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A protocol has been prepared on amending the DTT with Luxembourg

Pepeliaev Group advises that the Russian Government has prepared a draft of the[1] DTT with Luxembourg that proposes changes in the taxation of dividend and interest income.

The protocol proposing amendments to the DTT with Luxembourg is virtually the same as the amended protocol relating to the DTT with Cyprus.

The following persons may benefit from the beneficial rate of 5% on dividends:

  • institutional investors such as pension funds and insurance institutions;
  • the government and its political subdivisions;
  • public companies with at least 15% of voting shares in open circulation, provided that the share of direct participation of such a company in the entity paying out interests has been at least 15% for 365 calendar days;
  • the Central Bank.

The dividend income of other persons will be taxable at the source of the income at the rate of 15%.

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Therefore, the persons that could previously use the rate of 5% by virtue of meeting the participation criteria and investing funds in the issued capital of a Russian company will lose this opportunity from 1 January 2021 and the dividends paid to a Luxembourg company will be subject to taxation at the rate of 15%. Such a rate is already provided for by article 10 of the DTT and is applied when the dividend income is paid to a person that does not fulfil the criteria of participation and/or investment. The same rate is stipulated by Russian legislation.

With respect to interest income the following can be noted:

Firstly, the proposed protocol to the DTT with Luxembourg, unlike other protocols (to the DTTs with Cyprus and Malta) containing minor amendments in the articles, fully reproduces the article dedicated to the taxation of interest income.

Secondly, after reading the article carefully one may notice that it contains a new clause on separating the taxation of interest income paid by a permanent establishment. This clause (article 11(7) of the DTT) provides as follows:

  • it is considered that interest arises in Russia if the payer is a tax resident of Russia;
  • if the person paying the interest regardless of residency has a permanent establishment or a permanent base, for instance, in Luxembourg and the representative office bears expenses on the payment of debt, it is considered that interest arises in the state where the representative office or permanent base is located.

Thirdly, under the DTT with Luxembourg, interest income was previously exempted from withholding tax. Now such an exemption is granted exclusively to:

  • institutional investors;
  • banks;
  • persons receiving interest under bonds (state, corporate or Eurobonds) traded on a registered stock exchange;
  • the government and its political subdivisions;
  • the Central Bank.

Interest income of other persons apart from public companies, subject to the conditions being met, will be taxed at source at the rate of 15%.

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The term “registered stock exchange” still remains vague and ill-defined with respect to the exemption of interest income on traded securities. According to article 3(2) of the DTT with Luxembourg, terms not established by the DTT must be interpreted in accordance with domestic legislation.

The term “registered stock exchange” is absent from article 3 of the DTT with Luxembourg. This term is not defined in either the Russian Tax Code or legislation on securities. A “registered stock exchange” will presumably be understood as a stock exchange included in the list specified in Instruction No. 4393-U of the Central Bank dated 30 May 2017. References to this list are contained in both article 11 of the Tax Code and article 310 of the Tax Code.

It also remains unclear what is meant by “traded securities”: whether access to trading such securities must be granted or they must necessarily be in public circulation?

As previously noted, the amendments propose a beneficial rate of 5% for public companies with at least 15% of the voting shares in open circulation and the share of direct participation in the entity paying out interest remaining at least 15% throughout 365 calendar days.

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Article 11(4) relating to public companies, just like the similar provision in the Protocol to the DTT with Cyprus, is ambiguous. It starts with the words “Notwithstanding the provisions of clauses 1, 2 and 3...” and therefore may be understood as introducing an additional restriction with respect to the beneficial rate. Yet, such an understanding would be at variance with clauses 1-3, so the clumsy wording apparently owes to drawbacks in legal drafting.

Conclusions and recommendations

The amendments proposed by the protocols follow the logic of the anti-offshore campaign announced by the Russian President. The changes to the DTT may prompt businesses to think about corporate restructuring, redomiciliation to other tax jurisdictions or CAP, as well as changes in the structuring of a group or other financing.

Among the anticipated changes is the foundation or acquisition of a public company in Cyprus, Malta or Luxembourg for the beneficial rate of 5% to be applied under the DTT. The Russian state authorities, however, are ready for such a development and, thus, in its Principal Tax Policy Guidelines for the years 2021 - 2023 the Russian Government pointed out that it is necessary to counteract abusive practices of obtaining tax preferences using public companies.

Help from your adviser

The lawyers of Pepeliaev Group are ready to provide services in the area of advising on how to apply the DTT with Luxembourg, assist companies in assessing the prospects of redomiciliation to other jurisdictions or CAP and in implementing the redomiciliation procedure, as well as represent clients in administrative disputes and/or in court in connection with international treaties being applied.

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