Bill of law passed approving the Protocol to the Luxembourg-Russia Tax Treaty

11/02/2021

New withholding tax rates

The Protocol sets out the following withholding tax rates for dividend and interest payments:

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.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 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.

How can we help?

Our tax partners and your usual contacts at Arendt are at your disposal to assist you, together with our colleagues from , with the potential impact of these amendments on your cross-border Luxembourg/Russia investments.