Luxembourg and Russia ratify treaty protocol
The 2011 Protocol to the double tax treaty between the Grand Duchy of Luxembourg and the Russian Federation (‘DTT’) was ratified by Russia on 30 December 2012 and lately by Luxembourg on 4 July 2013. This means that starting 1 January 2014 the amended provisions of the DTT will apply.
With its stable political environment, its pro-business legislation and administration, and being amongst the few countries with an AAA credit rating, Luxembourg has become one of the world’s largest financial, investment fund and asset management centers. Despite the fact that some of the Protocol’s provisions are less advantageous for taxpayers compared to their current version, the entry into force of the Protocol can be regarded as a major step to increase the attractiveness of Luxembourg for Russian investors.
A brief overview of the key changes to the DTT is provided below.
The minimum withholding tax rate on dividend distributions is reduced by the Protocol from 10% to 5% provided the following criteria are met:
- the recipient of the dividends is their beneficial owner;
- the recipient directly holds at least 10% of the share capital of the distributing company;
- the amount of investment into the distributing company constitutes at least EUR 80,000 (or its equivalent amount in roubles).
Otherwise, the withholding tax rate amounts to 15%.
The decrease of the withholding tax rate on dividends to 5% makes Luxembourg comparable with the Netherlands, Switzerland or Cyprus when it comes to the choice of the jurisdictions for setting up a holding company for Russian business.
Moreover, the Protocol extends the definition of dividends, which, under the new version of DTT include the following payments:
- income from shares or other rights, not being debt-claims, which give rights for participation in profits;
- income – even if paid in a form of interest - which from the tax standpoint is treated as dividends in accordance with the domestic legislation of the country of origin;
- payments on units of mutual investment funds or other analogous collective investment institutions, (except for specific limitations related to investments in immovable property).
Thus, the introduced changes should allow collective investment vehicles distributing income to benefit from the DTT (previously, such entities were not covered by the treaty). At the same time there are certain practical questions as to how the respective changes shall be interpreted. For example, it is not clear whether Luxembourg funds receiving dividends from a Russian company will qualify for a reduced withholding tax rate under the amended DTT since, historically, Luxembourg funds have not been regarded as Luxembourg tax residents for the purposes of application of some of the tax treaties, including the tax treaty with Russia.
Furthermore, the Protocol clarifies the tax treatment of income distributed in a form of interest which qualifies as dividends under the domestic legislation of the country of origin. Starting 2014, such payments should be subject to dividend withholding tax in the country of origin. Before the enforcement of the Protocol, there was an uncertainty on the possibility to apply withholding tax on interest in the state of origin and also to impose income tax in the recipient state with respect to such interest payments.
In particular, this uncertainty arose with respect to interest payments under controlled loans in the portion exceeding the maximum deductible limits under the thin capitalization rules. This new provision will be relevant only for payments made out of Russia as in Luxembourg, in most cases, there should be no withholding tax neither on the dividend payments to a Russian company nor on interest payments.
One of the disadvantageous provisions of the Protocol refers to taxation of income from the sale of shares deriving more than 50% of their value directly or indirectly from real estate assets. After the entry into force of the Protocol, taxation becomes due in the state where the respective real estate assets are located, while the preceding version of the DTT provided for a tax exemption in this case.
However, the above rules do not apply when:
- the shares are alienated in the course of the reorganization of a company;
- the alienated shares are quoted on a registered stock exchange;
- the shares are alienated by a pension fund or analogous entity or the Government of either contracting state.
Another unfavorable amendment relates to taxation of other income (Article 21). Before the enforcement of the Protocol, the income not specifically mentioned in the DTT was subject to taxation in the state of the beneficiary of this income. Pursuant to the amended version of this Article, such other income could also be subject to taxation in its state of origin.
Further to these amendments, the double exemption from taxation that existed untill now should be terminated, at least in Russia.
Considering that there could be a number of payments which might be classified as other income for the purposes of the DTT application, more attention should now be given to structuring cross-border transactions between Russian and Luxembourg residents.
Article 26 of the Protocol also provides for a more detailed and extended procedure for the exchange of information between both countries which is based on OECD principles. In particular, the new provisions of the DTT clarify that:
- the exchange of information with respect to all taxes is allowed, even if the respective taxes are not covered by the DTT;
- the state which receives a request to provide information cannot refuse to do so based merely on the facts that (1) this state is not interested in the respective information from the standpoint of taxation, or (2) the respective information belongs to a bank, other financial organization, nominee holder, agent or trustee.
At the same time, limitations to the provision of information requested by another contracting state stipulated by the previous version of the DTT continue to apply as before. In particular, the requested state, inter alia, may not disclose information which:
- is unavailable in accordance with the local regulations or administrative practice of either of the contracting states;
- reveals trade, entrepreneurial, industrial, commercial or professional secrets or trade processes or information which would have violated the public order if disclosed.
It should be noted that this new provision does not allow an automatic or spontaneous exchange of information. The information may be provided only upon request. Moreover, the tax authorities of the requesting state may not engage in “fishing expeditions”. The requested information should “be relevant to the tax affairs of a given taxpayer”.
The Protocol also introduces anti-treaty shopping rules stating that DTT tax exemptions do not apply if the tax authorities of the contracting states agree that a Russian or a Luxembourg company was created mainly for the purposes of receipt of tax benefits which would have been unavailable otherwise.
However, it is not yet clear how the respective provisions of the DTT will be interpreted by courts, especially given the fact that the criteria to determine the tax-tailored structuring mechanisms are not established by the Protocol (although Russian courts and tax authorities tend to pay more attention to the substance of offshore vehicles used in the transactions with Russian companies). The procedure of cooperation between the Russian and Luxembourg tax authorities has also not yet been established.
At the same time, anticipating that, in May 2013, Luxembourg has joined the Convention on Mutual Administrative Assistance in Tax Matters (and Russia had done so in 2011), there are grounds to believe that the information exchange process should be established within a reasonable timeframe.
More guidance on the determination of the tax residence of legal entities is available under the Protocol. The criterion for designation of a company’s tax residence remains the same, which is the place of effective management; however, more clarity is provided as to how such place of management should be determined. In particular, in case of any doubts about the place of a company’s effective management, tax authorities of the contracting states shall conclude on its location based on the analysis of all related factors, which may include, inter alia, the following:
- place where board meetings are held;
- place where the company’s day-to-day operations are managed;
- place where the company’s top management usually executes its functions.
The amendments to the DTT introduced by the Protocol specify that a permanent establishment is created when a company provides services in the other state through an individual (or, in certain cases, several individuals) who stays in this other state for more than 183 days during 12 months, and when the share of the company’s revenue derived from such services exceeds 50% of its sales turnover in the respective period, whether such services are related to one or several related projects.
The amendments to the DTT agreed upon between Luxembourg and Russia clearly provide for new business opportunities between the two countries, in particular in respect to international holding activities. At the same time, the amended tax treaty follows the general trend in international tax structuring with enhanced tax transparency and reinforcement of substance of the respective group companies.
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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.