|Nollaig Murphy||Andrew Quinn||Stephen McLoughlin|
On December 31 2011, the Russian Ministry of Finance stated that in certain cases the issuers of Eurobonds would not be considered the beneficial owners of interest payments paid by Russian entities. It will require Russian entities to withhold tax on payments to such issuers, unless it can be demonstrated that the holders of the underlying Eurobonds qualified for an exemption under the Russian Tax Code.
The most commonly used Eurobond structures involving Russian banks and companies are loan participation notes issued by non-Russian issuers, and bond offerings by non-Russian subsidiary issuers with guarantees by Russian parent companies. In such structures, the issuers of the Eurobonds are located outside of Russia, commonly in Ireland, and the proceeds of the issuances are transferred to the Russian companies, typically in the form of a loan.
The interest and principal payments paid by the Russian company to the issuer under the terms of the loan usually correspond to the interest and principal payments owed by the issuer to the holders of the Eurobonds.
Ireland has increasingly become the European jurisdiction of choice for international bond issuers to conduct structured finance transactions, by reason of its position within the EU and OECD, its progressive tax regime and its extensive network of double taxation treaties (DTTs). Arrangers regularly choose Ireland for establishing the Russian Eurobond structures, considered above.
In general, interest on borrowed funds paid by a Russian company to a non-resident person is subject to Russian withholding tax of 20%, unless tax reductions or elimination is possible under a DTT. The Ireland/Russia DTT reduces withholding tax on interest payments to zero.
As noted above, the Russian Ministry of Finance stated that in certain cases it would look to the underlying bondholders in the structures as the beneficial owners of any interest payments. As a consequence, Russian borrowers would be required to withhold 20%, unless it could be demonstrated that the holders of the Eurobonds are resident in a jurisdiction that has a DTT with Russia, fully exempting interest payments from withholding tax.
On February 20 2012, the Russian Ministry of Finance published a press release and a draft law relating to Russian withholding tax on Eurobond structures.
Pre- and post-2013
The draft law provides that there will be no requirement to withhold tax on interest payments made to foreign issuers of bonds issued prior to January 1 2013 provided (a) that the bonds are "quoted bonds" (bonds quoted on one or more recognised stock exchange(s) or cleared through a recognised clearing system), and (b) the issuer is located in a jurisdiction that has a DTT with Russia exempting interest from Russian withholding tax.
In relation to bonds issued after January 1 2013 the draft law provides that there will be no requirement to withhold tax on interest payments made to foreign issuers provided that the requirements for pre-2013 issuances outlined above are satisfied, and additionally provided the bondholders are either Russian resident organisations or organisations resident in jurisdictions that have DTTs with Russia. The Russian Ministry of Finance has stated it will not expect the Russian company to identify the entire bond ownership chain, but simply to identify the bondholders registered in the relevant depositary/clearing systems.
The precise practical requirements of this additional test are somewhat unclear. It may be necessary to procure certification of the residency of the first level of bondholders registered with or maintaining direct accounts in the clearing systems, rather than the identity of the ultimate bondholders. This may require the clearing systems to agree to provide geographic certification as to bondholders before each coupon payment date this could present practical difficulties. However, other structural solutions may be available.
The press release states that there are no plans to challenge borrowers in connection with interest payments made on Eurobonds issued prior to or during 2012. This provision of clarity by the Russian Ministry of Finance in relation to historic and 2012 issuances is welcome and provides reassurance to bondholders and sponsors.
In relation to post-2013 issuances, the draft law is not yet final. Market participants have already engaged in high level lobbying, which may continue if the most recent position assumed by the Russian Ministry of Finance does not go far enough. Further assessment will be required as to the precise scope and nature of the legislative provisions, what will be required practically around bondholder certification by the authorities, and the impact of such requirements on the successful operation of the Eurobond structures in the capital markets.
Depending on the final position reached, arrangers will need to consider how they structure new deals, and, in particular, (based on the current position) the location of the first level bondholder. To the extent solutions present themselves at the Irish issuer level, there is considerable flexibility under the Irish regime to facilitate such solutions.
This article summarises the position in respect to such matters as at March 20 2012.
Nollaig Murphy, Andrew Quinn and Stephen McLoughlin