Russia Proposes Revision of Tax Treaties with the Netherlands, Cyprus, Malta, and Luxembourg

August 27, 2020

Russia has recently charted a course to increase withholding taxes on cross-border payments by renegotiating tax treaties with several of its partners. It is an example of how the willingness to forgo tax revenue may not be stable over time.

Cross-border taxation is a complicated area of tax policy. When a business has its headquarters in one country, offices in another, and sales in yet another, the laws of all three countries must be taken into account. Individual country tax policies often overlap so that income from sales in one country might be taxed twice—first in the country where the sale is made by a local office, and second when that income is paid as a dividend to the parent company in another country.

To address instances of double taxation and reduce the tax burden on cross-border investment, countries usually enter bilateral tax treaties. These treaties typically reduce withholding taxes on cross-border dividends and interest payments that are paid between entities in the countries that are part of the tax treaty. Essentially, the countries signing a treaty are agreeing to forgo collecting a portion (in certain cases a significant portion) of tax revenue on cross-border payments. The countries do this to reduce double taxation and improve cross-border investment opportunities.

In the absence of a tax treaty, Russia levies a 15 percent withholding tax on cross-border dividends and a 20 percent withholding tax on cross-border interest payments and royalties. If a company headquartered in Nigeria (which does not have a tax treaty with Russia) has a subsidiary in Russia and the Nigerian company makes a loan to its Russian subsidiary, interest payments to the parent company in Nigeria would face a 20 percent withholding tax owed to the Russian government. If the interest income is also taxed in Nigeria (and there is no foreign tax credit for the tax paid to Russia) the result would be double taxation and a higher cost for the Nigerian company to invest in Russia.

However, there are several countries that do have tax treaties with Russia which leave those interest payments untaxed (or have a very low withholding tax rate), removing the potential for double taxation. However, Russia is in the process of changing some of those treaties.

In March, with some of those low withholding tax arrangements in mind, Russian President Vladimir Putin suggested renegotiating those treaties to include a 15 percent tax on interest and dividend payments transferred to foreign entities. He threatened that Russia would withdraw from its bilateral tax treaties with foreign partners if the terms were not accepted.

Currently, Russia’s tax treaties with Luxembourg and Malta allow for the Russian domestic withholding tax rate of 15 percent to be reduced to 5 percent if certain conditions are met for dividend and interest payments. For interest, the 20 percent non-treaty rate may be reduced to 5 percent for residents of Malta. And no withholding tax applies for residents of Luxembourg.

On Aug. 11, in a televised meeting with Putin, Russian Deputy Prime Minister Alexei Overchuk said that Russia is currently in the process of reviewing the country’s other double tax agreements.

As mentioned above, dividends paid from Russia to foreign entities are subject to a 15 percent tax rate when there is no tax treaty in place. Interest payments are subject to a 20 percent rate. Dividends received by a domestic Russian entity from either a Russian or foreign entity are taxed at a 13 percent rate, unless reduced under a bilateral tax treaty.

For some treaty arrangements, Russia’s new cross-border tax agenda has changed withholding tax rates closer to those non-treaty rates. 

The island country of Cyprus has agreed to amended terms to its 1998 Double Taxation Agreement (DTA) with Russia. The amendment will increase the withholding tax rate to 15 percent on repatriated dividend and interest income. Prior to the amendment, cross-border dividends were taxed at either 5 or 10 percent while the withholding tax on interest was zero. Under the new amendment, some companies and interest payments will still be exempt from withholding taxes. The Russia-Cyprus tax treaty amendment is set to be signed in September and take effect on Jan. 1, 2021.

Malta, another island state, has also accepted a new protocol to its 2013 DTA. Under the protocol, the withholding tax rate will be increased to 15 percent on dividend and interest income. Exemptions will be granted to some institutional investments. The agreement between Malta and Russia was signed on Aug. 13.

Luxembourg has also agreed to increase withholding taxes to 15 percent; changes are expected to come into force on Jan. 1, 2021.

Russia is in negotiations with the Netherlands over the proposed 15 percent rate, which would be an increase from a current tax of 5 percent.

In his Aug. 11 appearance, Overchuk also noted that Russia may propose to amend tax agreements with Switzerland and Hong Kong.

Russia’s review of its network of tax treaties comes on the heels of lower government tax revenues resulting from the impact of the COVID-19 pandemic. In particular, record lows in oil prices have hurt the country, which produced 11 percent of the world’s oil in 2018.

The Russian Finance Ministry has estimated that €16 billion (US $17.92 billion) of earnings made in Russia were directed to Cyprus in 2018 and €21.9 billion ($24.52 billion) were redirected in 2019. Therefore, the forgone Russian tax revenues due to double tax relief is considerable.

Cyprus, Malta, and Luxembourg have long been on Russia’s radar. The three countries are often used for corporate structure optimization to reduce taxes on returns from investments in Russia. For example, a Russian company might arrange some of its activities to take advantage of the 0 percent withholding taxes on interest and dividends that are part of many of Russia’s current bilateral tax treaties, including Cyprus, Malta, and Luxembourg.

Russia’s targeting of favorable tax structures in certain jurisdictions will have consequences for the structuring decisions of firms and could also impact the attractiveness for investing in Russia over the longer term. In some cases companies will also need to reevaluate headquartering decisions.

Treaties to prevent double taxation are necessary. For example, an individual or a firm working temporarily in another country would benefit from treaties preventing double taxation. Hence, tax treaties reduce barriers to international investment, which can have benefits for the home country by creating growth of firms at home. However, in the current situation Russia is changing course to protect its tax base and raising taxes on cross-border income in the process.

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The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

Withholding is the income an employer taxes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests.

Double taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.