Luxembourg: Income tax treaty with Russia successfully renegotiated

After a few months of negotiations and ratification procedures, the new protocol amending the 1993 Convention between the Grand Duchy of Luxembourg and the Russian Federation regarding the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital (treaty) entered into force on March 5 2021 and will apply as from January 1 2022. 

The main change consists of an increase in the withholding tax rates for dividends and interest as provided in Articles 10 and 11 of the treaty, respectively.

Following a shift in tax policy announced by Russian President Vladimir Putin, which aims to improve economic conditions adversely impacted by the COVID-19 pandemic and achieve a fairer taxation system, Russia has decided to renegotiate its tax treaties. 

To this end, Russia has asked various countries to agree to amend the terms of their treaty with Russia in accordance with this new policy. If renegotiations fail with a particular country, Russia will unilaterally terminate its treaty with that country. 

After Cyprus and Malta, Luxembourg agreed to amend its treaty with Russia by signing the protocol on November 6 2020. Russia announced that it may start negotiations shortly with Switzerland and Hong Kong.

Withholding tax

Under the prior version of the treaty, the interest could only be taxed in the recipient state and thus was exempt from withholding tax. The default rate on dividends was limited to 15% and a 5% rate applied in cases where the beneficial owner fulfilled certain criteria, such as a 10% shareholding threshold and a minimum investment of €80,000 (approximately $97,000).

The renegotiated treaty sets the withholding tax rates on interest and dividends at 15%, which is the general Russian domestic rate for dividends and certain interest. In addition, the conditions to qualify for a reduced 5% rate for both dividends and interest as well as a 0% rate for interest are more restrictive.

Interest payments may still be exempt from withholding tax if the recipient of the interest income is the beneficial owner of the interest and a tax resident of a contracting state and if the recipient is either:

• An insurance undertaking or a pension fund;
• The government, a political subdivision, or a local authority of the contracting state
• The central bank of the contracting state; or
• A bank, or if the interest is paid in respect of government bonds, corporate bonds, or eurobonds listed on a registered stock exchange.

The reduced 5% withholding tax rate on interest will apply when the recipient of the interest income is the beneficial owner of the interest, a tax resident of a contracting state, and a company whose shares are listed on a registered stock exchange, provided that no less than 15% of its voting shares are in free float and provided that it holds directly at least 15% of the capital of the company paying the interest throughout a period of 365 days that includes the date of payment.

Regarding dividends, the reduced withholding tax rate of 5% will apply under similar conditions, i.e. when the recipient of the dividend income is a tax resident of a contracting state, the beneficial owner of the dividend, and either: 

• An insurance undertaking or a pension fund;
• The government, a political subdivision, or a local authority of the contracting state;
• The central bank of the contracting state; or
• A company whose shares are listed on a registered stock exchange, provided that no less than 15% of its voting shares are in free float and provided that it holds directly at least 15% of the capital of the company paying the dividend throughout a period of 365 days that includes the date of payment.

Closing remarks

While the new protocol could impose a higher tax burden on some private investors, it keeps preferential rates on interests and dividends for institutional investors. 

Also, it is worth noting that Russia’s renegotiations of its treaties with several countries creates a level-set environment. In that regard, for instance, Russia has started the treaty termination process after its first round of talks with the Netherlands failed, although the latter has reiterated its intention to renegotiate its tax treaty with Russia. 

Luxembourg, on the other hand, might expect to be in a competitively more advantageous position (e.g. for Russian entities investing in Luxembourg or Luxembourg entities investing in Russia) compared to countries whose tax treaty with Russia has been or will be terminated.

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