Russia's Suspension of Tax Treaties: A Move Towards Deeper Economic Isolation

In a strategic move that appears to align with President Vladimir Putin's long-term goals, the Russian government is taking the controversial step of suspending tax treaties with both major nations and smaller financial centres that it has maintained alliances with for decades. This decision is raising questions about whether it signifies a deliberate strategy aimed at further isolating Russia on the global economic stage.

The move, announced via an executive order signed by President Putin on August 8, entails the suspension of 38 double taxation agreements. These agreements will be suspended with countries that have imposed sanctions on Russia. The stated rationale behind this decision is to counteract what the order labels as "unfriendly actions by a number of foreign states." Before this suspension takes effect, it must first secure approval from the State Duma, the lower house of Russia's Federal Assembly.

Swift criticism of the decision came from Japan, which became the first country to voice its concerns. Japanese Chief Cabinet Secretary Hirokazu Matsuno expressed disappointment and stated that Japan had registered a formal protest with Russia over the suspension of the tax treaty between the two nations. Matsuno conveyed that the move could have negative repercussions for Japanese citizens and businesses and described it as an "unjustified measure."

The impact of this decision goes beyond Japan, extending even to nations like Cyprus and Malta. These countries, known for their financial ties with Russia, have found themselves unexpectedly affected by the suspension of tax treaties. The targeting of these nations raises intriguing questions. While they have histories of financial connections with Russia, both Cyprus and Malta have also displayed skepticism towards European Union sanctions related to the Ukraine conflict. This prompts speculation that the suspension may have wider implications, possibly being an attempt to curtail outbound investment and encourage capital inflow to Russia.

The motivation behind this move becomes more complex when considering the broader international context. The United States and a majority of European countries implemented economic sanctions against Russia in response to the Ukraine war. Russia's response involved the appropriation of intellectual property and assets belonging to foreign companies from the countries that imposed sanctions.

Interestingly, even well-known household brands such as Coca-Cola, McDonald's, and Starbucks made the decision to exit Russia in protest of the conflict. However, not all companies withdrew swiftly or with their complete assets intact. There were even calls within the United States to terminate the 1991 tax treaty with Russia during the Joe Biden administration. This proposed move would have eliminated a 30% withholding tax on Russian investors, thereby revoking their preferential tax treatment.

Although the US Treasury ceased sharing tax information with Russian authorities in April 2022, the decision was made not to terminate the agreement. Now, with Putin's suspension of this treaty, a new layer of complexity is added, potentially erecting barriers for Russian businesses with US holdings in the foreseeable future.

The suspension of tax treaties was initially proposed by the Ministry of Finance and the Foreign Ministry in March 2023, following the EU's decision to blacklist Russia as a non-cooperative tax jurisdiction. This action came after Russia had been on the EU's grey list since February 2022, triggered by its incursion into Ukraine.

The suspension of these treaties carries significant implications for cross-border transactions and transfer pricing arrangements. Transactions that previously were not subject to withholding taxes under these double taxation agreements will now be impacted. This change could result in heightened tax burdens for companies still operating in Russia from the countries affected, potentially prompting more foreign businesses to withdraw from the Russian market due to increased costs.

Experts suggest that Putin's long-standing policy of encouraging Russian businesses to repatriate their assets might play a role in this decision. Termed 'de-offshorization,' this policy gained momentum after Russia's annexation of Crimea in 2014 and the subsequent Western sanctions. Putin's adept use of adversaries' actions to advance his own agenda is a notable strategy, fostering elite consolidation and rallying national unity.

As a consequence of these developments, Russia's path towards economic isolation has been reinforced over time, a trend that may continue irrespective of the future resolution of the Ukraine conflict. Rebuilding economic relationships with Russia could pose formidable challenges, given the depth of the nation's current isolation.

The decision to suspend tax treaties is yet another testament to the complex interplay of international politics, economic strategy, and geopolitical dynamics, underscoring the intricacies of global financial interactions.

By fLEXI tEAM