The MLI Principal Purpose Test in Action: Lessons from a Russian Court Decision on Treaty Shopping through Kazakhstan
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) has fundamentally changed the landscape of international tax planning. One of its most powerful tools is the Principal Purpose Test (PPT) under Article 7, which allows tax authorities to deny treaty benefits when obtaining such benefits was one of the principal purposes of an arrangement. While much has been written about the PPT in theory, practical examples of its judicial application remain relatively scarce. A recent decision by the Arbitrazh Court of Saint Petersburg provides a valuable case study.
The case: Khimtekh LLC v. Tax Authority (Saint Petersburg)
On 12 December 2025, the Arbitrazh Court of Saint Petersburg and Leningrad Region (Judge Zakharov V.V.) delivered its decision in case No. A56-74616/2025, involving Khimtekh LLC, a Russian company and its related party in Kazakhstan, whose principal activity was software development. The sole participant (100% owner) of Khimtekh was the US corporation Chemical Technologies Inc. (in Russian transliteration: KemikalTeknolodjis Ink.). The company was registered in Russia on 19 December 2016.
The facts were straightforward. Chemical Technologies Inc. (USA) held US patents (including US2018/0353925A1, US2020/0117770A, and PCT/US2019/042555). Rather than licensing these patents directly to its Russian subsidiary, Chemical Technologies Inc. granted a license to Digital Twin LLP, a Kazakh entity. Digital Twin, in turn, sublicensed the patents to Khimtekh in Russia. Critically, the general director of Khimtekh and the founder of Digital Twin were the same individual, a Russian citizen named Bunin Evgeny Dmitrievich.
Under these sublicense agreements (dated 10 February 2023 and 27 February 2023), Khimtekh paid royalties to Digital Twin: 15.3 million rubles for 2023 and 4.9 million rubles for Q1 2024. Khimtekh did not withhold any tax on these payments, relying on the Convention between Russia and Kazakhstan for the Avoidance of Double Taxation (dated 18 October 1996).
The treaty framework and the MLI overlay
Under Article 12 of the Russia-Kazakhstan Convention, royalties arising in one Contracting State and paid to a resident of the other may be taxed at source, but the tax shall not exceed 10 percent of the gross amount of the royalties. This is a significant benefit compared to the domestic Russian withholding rate of 20 percent under Article 284 of the Tax Code, applicable to royalty income of foreign organizations under Articles 309 and 310.
However, since 1 January 2021 for withholding taxes (and 1 January 2022 for other taxes), the MLI has applied to the Russia-Kazakhstan Convention. Russia adopted the PPT as part of its minimum standard obligations under the MLI. This means that any benefit under the Convention, including the reduced 10 percent royalty rate, can be denied if it is reasonable to conclude that obtaining such benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.
In addition to the PPT, the MLI contains Simplified Limitation on Benefits (SLOB) provisions in Article 7, paragraphs 8 through 13. These provisions offer an alternative pathway to treaty benefits through three tests: the qualified person test (paragraph 9), the active business criterion (paragraph 10), and the equivalent beneficiary test (paragraph 11). If a taxpayer fails the PPT, it may still obtain benefits by satisfying one of these SLOB tests.
The court's analysis
The tax authority challenged Khimtekh's failure to withhold tax, issuing two decisions on 22 October 2024: Decision No. 20/4607 (assessing 3,060,000 rubles in profit tax and a 612,000 ruble penalty under Article 123 of the Tax Code for 2023) and Decision No. 20/4608 (assessing 980,000 rubles in profit tax and a 196,000 ruble penalty for Q1 2024). Both decisions were upheld on appeal by the Federal Tax Service Administration for Saint Petersburg on 27 June 2025.
The court sided with the tax authority on every point.
On beneficial ownership and the PPT. The court found that Digital Twin (Kazakhstan) lacked any genuine economic substance. It had no employees, no real office, and no active business in Kazakhstan. Its sole function was holding and sublicensing US patents received from the US parent company. The court concluded that routing royalty payments through Kazakhstan, rather than paying them directly to Chemical Technologies Inc. in the United States, served no business purpose other than accessing the favorable Convention rate. Had the royalties been paid directly to the US parent, there being no applicable treaty between Russia and the United States providing reduced rates on royalties, the full 20 percent domestic withholding rate would have applied.
On the SLOB tests. The court confirmed that Digital Twin failed all three alternative tests. It was not a qualified person under paragraph 9, as it had no substance. The active business criterion under paragraph 10 was not met, because merely holding and sublicensing patents does not constitute the active conduct of a trade or business. The equivalent beneficiary test under paragraph 11 was also not satisfied. The taxpayer argued that Bunin, the founder of Digital Twin and a Russian citizen, was an equivalent beneficiary, and further attempted to invoke the suspension of the Russia-Finland Convention from 8 August 2023 as relevant context. The court rejected both arguments.
On attempted recharacterization. An additional notable aspect of the case was the taxpayer's attempt, after the tax audit had begun, to retroactively recharacterize the license payments as payments for services (consulting and technical support) through supplementary agreements. The court treated these as sham transactions, finding that the substance of the payments remained royalties for the use of intellectual property regardless of how they were relabeled.
Implications for taxpayers in Kazakhstan and Central Asia
This decision carries significant implications well beyond Russia.
For Kazakh entities acting as intermediaries in cross-border IP structures, the message is clear: being interposed in the royalty chain without genuine economic substance, employees, or active business in Kazakhstan will not withstand scrutiny under the MLI PPT. The fact that Kazakhstan itself is an MLI signatory means that Kazakh tax authorities can apply the same reasoning in reverse, denying treaty benefits to entities claiming residence in other jurisdictions without substance.
For multinational groups operating in the CIS region, the case illustrates the real-world consequences of treaty shopping through intermediary jurisdictions. The dual penalty of losing the treaty benefit (from 10 percent to 20 percent withholding) combined with fines under Article 123 of the Russian Tax Code makes such structures economically punitive when challenged.
Recommendations: verifying treaty benefits under SLOB
In light of this decision, we recommend that taxpayers in Kazakhstan and the broader region take a proactive approach to verifying the applicability of tax treaty benefits, particularly in light of the MLI's SLOB provisions.
First, review existing structures involving Russia. Any arrangement where royalties, interest, or dividends are routed through an intermediary jurisdiction to access reduced withholding rates under a treaty with Russia should be critically reassessed. Russian tax authorities are actively applying the MLI PPT, and as this case demonstrates, Russian courts are willing to uphold those assessments.
Second, verify treaty benefits with India. India has adopted both the PPT and the SLOB provisions under the MLI, and Indian tax authorities have a long history of aggressive treaty abuse challenges. The Kazakhstan-India treaty, as modified by the MLI, now contains both the PPT and the simplified LOB provisions. Any structure involving a Kazakh intermediary receiving passive income (royalties, interest, dividends, capital gains) from Indian sources should be tested against the qualified person, active business, and equivalent beneficiary criteria. India's domestic GAAR (effective since 1 April 2017) provides an additional layer of scrutiny.
Third, apply the SLOB self-assessment. For each entity in the structure claiming treaty benefits, ask the following questions. Is the entity a qualified person (publicly listed, government-owned, or meeting ownership and base erosion tests)? Does the entity conduct an active trade or business in its state of residence that is substantial in relation to the income item? If neither test is met, would an equivalent beneficiary in a third state have been entitled to the same or better treaty benefits? If the answer to all three is negative, the treaty benefit is at serious risk under the SLOB provisions, even before the PPT is considered.
Fourth, ensure genuine economic substance. The single most important factor in defending treaty benefits remains substance. This means real employees, real decision-making, real offices, and a genuine business rationale for the entity's existence and location. As the Khimtekh case shows, an entity whose sole function is to hold and sublicense IP, with no staff and no independent business activity, will not survive challenge.
Fifth, avoid post-audit restructuring. The court's treatment of the supplementary agreements attempting to recharacterize royalties as service payments is a cautionary tale. Retroactive restructuring after a tax audit has commenced is likely to be viewed as evidence of abusive intent rather than legitimate business planning.
Conclusion
The Khimtekh decision is one of the first Russian court rulings to apply the MLI Principal Purpose Test to deny treaty benefits on royalty payments. It confirms that the MLI's anti-abuse provisions are not merely theoretical but are being actively enforced in CIS tax litigation. For taxpayers operating across Central Asia, the Caucasus, and the broader Eurasian region, the practical takeaway is that treaty benefits can no longer be assumed on the basis of formal legal structures alone. Substance, business rationale, and compliance with the SLOB criteria must be demonstrable and documented.
We recommend that businesses with cross-border structures involving Kazakhstan review their arrangements in light of this decision and the evolving application of the MLI, particularly in relation to treaties with Russia and India where SLOB provisions are now in effect.
