What Is the Status of the US-Russia Tax Treaty?

Tax treaties are agreements between countries designed to clarify tax obligations and prevent the same income from being taxed twice. They facilitate international commerce by providing clear rules and reducing taxes on cross-border income. For many years, the United States and Russia operated under such a convention. The treaty’s purpose was to allocate taxing rights and set limits on the taxes each country could impose on specific types of income, offering certainty to individuals and businesses with cross-border activities.

Suspension of the Treaty

The status of the U.S.-Russia income tax treaty shifted in 2023. In August of that year, Russia unilaterally suspended numerous provisions of the agreement. This action targeted the articles dealing with the taxation of business profits, dividends, interest, and royalties, dismantling the primary mechanisms designed to prevent double taxation.

In response, the U.S. Department of the Treasury provided formal notice to Russia on June 17, 2024, to suspend the operation of most of the treaty’s articles. This step was a direct reaction to Russia’s earlier decree.

The suspension of the treaty provisions became effective on August 16, 2024, for both taxes withheld at the source and other taxes on income. As of this date, taxpayers can no longer rely on the suspended articles for tax relief. The suspension will remain in effect until the two governments decide otherwise.

Key Treaty Benefits Lost

One of the benefits lost was the reduced withholding tax rates on cross-border payments. Under the treaty, the tax on dividends was limited to 5% if the beneficial owner was a company holding at least 10% of the voting shares, and 10% for other dividends.

Similarly, the treaty eliminated withholding taxes on interest and royalties paid to a resident of the other country, setting the rate at 0%. This provision was favorable for companies involved in cross-border lending or licensing of intellectual property.

Another protection removed is the treaty’s definition of a “Permanent Establishment” (PE). Article 5 set a high threshold for when a business from one country would be considered to have a taxable presence in the other, requiring a fixed place of business like an office or factory.

This PE threshold protected businesses from being taxed on their profits in the other country if their activities were merely preparatory or auxiliary, such as maintaining a storage facility. With the suspension of Article 5, this protection is gone.

Current Tax Implications Without the Treaty

With the treaty’s core provisions suspended, the default tax rules of each country now apply. For payments of dividends, interest, and royalties from U.S. sources to Russian residents, the statutory withholding tax rate is now 30%. This is a substantial increase from the rates available under the treaty.

Conversely, U.S. individuals and companies receiving payments from Russia will be subject to Russia’s domestic withholding tax laws. The absence of treaty protection means there is no internationally agreed-upon cap on these rates, creating uncertainty and a higher tax burden.

The loss of the Permanent Establishment article also has consequences. Without the treaty’s clear definition, it is easier for a company’s activities to create a taxable presence in the other country. Activities previously exempt could now be sufficient to trigger a tax liability under domestic laws.

The primary consequence of the treaty’s suspension is the heightened risk of double taxation. Without the treaty’s coordinated rules, it is possible for both the U.S. and Russia to tax the same income. This places the burden on the taxpayer to navigate the domestic laws of both countries to mitigate being taxed twice.

Navigating Foreign Tax Credits

For U.S. taxpayers facing Russian taxes on their foreign income, the U.S. foreign tax credit (FTC) is the main tool for mitigating double taxation. The FTC is a non-refundable credit that allows taxpayers to reduce their U.S. income tax liability for income taxes they have already paid to a foreign government.

To claim the FTC, a taxpayer must have paid or accrued creditable foreign income taxes. Only income taxes are eligible for the credit, and the taxpayer must have documentation to substantiate the claim, such as official tax receipts or statements from the foreign taxing authority.

The main form for claiming the credit is IRS Form 1116 for individuals, estates, or trusts, while U.S. corporations use Form 1118. On the form, taxpayers must categorize their foreign source income into different baskets, such as passive or general category income. The calculation is performed separately for each category.

The credit is limited to the lesser of the foreign tax paid or the U.S. tax liability on that foreign income. If foreign taxes paid exceed the U.S. limitation, the excess amount can be carried back one year or forward for up to ten years. Given the higher withholding rates, taxpayers may find themselves with excess foreign tax credits they cannot use immediately.