Global Tax Alert | 9 December 2013

Russian Finance Ministry comments on treaty relief for income from a capital reduction of an LLC

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The Russian Tax Code provides clear rules for the taxation of a company receiving income as a result of a liquidation of a subsidiary or withdrawal from participation in a Limited Liability Company (LLC). However, the treatment of a voluntary partial redemption of an LLC's charter capital is less clear.

Assets and property rights received by a participant in a company when it withdraws from an LLC or when the assets of an LLC which is undergoing liquidation are divided among the respective participants are not taxable income to the extent that they are within the amount of the participant's investment (contribution) to the LLC.1 This rule provides no basis for excluding from the tax base any income received as a consequence of a partial reduction in charter capital.

A Dutch participant in an LLC recently received a letter of clarification from the Ministry of Finance on this issue.2 The question concerned the tax treatment of the receipt of an amount within the limits of the Dutch participant's previous contribution to the LLC, as a result of a planned scaling down of the participant's investment through reductions in charter capital.

The Finance Ministry's response confirms that the exemption for liquidations and complete withdrawals from an LLC does not apply under the Russian Tax Code.

Therefore, the income of the Dutch company is subject to taxation at source under clause 1 of Article 309 of the Tax Code as Russian source income of a foreign organization which is not connected with activities via a permanent establishment in Russia. Subclause 2) of this clause is particularly relevant to the Dutch company's case as it catches income received as a result of a distribution in favor of a foreign organization of profits or assets of organizations.

The letter then addresses the availability of treaty relief and concludes that the income is exempt from tax in Russia under Article 21 “Other Income” of the tax treaty between the Netherlands and Russia. This article applies to income not mentioned in preceding articles of the treaty. The absence of any comments concerning the more limited exemption available for income caught by Article 10 “Dividends” implies that the Finance Ministry did not consider the income in question to be a dividend for the purposes of the treaty.

A “dividend” for the purpose of Article 10 means “income from shares, or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.” Income from a Russian source considered a dividend for the purposes of the Tax Code is defined as:

“Any income received by a shareholder (participant) from an organization upon a distribution of profit remaining after taxation (including in the form of interest on preference shares) on shares (holdings) belonging to the shareholder (participant) in proportion to the shares held by the shareholders (participants) in the charter (pooled) capital of that organization.”3

There are a number of exceptions, but none relevant to a partial reduction of share capital by an LLC. In addition income is treated as a dividend for profits tax purposes if it is non-deductible interest on controlled indebtedness under Article 269.4.

It is important to consider that the tax authorities would be less likely to treat a partial reduction in charter capital by an LLC as exempt from tax if the LLC in question had sufficient distributable profit to have made the payment to its participant as a dividend (which would certainly be subject to taxation at source) and has chosen to implement a voluntary reduction in capital instead.


1. Article 251.1 clause 4) of the Tax Code.

2. Letter No. 03-08-05/43186 of 16 October 2013.

3. Article 43.1 of the Tax Code.

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

Ernst & Young (CIS) B.V. branch in Moscow
  • Maureen O'Donoghue
    +7 495 228 3670
  • Vladimir V. Zheltonogov
    +7 495 705 9737
Ernst & Young LLP, Russian Tax Desk, New York
  • Julia Samoletova
    +1 212 773 8088

EYG no. CM4028