Hungary, Germany, Greece, Denmark, Ireland, Italy, Iceland, Spain, Canada, Cyprus, South Korea, Lithuania, Luxembourg, Malta, North Macedonia, New Zealand, Norway, Poland, Portugal, Romania, Singapore, Slovakia, Slovenia, United States, Sweden, Switzerland, Finland, France, Japan, Croatia, Czech Republic, and Montenegro.
While the DTTs remain valid, the suspension has an impact on the treaty provisions which grant reduced treaty rates on dividends, interest and royalties. Residents of these states will become subject to Russia’s domestic withholding tax rate of 15% on dividends, without the possibility to reduce this tax down to a treaty rate.
Note, however, that Russia’s announcement refers specifically to the “suspension” of certain DTT provisions, which does not necessarily reflect an intention to terminate the treaties which introduces an element of uncertainty since the treaties do not define or deal with the concept of a treaty “suspension”. It is thus unclear how the affected countries will respond.
Treaty Terminations: Understanding the Consequences
Residents in states whose treaties have been terminated may find themselves unable to prevent the same income from being taxed by both countries, leading to double taxation. This would result, for example, in cases where someone resides in one state but undertakes to work in the other and becomes subject to tax in both states without the relief otherwise granted in a treaty.
Similarly, residents of both states will no longer be able to reduce their withholding tax burden on interest, dividends and royalties, or benefit from tax credits, according to previous treaty stipulations. Specifically, the following dividend withholding tax rates will no longer be available following the effective termination of the relevant treaties:
- Ukraine-Russia: 15%
- Ukraine-Belarus: 15%
- Russia-Latvia: 10%
- Russia-Denmark: 10%
For countries like Ukraine and Belarus, the termination of these treaties will have minimal effect as Russia’s domestic withholding tax rate of 15% is the same as the treaty rate. However, residents in countries such as Latvia and Denmark, which have a 10% treaty rate, will find themselves suffering an additional 5% tax on their Russian-sourced dividend income once the DTT terminations become effective.
Conversely, Russian residents will find themselves paying the Danish domestic withholding tax rate of 27% on dividends paid by Danish companies, as opposed to the treaty rate of 10%.
WTax Remains Ahead of All Withholding Tax Changes
In the midst of such changing dynamics, WTax prides itself in staying abreast of all changes affecting the withholding tax landscape as they occur and will continue to monitor any treaty-related – and other – changes which may affect its clients. Where treaties have been terminated, WTax will still utilise all other available reclaim mechanisms to ensure that its clients are suffering the lowest withholding tax rate possible.
As always, be in touch with your regional WTax specialist to optimise your investment performance.