Protocol to the Double Tax Treaty between Luxembourg and Russia has entered into force
Tax alert - Luxembourg
As of 1 January 2014 the protocol to the Double Tax Treaty between Luxembourg and Russia has entered into force, meaning that the amendments to the Treaty have become applicable.
The amendments to the Treaty bring along more advantageous tax treatment of the dividend payments between two companies as the minimum withholding tax rate on dividends has been reduced from 10% to 5%. This change brings Luxembourg in line with other popular holding jurisdictions for investments in Russia, such as the Netherlands, Switzerland and Cyprus.
It is interesting to note that on the other hand, the investors should be more careful while considering the investments in the real estate as one of the disadvantageous change concerns the provision dealing with the taxation of the income from immovable property.
As a reminder, this current tax alert points out the most important amendments to the Treaty below hereafter.
Tax residence criteria
Article 4 of the Treaty has got an additional subparagraph which provides for a mutual agreement procedure in case the place of effective management of a company cannot be determined. In order to determine the place of effective management, which is the key to decide over the tax residency of the company, the following facts are particularly relevant:
- Where the meetings of the board of directors or equivalent body are usually held
- Where the senior day-to-day management of the person is carried on
- Where the managers usually exercise their functions
Extension to the definition of a permanent establishment
Article 5 has been supplemented with a new paragraph 3.1 and according to the new paragraph, where an enterprise of a Contracting State performs services in the other Contracting State:
- through an individual who is present in that other State for a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50% of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or
- for a period or periods exceeding in the aggregate 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in that other State,
the activities carried on in that other State in performing these services shall be deemed to be carried on through a permanent establishment of the enterprise situated in that other State.
However, no permanent establishment exists in the above cases if it concerns an activity which is deemed not to constitute a permanent establishment.
The minimum withholding tax rate on dividends has been reduced from 10% to 5% provided that the beneficial owner of the dividends is a company, which holds directly at least 10% of the capital of the company paying the dividends and has invested into the distributing company at least EUR 80,000 or the equivalent amount in RUB.
The definition of “dividends” has been clarified and includes, inter alia, the following payments:
- Income from shares or other rights, not being debt-claims, participating in profits
- Payments in respect of shares in an investment fund
- Income which is treated as dividends from a fiscal viewpoint in the source country
In other cases, the withholding tax will be limited to 15%. Under Luxembourg domestic law, dividends distributed by Luxembourg companies to Russian companies are exempt from withholding tax under certain conditions1.
Notably, individuals who were previously entitled to benefit from the reduced treaty rates under the same terms as corporate shareholders are subject to a 15% withholding tax rate as from 2014, regardless of the share they hold.
Real estate aspects
The taxing rights are attributed to the source state for capital gains on the alienation of shares deriving more than 50% of their value directly or indirectly from immovable property situated therein.
However, the above rules do not apply to gains derived in the following cases:
- The alienation of shares is done in the context of a corporate reorganization
- The alienated shares are listed on a registered stock exchange
- The gains from the alienation of shares are derived by a pension fund, a similar entity or the government of one of the Contracting States
Income from immovable property
Article 6 has been supplemented with a new paragraph 5 and according to the new paragraph, income which a resident of a Contracting State receives from shares in an investment fund organized in the other Contracting State mainly to invest in immovable property situated therein, may be taxed in that other State.
The income which is not covered by any specific article in the Treaty and which arises in the other Contracting State, may be taxed in that other state (Article 21).
Avoidance of double taxation
Article 23(1)(b) has been amended and as a result Luxembourg will avoid double taxation by means of a credit method for dividends and other income taxed in Russia. In practice, a credit method will apply were an exemption is not available under Luxembourg domestic law.
Exchange of information
The protocol provides for an exchange of information clause in line with article 26 of the OECD Model Convention.
Limitation of benefits
Article 29 has been deleted and replaced by a general limitation of benefits clause.
According to the new limitation of benefits clause, it is understood that a resident of a Contracting State shall not be entitled to a reduction of or exemption from tax under the Treaty in respect of income arising in the other Contracting State if it is established that the main purpose or one of the main purposes of the creation or existence of such resident was to obtain the benefits of this Convention which would otherwise not be granted.
Such conclusion requires a consultation between the competent authorities of both states, i.e., limitation of benefits should not be applied unilaterally.
Download the Tax alert (pdf, 88kb).
The parent company has to be fully subject to tax corresponding to Luxembourg income tax, and has to hold, or commit to hold, at least 10% of the share capital or a participation with an acquisition cost of at least EUR 1.2 million for at least 12 months.