In recent years, we have been frequently observing that the globalization activities, which reached an abnormal speed after the dissolution of the Union of Soviet Socialist Republics and its eastern block, have been reversed for various reasons. When it comes to taxes, countries have begun to voice louder for their rights regarding taxation, although they continue to keep their borders open to foreign investment. Of course, at this point, the voices of the countries are parallel to how powerful they are in the world.
With the opening up of the Russian Federation ("Russia") to the world, it is an indisputable fact that it has been the country that has attracted investments at the most tremendous rate in the last 30 years, and a vast majority of these investments are made by using Dutch holding companies, as is the case all over the world. According to the information published in the press, dividend and interest payments made by companies resident in Russia to its shareholders resident in the Netherlands were realized as 6.2 billion dollars in 2017, 5.6 billion dollars in 2018 and 4.6 billion dollars in 2019. When a country that has such a huge market and a country that can attract such a huge investment power come face to face, things may not always go quietly.
What is Happening between the Netherlands and Russia?
It is necessary to return to 2015 in order to get to the roots of the subject. In accordance with the concept of beneficial ownership, which was added to the Russian tax legislation in 2015, foreign companies that have subsidiaries in Russia since 2017 had to document and prove that they are the beneficial owners of these income in order to benefit from the advantageous tax rates included in the tax treaties with respect to the income they have obtained from their subsidiaries. This situation was in line with the basic logic of the BEPS (Base Erosion and Profit Shifting) initiative, which has been the hottest topic of our last decade in terms of international taxation, and of course, the companies resident in the Netherlands were also fairly affected by such developments. With this process, Dutch resident companies started to strive to fulfil the expectations of the Russian tax legislation from the beneficial owners.
By 2020, perhaps due to periodic global epidemic conditions, Russia have begun to take more strict and protective measures relating to taxation. Russia, which has very close economic relations with Luxembourg, Malta, Cyprus and the Netherlands, made an explicit request for the revision of the tax treaties in a way to increase the right of Russia to collect taxes, especially on interest and dividends and declared that they would withdraw from the tax treaty unilaterally if the requests were not realized. This showdown was immediately responded by Luxembourg and Malta, and the process of revision of tax treaties has begun. Cyprus, on the other hand, did not want to accept Russia's offer but had to accept it with the announcement that Russia had started the unilateral withdrawal process from the tax treaty. The situation between the Netherlands and Russia is currently at this point; the Netherlands did not accept Russia's offer, and Russia announced that it had started the unilateral withdrawal process from the tax treaty. It is very clear that the Netherlands is not Cyprus, on the other hand, Russia is not a mediocre market, and we will closely follow to which direction the showdown will evolve.
What is Russia’s Demand?
We can summarize the demands of Russia as increasing the rates included in tax treaties in a way that are in line with the local legislation. The changes on the agenda at the end of the similar process in the Cyprus tax treaty will probably be alike for the Netherlands. Accordingly, Russia, as the source country, wants to increase its right to levy tax over the dividends from 5%, as it is in the tax treaty, to 15% in parallel with the rate in the local legislation. Likewise, Russia, as the source country, also wants to increase its right to levy tax over interest payments, for which all taxation rights are given to the Netherlands in the current tax treaty, to 15%. If these offers are accepted, the result is very obvious; the tax burden on the interest and dividend income to be obtained indirectly from the Netherlands by companies investing through Dutch holding companies in Russia will increase significantly, and the investment will become considerably more expensive.
Unilateral Withdrawal Process from the Tax Treaty
If Russia decides to unilaterally withdraw from the tax treaty, the country must notify the Netherlands six months before the end of any fiscal year, at the latest, and the tax treaty will be terminated as of the following year. According to this calendar, it is too late for 2020, but if the notification regarding the process is made until the end of June 2021, it means that there will be no tax treaty as of January 1, 2022. In other words, the tax treaty will remain in effect until at least 1 January 2022.
In the event that the tax treaty is no longer in force, dividend payments to be made by Russian resident companies to their shareholders resident in the Netherlands will be subject to withholding tax over dividend and interest payments at the rate of 15% and 20%, respectively. From this point of view, there is not much difference for Russia between withdrawal from the tax treaty and its revision. Russia is playing this game with showdown, exactly the way it played with Cyprus, but we do not know how the Netherlands will play this game. We will live and see together.
Impact of Developments on Turkish Investors
When we look over all the statistics regarding the investments, we know that a significant majority of investments from Turkey are made through the Netherlands, and we also know that the vast majority of such investments, which are made through the Netherlands, go to Russia. Therefore, the developments in the tax treaty between the Netherlands and Russia will seriously affect Turkish investors, and if Russia does not accept the Netherlands' counter proposals regarding the conservation of the tax treaty provisions, the tax burden on dividends and interest income will remarkably increase.
We certainly must interpret this development together with the development of the entry into force of Multilateral Convention (MLI) which has been on the agenda in Turkey. While, for the last 6 months, Turkish investors have already focused on whether the exemption clause of the Dutch tax treaty will be disabled, and, consequently, whether the tax burden on dividends will increase by 20%, news coming from a completely different front will further increase their apprehension. While, the current tax burden on investments made by Turkish companies in Russia through the Netherlands is 24%, consisting entirely of taxes paid in Russia, (20% corporate tax in Russia + 5% dividend withholding tax over after-tax profit in Russia), this rate will increase to 45.6% (20% corporate tax in Russia + 5% dividend withholding tax over after-tax profit in Russia + 20% corporate tax in Turkey over the dividends received by Turkey) in case of the dissolution of the exemption clause in the tax treaty between Turkey and the Netherlands together with unilateral withdrawal of Russia from the double tax treaty with the Netherlands.
As explained above, it is clear that the outcome is intolerable, and Turkish companies investing in Russia through the Netherlands have to closely follow the developments not only in Turkey, but also between the Netherlands and Russia. However, while fulfilling the duties assigned by the BEPS initiative, it is highly likely for the Dutch holding companies, whose position against the venture capital funds abroad has been weakened, and which have to maintain a stricter stance with the CFC (Controlled Foreign Companies) regulations, to face with new threats directly (as in the case of Russia) or indirectly (as in the case of Turkey) in this general international tax agenda. Accordingly, it seems that the business of Turkish investors will get harder day by day. Considering the alternatives to the Netherlands as a holding location, we will come across provisions regarding the main purpose test of the MLI. With increasing protectionism and cross-border cooperation of tax administrations when it comes to tax collection, the world will gradually become much smaller.