Taxation of self-employed in Russia: potential discrimination

Citizenship can be used as either a principal or a supplementary tax nexus. As it has been mentioned before, the US government applies it as a principal criterion for tax purposes, although this criterion is more usually applied for cross-border taxation when the status of a tax resident is to be determined. According to the OECD Model Convention of 2017, nationality should be applied as a supplementary connecting factor if a person does not fit the criteria of permanent home, center of vital interests, or habitual abode. In some countries citizenship or nationality can be used for establishing domicile. Because it is a civic nexus, domicile status can be based on citizenship or nationality. For example, Japan presumes a person is domiciled if they reside in Japan continuously for more than one year in the light of such circumstances as whether they have Japanese nationality, or whether they have relatives who share the same livelihood with that individual in Japan have Japanese nationality, or whether they have their occupation and assets in Japan. Beretta [Beretta G., 2019] provides another example of citizenship as a supplementary nexus in analyzing the practices of EU countries in exit taxation aimed at preventing tax avoidance by changing citizenship or nationality through emigration. A country's tax rights may be expanded even in the context of bilateral tax treaties by a saving clause that may apply to non-resident citizens [Kallergis A., 2021], and this provides one more example of how the citizenship criterion may be employed to modify a tax nexus.

If citizenship can function as a principal or supplementary tax nexus, is citizenship a principal or supplementary nexus for Russia's professional income tax? One can arrive at two possible answers depending on how the characteristics of the tax itself are classified. If the professional income tax is distinct from personal income tax, then the citizenship connection should be recognized as principal. However, in this case design of the professional income tax makes no sense because there is no reason to pay the tax at all without tax residence status in Russia. Consequently, the only reasonable answer may be that the citizenship factor is a supplementary nexus within the professional income tax when it is regarded as an alternative tax to the personal one. In this case the citizenship criterion serves as a restriction on a category of taxpayer. Therefore, every individual who is a self-employed tax resident must pay personal income tax on a worldwide basis, except for citizens of EAEU countries, who are the only tax residents entitled to pay income tax at 4% or 6% instead of 13%. Currently, individuals who are not citizens of EAEU countries but are living and undertaking economic activities as self-employed in Russia, for instance, citizens of Ukraine living in Russia, are not eligible for the professional income tax because of their citizenship. This differentiation cannot legitimately qualify as objective, and the difference in tax treatment cannot be accepted as reasonable even with the explanation that the Russian government is employing it to strengthen economic integration within EAEU countries.

Political and economic integration processes affect domestic tax law, inter alia, as part of direct taxation. For instance, the impact of fundamental human rights and freedoms, including the non-discrimination requirement, on direct taxation in the EU has been studied by K.A. Ponomareva [Ponomareva K.A., 2020: 185-206]. She observed what has been called negative harmonization in personal income taxation, which has meant protecting the Union's fundamental premise predominantly through judicial proceedings, as opposed to positive harmonization, which would require the creation of supranational positive law as in indirect taxation or corporate taxation [Panayi Ch., 2005: 487]. In Russia any impact of EAEU integration processes on direct taxation is still weak; however, a few provisions in the Tax Code concerning corporate taxation exemplify the EAEU's integration tendencies. For instance, in accordance with Article 25.13-1, the foreign-controlled company rule is not applied when a foreign-controlled company is incorporated in an EAEU member state. In the expectation that the ECJ and EU countries' national judicial practices will be followed as a model, UK: ECJ, 13 March 2007. Case C-524/04. Test Claimants in the Thin Cap Group Litigation v. Commissioners of Inland Revenue, Case Law IBFD.; France: Conseil d'Etat (Supreme Administrative Court), 30 December 2003, Case 233894, SA Andritz (the taxpayer) v. Ministre de leconomie, des finances et l'industrie (the tax authorities), Case Law IBFD; Spain: Tribunal Economico Administrativo Central (Central Economic-Administrative Court), 20 December 2007, Company, name not disclosed (the taxpayer) v. Administracion (the tax authorities), Case Law IBFD. we assume that in the future Article 269 of the Tax Code will be amended to limit the coverage of the thin capitalization rule to tax residents of EAEU countries. Interest payments would then be permitted for companies that are Russia's tax residents to foreign companies that are tax residents of other EAEU member states without further reclassification of them as dividends that would increase tax liability.

The distinctive features of EU countries' individual taxation are determined by both internal markets and EU citizenship. The Schempp case DE: ECJ, 12 July 2005, Case C-403/03, Egon Schempp v. Finanzamt Munchen V, Case Law IBFD. is one clear example. The ECJ examined the rights of Mr. Schempp as an EU citizen Under Art. 20 (1) of the TFEU, `Citizenship of the Union shall be additional to and not replace national citizenship'. with respect to the German income tax system, under which the taxpayer is entitled to deduct maintenance payments for an ex-spouse if those payments are included in that recipient's tax base, regardless of whether the recipient is a tax resident of Germany or another EU member state. Mrs. Schempp moved to Austria where such payments are not taxable, and consequently the German tax authorities refused Mr. Schempp's tax deduction. The plaintiff asserted that the non-discrimination principle would be breached if he could not deduct these payments while other German residents could. The ECJ decided this did not involve any breaches of EU guarantees of citizens' rights. Determinations of which EU member state's taxation should apply have been made only through residence status but not through nationality or citizenship. It is important to note that the German tax rules in question are aimed at keeping the tax base inside EU territory, while the citizenship nexus as it applies to the professional income tax is meant to restrict a potential taxpayer group.

It is useful to look at the design of the professional income tax in light not only of the non-discrimination principle set by national tax legislation and case law, but also with respect to the non-discrimination principle stipulated by tax treaties of the Russian Federation. The Double Taxation Treaty (DTT) between Russia and EAEU non-member Azerbaijan of 1997 includes a non-discrimination provision in Article 24, under which citizens of a contracting state shall not be subjected in the other contracting state to any taxation, or any requirements connected therewith, which are other or more burdensome than the taxation and related requirements which apply or may apply to nationals of that other state in the same circumstances -- in particular with respect to residence. Article 2 of the Treaty stipulates that all provisions may be applied not only to the taxes explicitly listed in the DTT and in force at the time of signature, but also to identical and analogous taxes that may be imposed in the future. As previously mentioned, Russia's Finance Ministry ha maintained that the professional income tax is not covered by DTTs because the tax in question was not listed.

This issue has often been raised by foreign courts. For instance, the Federal Court of Australia Federal Court of Australia, 30 October 2019, QUD 108 of 2018, Catherine Victoria Addy v. Commissioner of Taxation, Case Law IBED. in 2018 judged a case on discrimination against a British citizen who had a working holiday visa and was a tax resident in Australia. The tax authorities rejected the claim of the tax-free threshold and reassessed the tax liability based on a working holiday visa. The Federal Court held that the taxpayer, who was an Australian resident, was claiming to be entitled to a different rate of tax than an Australian resident who was a national of Australia solely because she was on a working holiday visa and that this was exactly the type of discrimination that was prohibited by Article 25 on non-discrimination of the DTT between Australia and the United Kingdom. Art. 25 of DTT between Australia and United Kingdom corresponds to Art. 24 of the OECD Model Convention on Income and on Capital and the Art. 24 of DTT between Azerbaijan and Russia that was previously mentioned. Use of the tax-free threshold was denied because it was supported only by a kind of visa for foreign citizens, and that differentiation did not meet the objective criterion test.

The ECJ arrived at the same position concerning the non-discrimination principle prescribed by EU law. In 2011 the ECJ held that granting an exemption, subject to certain conditions, only to Greek nationals and persons of Greek origin constituted direct discrimination based on nationality and was prohibited by EU law. ECJ, 20 January 2011, C-155/09. Commission of the European Communities v. Hellenic Republic. Case Law IBFD.

The introduction of the professional income tax as currently formulated might also have adverse effects. First, EAEU non-citizens living in Russia who are self- employed persons will probably not pay any income tax because there is no incentive to comply; second, the risk of tax avoidance will increase because any preferential tax regimes open the way to potential tax avoidance or evasion; third, the citizenship-based approach is dubious from the viewpoint of constitutionality.

Conclusion

The article indicates that the professional income tax based on EAEU citizenship is presumably discriminatory. The Russian Tax Code's non-discrimination provision as it applies to the professional income tax is subject to varying interpretations. On the one hand, the non-discrimination provision prohibits differentiation solely for rates or incentives as tax components. On the other hand, if the professional income tax is interpreted as a preferential regime which constitutes an alternative to personal income tax and functions as part of the entire income taxation system, the professional income tax would be discriminatory.

Tax discrimination has been understood by Russia's high courts as the imposition of different tax regimes based on biased criteria. Although resident status might be considered an objective and fair criterion for differing tax treatments, nationality or citizenship cannot. Moreover, the prohibition of discrimination on grounds of nationality is explicitly set forth by the Tax Code of the Russian Federation.

Citizenship or nationality is primarily defined as a political connection rather than an economic one, whereas the tax reflects an economic connection and should be understood as a payment for the consumption of public goods. Within the contemporary understanding of legitimate taxation, the citizenship-based approach would be regarded as discriminatory in nature.

If the professional income tax is considered as an alternative tax regime to personal income tax, it should be based on the same residence-based approach. The self-employed who are Russian tax residents but of different citizenship should not be treated differently. A self-employed person who meets all the criteria except citizenship should not be denied eligibility for the same tax regime as Russian nationals or citizens of other EAEU countries. That would balance personal income tax and the professional income tax with each other and improve the collectability of the professional income tax both inside the country and outside.

If the Russian government intends the new professional income tax to expand the tax base available from self-employment -- especially as it pertains to crossborder services provided by the self-employed -- a review of DTTs from the viewpoint of coverage for personal income tax would be useful. In any event, the design of the professional income tax should be reconsidered both in order to make it an effective component of current Russian external policy and also to align it with the fundamental principles of tax law.

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