Global Tax Alert | 14 September 2017

Japan signs revised income tax treaty with Russia

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Executive summary

On 7 September 2017, representatives of Japan and Russia signed a revised income tax treaty (the Revised Treaty) and protocol (the Protocol) which will replace the existing 1986 treaty.

The Revised Treaty is aimed at further promoting investment and economic activities between Japan and Russia. It eliminates barriers for cross-border collaboration and offers various opportunities for both countries. The revisions are also meant to align the Revised Treaty with the current Organisation for Economic Co-operation and Development (OECD) Model Convention as well as with the recommendations in the OECD’s final reports in its Action Plan on Base Erosion and Profit Shifting (2015 BEPS Reports).

Significant provisions in the Revised Treaty are:

  • Introduction of a fiscally transparent entity/arrangement concept
  • Tie-breaker rule for a treaty residency determination of non-individual dual resident persons
  • Expanded scope of permanent establishment
  • Reduction of withholding tax on dividend
  • Introduction of full exemption of withholding tax on interest and royalties
  • Relaxed source country capital gains on share dispositions
  • Limitation on benefits and principal purpose tests for the entitlement of benefits

The Revised Treaty and Protocol will enter into force 30 days following the exchange of ratification instruments. The provisions of the Revised Treaty and Protocol will become effective as of 1 January of the year following entry into force.

Unlike the existing 1986 treaty, the revised Treaty and Protocol will be effective only with Russia.

This Alert summarizes the key provisions of the Revised Treaty and Protocol.

Detailed discussion

Fiscally transparent entity/arrangement concept (Article 1)

Paragraph 2 of Article 1 states that income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State would be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that Contracting State, as the income of a resident of that Contracting State.

The term “fiscally transparent” means situations where, under the tax law of a Contracting State, income or part of the income of an entity or arrangement is taxed not at the level of the entity or arrangement but at the level of the persons who have an interest in that entity or arrangement.

Tie-breaker rule for non-individual dual resident persons (Article 4)

Paragraph 3 of Article 4 provides that, in cases where a person other than an individual is a dual resident, the competent authorities of the two Contracting States will seek a determination by mutual agreement of the country of residence based on the place of effective management, the place of head or main office, the place of incorporation or otherwise constituted and any other relevant factors. In the absence of such agreement, such person will not be entitled to any relief under the Revised Treaty.

Permanent establishment (PE) (Article 5)

Reflecting the recommendation in the 2015 BEPS Reports on Action 7, the PE definition is expanded by adding:

  • The anti-fragmentation rule. The exceptions to a PE definition (Paragraph 4 of Article 7) do not apply to a place of business that would otherwise constitute a PE where the activities carried on at that place and other activities of the same enterprise or of closely related enterprises exercised at that place or at another place in the same State constitute complementary functions that are part of a cohesive business operation (however, at least one of the places where these activities are exercised must constitute a PE or, if that is not the case, the overall activity resulting from the combination of the relevant activities must go beyond what is merely preparatory or auxiliary).
  • An enterprise is deemed to have a PE if a person acting in a Contracting State on behalf of an enterprise habitually concludes certain contracts, or habitually plays the principal role leading to the conclusion of those contracts that are routinely concluded without material modification by an enterprise.

Business income (Article 7)

The Revised Treaty’s taxation on business income attributable to a PE does not adopt the Authorized OECD Approach (Article 7 of the OECD Model Convention as amended in 2010 or AOA), and instead keeps the pre-AOA version of the attribution of profits to PE rules.

Dividends (Article 10)

The Revised Treaty provides the following four withholding tax rates:

  • A full exemption on dividends is applicable to a pension fund that is the beneficial owner.
  • A 5% rate applies to a corporate shareholder which has owned directly at least 15% of the voting power of the company paying dividends for period of 365 days ending on the date which entitlement to the dividends is determined.
  • A 15% rate applies to dividends from shares of a company or comparable interests, such as interests in a partnership, trust or investment fund if, at any time during the 365 days preceding payment of the dividends, these shares or comparable interests derived at least 50% of their value directly or indirectly from immovable property.
  • A 10% rate applies in all other cases.

Interest (Article 11)

The Revised Treaty provides a full exemption on interest other than the following:

  • Interest that is determined by reference to receipts, sales, income, profits or other cash flow of the debtor or a related person, to any change in the value of any property of the debtor or a related person or to any dividend, partnership distribution or similar payment made by the debtor or a related person, or any other interest similar to such interest arising in a Contracting State. In this case, a 10% rate applies.

Royalties (Article 12)

The Revised Treaty provides exclusive resident country taxation on royalties.

Capital gains (Article 13)

The Revised Treaty grants a full exemption on gain from disposition of shares other than the shares in a company deriving at least 50% of the value directly or indirectly from immovable property at any time during the 365 days preceding the transfer, unless the shares are traded on a recognized stock exchange and the resident (including persons related to that resident) owns in aggregate 5% or less of the shares.

Entitlement to Benefits (Article 21)

Article 21 of the Revised Treaty introduces the provisions that set forth the criteria that would determine whether a person is considered as a qualified person (as defined in Paragraph 2 of Article 21) or satisfies any other specified objective tests to be entitled to the benefits (dividends, interest and royalties) in the Revised Treaty. The objective tests are based on characteristics such as legal structure, ownership, or activities reflecting a link between the person and the residence state.

The competent authority may still grant benefits to a resident of Contracting State even if the resident fails to be a qualified person or satisfy one of the objective tests.

Paragraph 8 of Article 21 of the Revised Treaty provides that a benefit under the Revised Treaty will be denied if obtaining the benefit under the treaty is one of the principle purposes of any arrangement or transaction that would result directly or indirectly in that benefit.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Co., Tokyo
  • Hiroyuki Nishida
    +81 3 3506 2026
  • Jonathan Stuart-Smith
    +81 3 3506 2426
Ernst & Young LLP, Japanese Tax Desk, New York
  • Hiroaki Ito
    +1 212 360 9378
Ernst & Young LLP, Asia Pacific Business Group, New York
  • Chris Finnerty
    +1 212 773 7479
  • Kaz Parsch
    +1 212 773 7201
  • Bee-Khun Yap
    +1 212 773 1816
Ernst & Young LLP, Asia Pacific Business Group, Houston
  • Trang Martin
    +1 713 751 5775

EYG no. 05249-171Gbl