PLEKHANOV RUSSIAN ECONOMIC UNIVERSITY

INTERNATIONAL FINANCIAL MANAGEMENT

RESEARCH & ANALYSIS

TAX CONSEQUENCES
OF THE TRANSACTIONS BETWEEN
LEGAL ENTITIES FROM
RUSSIAN FEDERATION AND SWITZERLAND

LOAN AND PROFIT REPATRIATION

Professor:
Anastasia V. KNIAZEVA

Performed by:
Budeanu Diana
Gabaydullin Ilnar
Kulikova Ekaterina
Malev Mikhail
Potapova Galina

LOAN AND PROFIT REPATRIATION

Russian Federation and Swiss Confederation
 THE CASE:
A Russian Bank “R”, payer of income tax and resident of the Russian Federation,
drew a loan of 260 mln. Russian rubles (RUB) at 24% per annum from a Swiss Bank
“S”, resident of the Swiss Confederation.

The Russian Bank “R” has the following balance sheet structure:
Assets Liabilities
Equity capital - 10 mln. RUB
of which the share of the Swiss Bank “S” - 30% - 3 mln. RUB
Debt – 290 mln. RUB.
of which the share of the Swiss Bank “S”- 260 million RUB.
Total - 300 mln. RUB. Total 300 mln. RUB

The Swiss Bank “S” has 30% of the share capital of the Russian Bank “R”. Hence,
the outstanding debt of the Russian bank “R” to foreign in the amount of 260 million
RUB is controlled.
Therefore we have to analyze the tax consequences of 2 types of income from 2
types of transactions:

30% EQUITY

Swiss Bank “S” 1. Profit repatriation

DIVIDENTS Russian Bank “R”

INTEREST 24%
INTEREST 24%

2. LOAN (260 mln. RUB)

I. ANALYSIS OF THE TAX CONSEQUENCES OF THE TRANSACTION
IN THE RUSSIAN FEDERATION
According to the paragraph 2 of Article 269 of the Tax Code of the Russian
Federation if a taxpaying Russian organization has a debt liability in respect of a
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foreign organization which directly or indirectly has under its ownership more than 20
per cent of the authorized (pooled) capital (fund) of this Russian organization
(hereinafter referred to in this Article as controlled debt) and if the amount of debt
liabilities on the credits granted by the foreign organization and not settled by this
Russian organization exceeds more than three-fold (for banks and organizations
engaged in leasing activity - more than twelve times and a half) the difference
between the sum of its fixed assets and the amount of liabilities (hereinafter for the
purposes of the present Item - one's own capital), as on the last day of every reporting
(tax) period, the following rules shall be applied to define the ultimate amount of
interest to be included into the composition of the outlays.

In our case the debt of the Russian Bank “R” is more than 12,5 times higher than
its equity: 290 mln. RUB. ÷ 10 mln. RUB = 29 (> 12,5)

This means we have to use the Thin Capitalization in order to calculate the
maximum amount of interest on this debt, which the bank has the right to deduct for
tax purposes.

The amount of interest which the Russian Bank “R” has to pay to the Swiss Bank
“S”: 260 mln. RUB X 24% = 62.4 mln. RUB

Therefore, the Capitalization Ratio is: 260 mln. RUB ÷ 3 mln. RUB ÷ 12,5= 6,93

According to the paragraph 3 of Article 269 of the Tax Code of the Russian
Federation, the maximum amount of interest on this debt, which the bank has the right
to deduct for tax purposes in the current fiscal period (the marginal interest), will be:
Actual interest ÷ the capitalization ratio = 62.4 mln. RUB ÷ 6.93 = 9 mln. RUB.

Therefore, according to the paragraph 4 of Article 269 of the Tax Code, the
positive difference between the calculated interest and the ultimate interest calculated
in conformity with the order established shall be equated for taxation purposes to the
dividends and shall be levied with tax in conformity with paragraph 3 of Article 284
of the Tax Code.

In our case it will be 53.4 mln. RUB (62.4 mln. RUB - 9 mln. RUB). This amount
does not reduce the tax base, and normally it should calculate the tax of 10,68 mln.
RUB at a rate of 20%, according to paragraph 2 of Article 284 and paragraph 1 of
Article 310 of the Tax Code.
But, according to the Article 7 of the Russian Tax Code (Effect of International
Treaties on Taxation), if a tax treaty of the Russian Federation, which contains
provisions concerning taxation and fees, establishes rules and standards other than
those provided by this Code or laws and other regulatory legal acts on taxes and/or

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fees adopted in accordance with it, the rules and standards of tax treaties of the
Russian Federation shall prevail.
Thus, as in the relations between the Russian Federation and the Swiss
Confederation is an Agreement for the Avoidance of Double Taxation with Respect to
Taxes on Income and on Capital from 15.11.1995 (hereinafter - Agreement), in our
case the transaction will be taxed in accordance with the provisions of this
Agreement.

I.1. INTEREST
First type of income to be taxed is the amount of Interest that the Russian Bank
“R” has to pay to the Swiss Bank “S”, from which the part that is not tax exempted
equals to 53.4 mln. RUB.
According to the paragraph 1 of the article 11 of the Agreement, the interest
arising in a Contracting State and paid to a resident of the other Contracting State may
be taxed in that other State.
However, according to the paragraph 2 of the article 11 of the Agreement, such
interest may also be taxed in the Contracting State in which they occur (in our case in
Russia), in accordance with the laws of this State, but if the recipient is the beneficial
owner, the tax so charged shall not exceed 10 percent of the total amount of
interest. Notwithstanding the preceding provisions of this paragraph, if any kind of
loan to the bank, the tax shall not exceed 5 percent of the total amount of interest.
The commentary to Article 11 of the Model Tax Convention on Income and
Capital OECD, which regulates the taxation of interest, said that paragraph 1 of this
article defines the principle, indicating that the interest arising in a Contracting State
and paid to a resident of the other Contracting State may be taxed the
latter. Moreover, this paragraph does not stipulate the exclusive right to tax interest in
favor of the country of residence.
Furthermore, paragraph 2 of this article establishes the right of taxation of interest
for the state in which such interest arise, but it limits the right marginal tax, calculated
at a rate that can not exceed the bid amount of which in a bilateral agreement by the
Contracting States.
Thus, limiting the possibility of taxation of interest means that the state income
source (Russia) limited the right to apply its national legislation, in particular the rates
of 20% for the taxation of income of foreign organizations in the form of interest on a
loan agreement under the legislation of the Russian Federation to implement the
taxation of income foreign organizations withheld.
In this case, the right to tax interest income earned by banks is limited by lowering
the rate from the law of the Russian Federation up to 5% rate envisaged by the
Agreement.

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 Consequently, in the case of payments to the Swiss Bank “S”, interest on the loan
agreement, the Russian Banks “R” is obliged to calculate and withhold tax at the rate
established by paragraph 2 of Article 11 of the Agreement – 5%:
53.4 mln. RUB X 5% = 2,67 mln. RUB

I.2. DIVIDENDS
According to the paragraph 1 of the article 10 of the Agreement, dividends paid by
a company which is a resident of a Contracting State to a resident of the other
Contracting State may be taxed in that other State.
However, according to the paragraph 2 of the article 10 of the Agreement, such
dividends may also be taxed in the Contracting State of which the company paying
the dividends, and in accordance with the laws of that State, but if the beneficial
owner of the dividends the tax so charged shall not exceed:
a) 5% of the total amount of the dividends if the beneficial owner of the dividends
is a company (other than a partnership), which directly owns at least 20 percent of the
capital of the company paying the dividends, and foreign capital invested in it, more
than two hundred thousand (200.000) Swiss francs or its equivalent in any other
currency at the time of accrual of dividends;
b) 15% of the total amount of the dividends in all other cases.

200.000 Swiss francs = 6,2 mln. RUB

In our case, the Swiss Bank “S” has invested only 3 mln. RUB in the equity of the
Russian Bank “R”. Therefore, the tax at source at a rate 15% will be imposed.
We assume that the Swiss Bank “S” received in form of dividends from the
Russian Bank “R”.
Hence, from the Swiss Bank “S” there has to be retained income tax on dividends:
1 mln. RUB X 15% = 150 000 RUB

The total amount of taxes withheld from the Swiss Bank “S” in the Russian
Federation will be:
2 670 000 RUB + 150 000 RUB = 2 820 000 RUB

According to the paragraph 1 of Article 312 of the Tax Code of the Russian
Federation, when applying provisions of international treaties of the Russian
Federation, the foreign organization shall submit to the tax agent, paying out the
income, confirmation of the fact that the foreign organization has a permanent place
of location in the state with which the Russian Federation has signed an international
treaty (agreement), regulating the questions of taxation which shall be certified by a
competent body of the corresponding foreign state. Where the given confirmation is
in a foreign language, its translation into Russian shall be likewise submitted to the
tax agent.

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 When the foreign organization having the right to the receipt of income submits
the confirmation mentioned in Item 1 of this Article to the tax agent, paying out the
income before the date of the payment out of the income with respect to which a
privileged regime of taxation is envisaged by the international treaty of the Russian
Federation, with respect to such income is applied relief from withholding the tax
from the source of payment, or the tax from the source of the payment is withheld at a
reduced rate.
But, according to the paragraph 3 of Article 310 of the Tax Code of the Russian
Federation, in the event of paying out by the tax agent to a foreign organization of the
incomes which are taxable under international treaties (agreements) in the Russian
Federation at reduced rates, the calculation and withholding of the tax from incomes
shall be effected by a tax agent at appropriate reduced rates, provided that a foreign
organization presents to the tax agent the confirmations stipulated by Item 1 of Article
312 of the Code. With this, in the event of paying out by Russian banks of incomes
from operations with foreign banks, the confirmation of the fact of a foreign bank's
permanent location in a state, with which an international treaty (agreement)
regulating taxation matters is made, shall not be necessary, if such location is
confirmed by the data from international reference-books open to general use.

II. PROFIT REPATRIATION AND TAX CONSEQUENCES OF THE

TRANSACTION IN THE SWISS CONFEDERATION
Profit repatriation largely depends on whether the Swiss entity is structured as a
company or branch. The main advantage of the branch is that it is quite easy to
transfer money from the parent company to the branch and vice versa. The branch is
not a separate legal entity; it is simply a subdivision of a foreign company. All cash
flow is within the same company, therefore there is no withholding tax in case of
repatriation of profits to the foreign parent company state. All profits obtained in
Russia can be transferred abroad without additional taxation.

Tax is imposed in Switzerland at the federal and cantonal/communal levels.

Federal taxes are withholding tax, stamp issuance and transfer tax, and value added
tax (VAT). At the cantonal/communal levels, companies are levied on capital taxes on
net equity and real estate taxes. Resident companies are taxed on their worldwide
income except for profits, derived from foreign branches and foreign immovable
property, which are tax exempt. Nonresident companies are taxed on permanent
establishment/branch income and/or immovable property located in Switzerland.
Corporate income tax is levied on a company’s net profit, which consist of
business/trading income, passive income and capital gains. Foreign-source income is
included in taxable income but relief is granted for dividend income. Business
expenses are deductible in computing taxable income. The federal tax rate on net
income is 8,5%. Since income and capital taxes are deductible in determining taxable
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income, the effective tax rate that a company pays on its profit before tax is 7,78%.
The cantonal/communal level rates vary widely, depending on the place of legal seat
or management of the company, and in the last years several cantons have revised
their corporate tax rates to become even more attractive to investors. Most cantons
apply a flat base rate. E.g. total tax rate on income of for companies registered in
canton Zug is 13.51%. Depending on place of residence the combined effective
income tax is between 13% and 22%.
There’re several special tax regimes in Switzerland. Various tax privileges exist at
the cantonal level, in particular for holding companies and domiciliary/mixed
companies. The holding company tax privilege is granted to companies whose
primary statutory purpose is the holding of participations (i.e. when at least 2/3 of the
total assets consist of investments in subsidiaries or, alternatively, at least 2/3 of
income consist of dividends) and that have no active trade or business in Switzerland.
Assume the Swiss company in our example is a holding company and their 2/3 of the
total assets consists of investments in foreign subsidiaries. In this case the company is
fully exempt from cantonal and communal income taxes. The effective federal income
tax rate on non-dividend income is 7,78%.
Under Swiss law, no withholding tax is levied on interest. Exceptions apply to
interest derived from deposits with Swiss banks, bonds and bond-like loans, which are
subject to a 35% withholding tax at the federal level. The thin capitalization rules,
which require a minimum equity ratio for each asset class is in force in Switzerland
(e.g. receivables may be debt financed by 85%, investments by 70%, intellectual
property by 70%). For taxation purpose interests on receivables from the loan
borrower, that exceeds the legal size, are recognized as dividends.

II.1. Interest
According the double taxation agreement between Russian Federation and
Switzerland, tax is imposed on interest at tax rate 5 or 15 %. In our case the right to
tax interest income earned by banks is limited by lowering the rate from the law of the
Russian Federation up to 5% rate envisaged by the Agreement. Tax on interest is paid
in Russia.

A) In case of holding company

In our case the Swiss Bank “S” that has provided the Russian Bank “R” with the
loan is considered as a holding company. The Swiss Bank “S” is only registered in
canton Zug, but conducting its business outside Switzerland, hence it is subject only
for federal income tax rate of 8,5 and as explained earlier, effective federal tax rate is
7.78% more over, such holding entity as the Swiss Bank “S” in our case is exempted
from any cantonal income taxes. Tax calculation of The Swiss Bank “S” is provided
in table below:

Interest from Russian Bank 59 730 000,00 RUB

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 Exchange rate RUR per CHF 31,00 RUB
Interest received by the Swiss Bank “S” 1 926 774,19 CHF
Tax deductible at rate 8,5% 163 775,81 CHF
Taxable amount on interest 1 762 998,39 CHF
Federal Tax 8,5% 149 854,86 CHF
Effective Tax rate in Switzerland 7,78%

B) In case of ordinary Swiss company located in canton Zug

If the Swiss Bank “S” did conduct business in Switzerland itself or had office and
employees in canton Zug, then it would be subject of total income tax rate (Cantonal
and Federal) of 16.1%, what as well is deductible, hence effective total tax rate would
be 13.51%. Table below states it numerically:

Total on taxes would be spent by the Russian Bank “R” 2.67 mln. RUB (effective rate
of 4.28%) and 7.78% or 13.51% by the Swiss bank “S” subject to business of the
entity.

Tax rate in Switzerland in Zug

Interest from Russian Bank 59 730 000,00 RUB
Exchange rate RUR per CHF 31,00 RUB
Interest received by the Swiss Bank “S” 1 926 774,19 CHF
Tax deductible at rate 16,1% 310 210,65 CHF
Taxable amount on interest 1 616 563,55 CHF
Federal + Cantonal Tax 16,1% 260 266,73 CHF
Effective Tax rate 13,51%

II. 2. DIVIDENDS
In case of a local company, repatriation of profits is normally done in the form of
dividends, whereas Russian legal entities suffer a withholding tax of 35%. This may
nevertheless be reduced in-full or in-part under applicable international tax treaties.

According the double taxation agreement between Russian Federation and

Switzerland, if the Swiss company directly owns at least 20 percent of the capital of
the Russian company and the invested capital exceeds CHF 200,000 at the moment
the dividends become due, it is imposed on the rate of 5%, and on the rate of 15% if it
doesn’t meet these conditions. In our case dividends do not meet these conditions and
therefore dividends are levied in Russia at rate 15%.

A) In case of holding company

We consider dividends received by the Swiss bank “S” from the Russian bank,
according to owned share of equity. Table shows Taxes on dividends due to the Swiss
Bank “S” from the Russian Bank “R” and taxes paid to Russian Federation (RF) and

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Confederation of Switzerland considering that the Swiss Bank “S” is only registered
in Zug canton of Switzerland:

Dividends due 1 000 000,00 RUB

Tax due by the Swiss Bank “S” to RF at 15% 150 000,00 RUB
Dividends from Russian Bank 850 000,00 RUB
Exchange rate RUR per CHF 31,00 RUB
Dividends received by the Swiss Bank “S” 27 419,35 CHF
Tax deductible at rate 8,5% 2 330,65 CHF
Taxable amount on dividends 25 088,71 CHF
Federal Tax 8,5% 2 132,54 CHF
Effective Tax rate in Switzerland 7,78%

B) In case of ordinary Swiss company located in canton Zug

Table shows Taxes on dividends due to the Swiss Bank “S” from the Russian
Bank “R” and taxes paid to Russian Federation (RF) and Confederation of
Switzerland considering that the Swiss Bank “S” is registered in Zug canton of
Switzerland and working within Switzerland:

Dividends due 1 000 000,00р.

Tax due by the Swiss Bank “S” to RF at 15% 150 000,00р.
Tax rate in Switzerland in Zug
Dividends from Russian Bank 850 000,00р.
Exchange rate RUR per CHF 31,00р.
Dividends received by the Swiss Bank “S” 27 419,35 CHF
Tax deductible at rate 16,1% 4 414,52 CHF
Taxable amount on Dividends 23 004,84 CHF
Federal + Cantonal Tax 16,1% 3 703,78 CHF
Effective Tax rate 13,51%

Glossary:

Resident - a person who is liable for tax in a country or state because of domicile,
residence, place of management, or other similar criterion.

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Income tax - a tax levied on the income of individuals or businesses (corporations or
other legal entities).
Profit repatriation –return of foreign-earned profits or financial assets back to the
company's home country.
Thin capitalization - a company is said to be "thinly capitalized" when its equity
capital is small in comparison to its debt capital.
Beneficial owner - a legal term where specific property rights ("use and title") in
equity belong to a person even though legal title of the property belongs to another
person.
Dividends - a payment by a corporation to shareholders, which is taxable income of
shareholders.
Withholding tax - Tax on income imposed at source, i.e. a third party is charged with
the task of deducting the tax from certain kinds of payments and remitting that
amount to the government.
Tax base - the thing or amount on which the tax rate is applied, e.g. corporate income,
personal income, real property.
Interest - the fee charged by a lender to a borrower for the use of borrowed money,
usually expressed as an annual percentage of the principal.
Tax agent - term which refers to a tax adviser who assists the taxpayer in fulfilling his
obligations under the legislation.
Transfer tax - tax levied on the transfer of goods and rights, e.g. purchase and/or sale
of securities and immovable property.
Value added tax (VAD) - specific type of turnover tax levied at each stage in the
production and distribution process.
Permanent establishment - term used in double taxation agreement (although it may
also be used in national tax legislation) to refer to a situation where a non-resident
entrepreneur is taxable in a country; that is, an enterprise in one country will not be
liable to the income tax of the other country unless it has a "permanent establishment"
thorough which it conducts business in that other country. Even if it has a PE, the
income to be taxed will only be to the extent that it is ‘attributable’ to the PE.
Branch - division, office or other unit of business located at a different location from
the main office or headquarters. It is not a separate legal entity.

Sources of the Research:

1. Agreement for the Avoidance of Double Taxation between Russian Federation and
the Swiss Confederation with Respect to Taxes on Income and on Capital from
15.11.1995

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2. The commentary to Article 11 of the Model Tax Convention on Income and Capital
OECD
4. Article 7 of the Russian Tax Code
5. Paragraph 2, 3 and 4 of Article 269 of the Tax Code of the Russian Federation
6. Paragraph 2 and 3 of Article 284 of the Tax Code of the Russian Federation
3. Paragraph 1 and 3 of Article 310 of the Tax Code of the Russian Federation
7. Paragraph 1 of Article 312 of the Tax Code of the Russian Federation,
9. Direct Federal Tax Law (DBG) of the Swiss Confederation
10. Tax Harmonization Law (StHG) of the Swiss Confederation
11. Withholding Tax Law (VStG) of the Swiss Confederation
12. “Doing business in Russia 2010”, Deloitte
13. “International Tax and Business Guide. Switzerland” Deloitte

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