28 October 2009

RUSSIAN PERMANENT ESTABLISHMENTS AND

SUBSIDIARIES OF FRENCH LEGAL ENTITIES
ARE ELIGIBLE TO DEDUCT ALL THEIR COSTS
INCURRED WITH RESPECT TO THEIR INDUS-
TRIAL AND COMMERCIAL ACTIVITIES

The Russian Ministry of Finance issued a letter setting out its position on the applica-
tion of clause 4 of the Protocol to Convention between the Government of the
Russian Federation and the Government of the Republic of France for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion and Fraud with Respect to
Taxes on Income and on Capital signed on 26 November 1996 in respect of the
deduction of expenses by permanent establishments (Letter No. 03-08-05 dated
29 September 2009).

The Department Tax and Customs Policy of the Russian Ministry of Finance was inquired whether it
was possible to recognise for corporate profit tax purposes voluntary insurance costs incurred with
respect to industrial or trading activities carried out by the Russian permanent establishment
(Russian subsidiary) of a French legal entity.

This question was triggered by the fact that taxpayer’s expenses on voluntary insurance may be de-
ductible only if a respective type of insurance is specified in clause 1, article 263 of the Russian Tax
Code. If such type of insurance is not included on the above-mentioned list and legislation does not
stipulate the obligation to provide insurance against the corresponding risk, expenses on such insur-
ance may not be recognised as deductible for corporate profit tax purposes.

At the same time, several Russian tax treaties signed in mid-90s contain a deviating from the OECD
Model Convention clause under which subsidiaries resident in a treaty state controlled by residents
of another treaty state are entitled to full deductibility of all or specific expenses. The reason for this
was the fact that at that time Russian tax law contained numerous limitations on deductibility of ex-
penses. The tax treaty with France is one of such treaties. The question, therefore, arose on whether
the Ministry of Finance would confirm whether this tax treaty provision overrules the domestic limi-
tation on deductibility of expenses.

In accordance with clause 4 of the Protocol, a Russian company controlled by a French resident
company, when assessing its corporate profit tax, is eligible to deduct expenses incurred with respect
to its industrial or trading activities. Said provision is applicable under certain conditions specified in
clause 4 of the Protocol, namely: at least 30% ownership interest and at least FRF500,000 invest-
ments, which is equivalent of approximately EUR 76,000.
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In its Letter, the Russian Ministry of Finance stated that the Protocol did not impose any restrictions
on deductibility of expenses. Moreover, the French text of the Protocol refers to the possibility to
deduct all expenses incurred by the company with respect to its industrial and trading activities. It
should be noted that the Russian Ministry of Finance did not limit its conclusions only to insurance
expenses in its response.

The Russian Ministry of Finance made the above conclusion on the basis of its interpretation of the
Protocol with due account of the protocol of negotiations held between the Russian and French con-
tracting parties, as well as the French text of the Protocol.

Following the provisions of article 32 of the Vienna Convention on the Law of Treaties done on 23
May 1969 allowing in cases when the interpretation leaves the meaning ambiguous or obscure to
recourse to the supplementary means of interpretation, including the preparatory work of the treaty,
the Russian Finance Ministry found it possible to use the draft Protocol in the French language,
which is identical to the official French text of the Protocol, for the interpretation.

Consequently, if expenses are incurred with respect to the activity aimed at obtaining profits and are
justified and documented, i.e., they comply with the requirements established in article 252 of the
Russian Tax Code, the expenses should be deductible for corporate profit tax purposes in accordance
with the Convention and the Protocol thereto.

In view of the above position of the Russian Ministry of Finance, we believe that when assessing the
possibilities for Russian permanent establishments and Russian subsidiaries of French resident com-
panies to deduct expenses, the general provisions of the Russian Tax Code should be followed. Such
provisions allow the taxpayer to deduct expenses to an extent to which they are deemed economi-
cally justified (i.e., within the meaning of clause 4 of the Protocol, “they are incurred with respect to
industrial and trading activities”) and documented. Restrictions imposed by certain provisions of
Chapter 25 of the Russian Tax Code on deduction of specific expenses should not be applied.

It should be noted that Russian double tax treaties with such countries as Germany, the Netherlands,
Belgium, the UK and the USA, contain special provisions on the deduction of expenses incurred by
permanent establishments of non-residents in Russia or their subsidiaries. The analysis of the appli-
cability of such double tax treaties to a specific situation may reveal a possibility for full deduction
of certain expenses.

Conclusion

To benefit from the tax treaty provisions a Russian subsidiary of a resident in a tax treaty country
would need to perform a 3 step analysis and to identify:

1. Whether relevant tax treaty contains a clause on full deductibility of all or specific expenses?
2. If such clause exists, whether the subsidiary qualifies for its application?
3. If the subsidiary qualifies for such a full deductibility, it needs to check whether it uses all avail-
able benefits.

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CONTACT INFORMATION

Andrey Tereschenko
Partner
Pepeliaev, Goltsblat & Partners
Tel.: (495) 967-00-07
Fax: (495) 967-00-08
a.tereschenko@pgplaw.ru

Roustam Vakhitov
Senior tax manager of the Group for
International Taxation
Pepeliaev, Goltsblat & Partners
Tel.: (495) 967-00-07
Fax: (495) 967-00-08
r.vakhitov@pgplaw.ru
Sergey Sosnovsky
Head of Tax Practice, St. Petersburg
Pepeliaev, Goltsblat & Partners
Tel.: (495) 967-00-07
Fax: (495) 967-00-08
s.sosnovsky@pgplaw.ru

Daniil Krymskiy
Junior attorney
Pepeliaev, Goltsblat & Partners
Tel.: (495) 967-00-07
Fax: (495) 967-00-08
d.krymskiy@pgplaw.ru

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MINISTRY OF FINANCE OF THE RUSSIAN FEDERATION

9, Ilyinka St., Moscow 109097

Teletype: 112008, telefax: 625-08-89

29 September 2009 No. 03-08-05 Association of European Business

to No. 08/920 dated 16 July 2009 40-2, Bolshaya Ordynka St., Moscow, 119017

The Department for Tax, Customs and Tariff Policy considered your request regarding the applica-
tion of the Convention between the Government of the Russian Federation and the Government of
the Republic of France for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
and Fraud with Respect to Taxes on Income and on Capital signed on 26 November 1996 (the
“Convention”) in respect of deducting expenses for corporate income tax purposes incurred with
respect to industrial and trading activities carried out by the Russian permanent establishment and/or
Russian subsidiary of a French legal entity and informs as follows.
In accordance with clause 4 of the Protocol to the Convention, which constitutes an integral part
thereof, when calculating taxable income and profits of the Russian permanent establishment of the
French resident company, expenses incurred by said permanent establishment with respect to its in-
dustrial and trading activities are deductible.
The above provision is also applicable to a company or other establishment that pays taxes and is a
Russian resident, provided:
– at least 30% of the Russian company’s authorised capital is held by one or more French residents;
– total Russian company’s authorised capital amounts to at least FRF500,000 or its equivalent in
other currency.
The amount is equal to €76,220 at the official rate of the European Central Bank.
The above-mentioned Protocol does not impose any restrictions on deductibility of expenses. More-
over, the French text of the Protocol refers to the possibility to deduct all expenses incurred by the
company with respect to its industrial and trading activities. It should be noted that negotiations on
the Convention were held in French and that both parties initialled the French version of the draft
Convention containing said provision. In accordance with Article 32 of the Vienna Convention on
the Law of Treaties signed on 23 May 1969, when the interpretation leaves the meaning ambiguous
or obscure, recourse may be had to supplementary means of interpretation, including the preparatory
work of the treaty, namely the draft Protocol in the French language that was agreed on by the par-
ties and is identical to the official French text of the Protocol.
Consequently, if expenses are incurred with respect to the activity aimed at obtaining profits and are
justified and documented, then such expenses should be deductible for corporate income tax pur-
poses in accordance with the Convention and the Protocol thereto. It should be noted that, in accor-
dance with the Regulations of the Russian Finance Ministry, requests relating to the evaluation of
particular business situations are not considered.
At the same time, please be advised that this letter issued by the Department does not contain legal
rules or general rules specifying the statutory provisions. Nor does it constitute a regulatory legal
act. In accordance with Letter No. 03-02-07/2-138 of the Russian Ministry of Finance dated 7 Au-
gust 2007, the opinion sent by the Department is of informational and explanatory nature as regards
to the application of Russian legislation on taxes and levies and does not prevent from following the
rules of law on taxes and levies in interpretation that is different from same expressed in this letter.

I.V. Trunin Executed by D.V. Nikolaev

Head of Department Tel.: 225-43-72