ON 9 FEBRUARY 2021, THE LUXEMBOURG PARLIAMENT PASSED BILL OF LAW NO. 7725 RATIFYING THE NEW PROTOCOL (THE “PROTOCOL”) AMENDING THE TREATY FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME AND CAPITAL BETWEEN THE RUSSIAN FEDERATION AND LUXEMBOURG (THE “TREATY”).
Background
At the request of the Russian authorities, Luxembourg and the Russian Federation agreed to amend the Treaty, signing the Protocol on 6 November 2020. The Protocol reflects the new fiscal policy of the Russian Federation with regard to the levy of Russian withholding taxes, and provides for new rates and rules for the taxation of dividend and interest payments. It does not include changes with respect to royalty payments. Similar protocols were discussed and/or agreed by the Russian Federation with other States earlier in 2020, in particular Cyprus (signed on 8 September 2020), Malta (signed on 1 October 2020) and the Netherlands.
New withholding tax rates
The Protocol sets out the following withholding tax rates for dividend and interest payments:
Dividends (art. 10 as amended by the Protocol)
Interest (art. 11 as amended by the Protocol)
Basic rate
15% 15%Reduced rate
5% where the beneficial owner (“BO”) of the dividend is a resident of the other contracting State, and either
i. the BO is an insurance enterprise or a pension fund;
ii. the BO is a company whose shares are listed on a registered stock exchange, provided that (a) no less than 15% of the BO’s shares bearing voting rights are in free float and (b) the BO holds directly at least 15% of the capital of the company paying the dividend throughout a 365-day period including the date of the dividend payment;
iii. the BO is the government, a political subdivision or a local authority of a contracting State; or
iv. the BO is the central bank of a contracting State.
5% where the BO of the interest is a resident of the other contracting State and is a company whose shares are listed on a registered stock exchange, provided that (a) no less than 15% of the BO’s shares bearing voting rights are in free float and (b) the BO holds directly at least 15% of the capital of the company paying the interest throughout a 365-day period including the date of the dividend payment.
Exemption
0% where the BO of the interest is a resident of the other contracting State, and
A) the BO is either:
i. an insurance enterprise or a pension fund,
ii. the government, a political subdivision or a local authority of a contracting State,
iii. the central bank of a contracting State, or
iv. a bank;
B) or the interest is paid under one of the following financial instruments listed on a registered stock exchange:
i. government bonds,
ii. corporate bonds,
iii. Eurobonds.
The term “dividends” is further defined as income from shares or other beneficiary units which does not constitute a debt receivable, as well as any income (even that received in the form of interest) which, under the law of the State in which the company making the distribution is a resident, is subject to the same tax treatment as income from shares. The term thus includes payments made under units in an investment fund or any other collective investment vehicle (with the exception of an investment fund established in a contracting State investing in real estate assets situated in that State).
The remaining provisions of the new articles 10 and 11 of the Treaty follow the OECD 2017 Model Tax Convention.
For Luxembourg-outbound dividends and interest, these amendments should have no significant effect in most cases, since an exemption from dividend withholding tax is available to qualifying shareholders under the participation exemption, and no withholding tax is generally levied in Luxembourg on arm’s length interest.
For inbound dividends coming from Russia, the amended Treaty is less favourable than the previous version, which provided for a reduced 5% withholding tax rate for BOs that are Luxembourg companies holding a direct participation of at least 10% in the share capital of the Russian payor, and investing at least EUR 80,000 (or the equivalent in RUB) through that participation. Furthermore, the previous version of the Treaty did not provide for any withholding tax on interest. Nevertheless, the current version of the Treaty lowers the Russian domestic withholding tax rate on interest from the maximum of 20% down to 15%, 5% or even 0%.
Elimination of double taxation
Although a new withholding tax on interest has been introduced in article 11 of the Treaty, article 23 regarding the elimination of double taxation has not been consistently adjusted to apply the credit method to interest received by a Luxembourg resident. Pursuant to article 23, paragraph 1 (a) and (b) of the Treaty, Luxembourg avoids double taxation through the exemption method, except for income that is taxable in Russia, under articles 10 (dividends) and 21 (other income). Hence, interest received by a Luxembourg resident from a Russian payor would be subject to withholding tax in Russia at the rate of 5% or 15%, but exempt in Luxembourg. This is quite an unusual feature, as Luxembourg’s double tax treaty policy foresees the application of the credit method in such cases, so that the interest income would be subject to ordinary Luxembourg income tax, but eligible for a tax credit for the Russian withholding tax.
Entry into force
The Protocol will enter into force once the parties have notified each other of their completion of the ratification procedures required under their domestic legislation. The Russian Federation ratified the Protocol on 25 December 2020, but since Luxembourg did not complete the ratification process by the end of 2020, the Protocol will only take effect from 1 January 2022.
Conclusion
The Treaty has been renegotiated with Luxembourg as part of broader renegotiations by the Russian Federation of a series of treaties that reflect recent changes in the fiscal policy of the Russian Federation. The Protocol further restricts the application of the reduced 5% withholding tax rate on dividends, and introduces a withholding tax on interest. Although the amended Treaty appears less favourable than the previous version, it should be noted that even in the past, the Russian tax authorities were known in practice to challenge the application of the reduced treaty rates on the basis on non-compliance with the beneficial ownership condition.
Further clarification (e.g. an exchange of explanatory notes from both governments) is expected to be released that will provide certain details on the terms of the Treaty, in particular with respect to the definition of “registered stock exchange” in the context of the new reduced withholding tax rates on dividend and interest payments.
Finally, in light of the circumstances, one would expect Luxembourg to propose additional amendments with regard to article 23 of the Treaty in order to introduce the credit method for interest payments.
