On 27th June 2023, the Latvian government adopted Cabinet Regulation No 333 “List of Low-tax or Tax-free Countries and Territories”, which approves a new list of low-tax or tax-free countries and territories, including Russia. The Regulation enters into force and is applicable as of 1st July.

Krievija ofšors

According to the updated to the updated list of the Ministry of Finance, as of 1st July, the tax-free zones are as follows:

  1. Anguilla territory;
  2. Commonwealth of the Bahamas;
  3. The Republic of Costa Rica (as from 1st July 2023);
  4. Guam, territory of the USA;
  5. The Republic of Fiji;
  6. The Republic of the Marshall Islands (as from 1st July 2023);
  7. The Republic of Palau;
  8. The Republic of Panama;
  9. The Russian Federation (as from 1st July 2023);
  10. Samoa, territory of the USA;
  11. The Independent State of Samoa;
  12. The Republic of Trinidad and Tobago;
  13. Turks and Caicos Islands;
  14. The Republic of Vanuatu;
  15. The British Virgin Islands (as from 1st July 2023);
  16. Virgin Islands, territory of the USA.

On 14th February 2023, The British Virgin Islands, the Republic of Costa Rica, The Republic of the Marshall Islands and the Russian Federation were added to the list of non-cooperative tax jurisdictions, as updated by the European Union.

Latvian tax legislation provides for a special tax regime (safeguards) for transactions with persons located or established in low-tax or tax-free countries and territories.

These safeguards are as follows:

Withholding tax on payments to Russia

Corporate income tax at the rate of 20% is withheld from all payments and dividends paid by Latvian residents or permanent establishments of non-residents to legal, natural and other persons located, established or incorporated in low-tax or tax-free countries or territories, including payments to agents of such persons or payments to third party bank accounts and payments made by way of netting, except for payments for supplies of goods and securities purchased for public circulation in the European Union or the European Economic Area, where such goods and securities are purchased at market prices (value).

In simple terms, 20% must be withheld from all payments except for the supply of goods (at market value) and public loans, where goods and securities are purchased at market value. What market value means is a broad question; very briefly, market value is the price that would be charged by unrelated (uncontrolled) firms to each other under comparable conditions (the so-called arm’s length principle). The Russian partner is no longer considered as an unrelated company and the transaction is considered as controlled.

So what needs to be done to prove market value:

  • (1) A comparability analysis, including a functional analysis, must be carried out,
  • (2) Select the most appropriate transfer pricing method,
  • (3) A comparable data study (internal or external data) should be carried out to determine whether market value has been met.

If the purchase price of the goods and securities is not above market value, no withholding is required.

Notwithstanding any provision of law, unless there is an obligation to withhold personal income tax, corporate income tax is withheld on interest payments and payments for intellectual property – 20%, payments to persons in low and tax-free countries, territories, including payments to their representatives or payments to third party bank accounts and payments made in the form of mutual settlements.

Flow-through dividends

A Latvian enterprise shall be entitled to reduce the amount of dividends included in the taxable base during the tax period to the extent that it has received dividends during the tax period from a dividend payer that is a corporate taxpayer in its country of residence or dividends from which tax has been withheld in the country of payment, except dividends received from a person located, incorporated or established in low-tax or tax-free countries or territories.

Thus, dividends received by a Latvian company from a Russian company will in fact be taxable in Latvia (at the time of payment), or in other words – the dividends are no longer flow-through.

Prohibition on reducing the tax base on income from the sale of shares

When a Latvian company sells shares that have been held for more than 3 years, the capital gain is payable as a dividend, tax-free. Of course, this exception does not apply to investments made in low-tax countries. So if a Latvian company owns shares in a Russian company which the Latvian company will dispose of, then accordingly this exemption will not apply and the gain on the sale of the shares will effectively be taxed.

Treating transactions as related party transactions

All companies located in low-tax areas are considered to be related companies, even if there are no other indications of related companies. This means that in transactions with them, in addition to the above mentioned restrictions on the acquisition of goods, the arm’s length value must also be applied to the other transactions, including the sale of goods and provision of services to Russian companies.

This means that a transfer pricing analysis must be carried out, as outlined above, and transfer pricing documentation must be prepared if the value of the transaction exceeds 250 000 EUR. It is particularly important to mention that above the threshold of 5 000 000 EUR the submission of local transfer pricing documentation becomes mandatory.

Application of controlled foreign company rules.

A Latvian company must include in its taxable base for corporation tax purposes the share of profits (increase in the value of assets) derived from artificially created transactions in a foreign company in which the taxpayer itself or together with related parties owns a substantial interest.

An artificial transaction is a transaction (including a set of transactions) the main reason for which is to obtain a tax advantage, i.e. a transaction (including a set of transactions) to the extent that the foreign company would not assume the risks or acquire the assets if the foreign company or permanent establishment were not controlled by the company which performs the essential administrative functions in respect of those risks and assets for the production of that income.

These provisions do not apply if in the reporting year of a foreign company or permanent establishment:

  • profits do not exceed 750 000 EUR,
  • income not derived from the sale of goods and services does not exceed 75 000 EUR.

However, these thresholds do not apply to companies registered in low-tax countries, so if a Latvian company has a subsidiary in Russia, it needs to make sure that no transactions that meet the definition of artificial transactions are carried out.

Conclusion

We will not judge the decision to include Russia on the low-tax list, for which there are obviously plenty of reasons. However, it is clear that for Latvian companies that do any business with Russian companies or have investments in Russia, now is the time to reassess the situation. If you need advice, let us know!

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