Background
Announcement 2024-26 is in direct response to Russia’s notification on Aug. 8, 2023, of its desire to suspend paragraph four of Article 1 and Articles 5-21 and 23 of the U.S.-Russia Tax Convention (the Treaty), as well as the Protocol.
The IRS and Treasury have already removed the treaty with Russia from the list of U.S. income tax treaties that meet the requirements of section 1(h)(11)(C)(i)(II) (Notice 2024-11). The list is relevant in determining whether a corporation is a “qualified foreign corporation” and if a reduced capital gains rate on certain dividends can be applied. Notice 2024-11 is effective for dividends paid on or after Jan. 1, 2023. Taxpayers looking for additional information on Notice 2024-11 can read RSM US's previous tax alert (List of US income tax treaties meeting qualified dividend requirements updated).
Key tax consequences of the suspension
An income tax treaty, in the most basic sense, is a bilateral (two-party) agreement made between two countries to reduce or eliminate double taxation and to promote international trade. A treaty may only be relied upon if it is in force. Suspension of certain provisions of a treaty means that taxpayers can no longer rely on such provisions of the treaty until that suspension has been lifted. In this case, the Treaty has not actually been terminated but portions of the Treaty have been suspended.
As a result, taxpayers may no longer claim certain benefits under the United States-Russia income tax treaty beginning Aug. 16, 2024.
Rate of withholding to increase
The partial suspension of the treaty will require taxpayers to withhold tax at the statutory rate, a rate much higher than the applicable treaty rate. As a result, the United States will generally impose a rate of withholding on dividends, interest, royalties and other similar payments at 30%. Russia will generally impose a rate of withholding on dividends, interest, royalties and other similar payments at rates ranging from 15% to 20%.
Taxpayers should review their payment systems and make adjustments to ensure they are withholding at the appropriate rate in order to avoid liability for failure to withhold at the correct rate. U.S. taxpayers should also expect withholding taxes to increase on amounts paid by Russian payors and they should consider the impact of such taxes on their foreign tax credit position.
Taxable presence exposure
The partial suspension of the treaty could create greater exposure to taxable presence in Russia or the U.S. because taxpayers will no longer be able to claim protection under the permanent establishment article of the Treaty. Beginning Aug. 16, 2024, only local country law (i.e., U.S. or Russian law) will be applicable in determining whether a taxpayer has taxable presence. Thus, U.S. companies claiming exemption from Russian tax under the permanent establishment article may have tax liability. Russian taxpayers may have similar exposure to U.S. income tax.
Taxpayers should analyze whether they will have a taxable presence in Russia (or the U.S.) upon suspension of Article 5 of the treaty.
Double taxation
Announcement 2024-26 suspends certain provisions regulating taxing rights to various categories of income including but, not limited to: business profits; passive income (i.e., dividends, interest and royalties); income earned by teachers, trainees, artists, athletes, etc.; gains from the sale of personal property; real property income; employment income; shipping and air transport income; and other income. U.S. taxpayers may now be more likely subject to double taxation because the Announcement suspends paragraph four of Article 1, which allowed U.S. citizens and residents to claim relief under Article 22, which provided relief from double taxation.
Taxpayers should analyze whether they will be subject to additional tax to ensure they are correctly estimating their tax liability.
Final reminders
The suspension will take effect on Aug. 16, 2024, and will continue until otherwise decided by the two governments.
The full text of the Treaty and other treaty documents can be found on the Treasury website.
