European Union: Changes To Poland – Luxembourg Double Tax Treaty

Last Updated: 14 August 2012
Article by Charles Savva

On 7 June 2012, Luxembourg and Poland officials signed a Protocol to the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital of 14 June 1995 ("the Treaty"). The Protocol amends the Treaty significantly, and is widely expected to considerably decrease the use of Luxembourg intermediary vehicles used for structuring investment into Poland.

Amendments to the Treaty include the introduction of a property rich company clause, altered methods of relieving double taxation, and new rules concerning the taxation of cross border dividends, interests and royalties.  The Protocol also updates the Treaty in line with the current standards of the OECD concerning the exchange of information. The Protocol also introduces a new provision that denies the benefits of the Treaty to income received in connection with "artificial arrangements".

The main changes introduced by the Protocol are summarized as follows:

The property rich clause

According to the Protocol, capital gains from a transfer of shares, deriving more than 50% of their value from immovable property, will be taxable in the state where the property is situated, regardless of whether the derivation is direct or indirect. This amendment is of critical importance to Luxembourg entities holding shares in Polish companies that own real estate situated in Poland. The gains derived by the Luxembourg entity from the sale of shares in such a Polish company will be subject to tax in Poland. This is a market departure from the current regime, which under the current Treaty, provides sole taxing rights only in Luxembourg.

It should be noted that such property rich provisions were not introduced in the recently concluded Protocol to the Double Tax Treaty between Poland and Cyprus, hence restructuring using a Cypriot vehicle can potentially provide a viable alternative.

Artificial arrangements

The Protocol introduces an anti-abuse clause, hence the possibility to refuse Treaty benefits to income received and/or derived in connection with an artificial arrangement. No definition to the term "artificial arrangement" is provided in the Protocol. The tax authorities of both states will be entitled to test for business substance beyond the apparent structure, which may have been created solely for tax purposes. If the business structure is found to be "artificial", then the tax authorities will be entitled to refuse the application of Treaty benefits.

Withholding tax rates

The Protocol introduces new rules for the taxation of cross-border dividends. It provides for exemption from withholding tax, if the beneficial owner is a company (other than a partnership) directly holding at least 10% of the capital in the dividend paying company, for at least 24 months preceding the payment of dividends. The Protocol also provides for a maximum of 15% withholding tax in all other cases.

The Protocol also reduces the withholding tax on interest and royalties from 10% to 5%, however in most cases a more favorable treatment may apply on application of the EU Parent-Subsidiary Directive, and Interest and Royalties Directive.

Exchange of information

The protocol introduces full exchange of information. It adapts Article 27 of the Treaty to align it with OECD model standards.

Avoidance of double taxation

From the Polish perspective, the principal method of avoiding double taxation is exemption with progression. However, with respect to certain categories of income (including dividends, interest and royalties) received by Polish residents, the proportional credit method applies. This amendment is important to Polish tax residents who receive dividend payments from Luxembourg entities. According to the current Treaty in force, such dividends are exempted from Polish income tax, however once the Protocol comes into force they will be subject to Polish income tax, in addition to Luxembourg income tax.

The Protocol will enter into force after Luxembourg and Poland proceed to ratification. Assuming that the ratification process and exchange of diplomatic notes will be completed in 2012, which is widely expected to be the case, the Protocol's regulations will be in force and have effect as of 1 January 2013.

Numerous existing structures will need to be revisited, in light of the Protocol. These include in particular real estate structures involving Luxembourg companies that hold properties located in Poland (e.g., SIFs, SICAVs and securitization vehicles) and structures taking advantage of the Polish exemption of dividends distributed by Luxembourg companies under the current Treaty.

Savva & Associates and our team of tax professionals are well positioned to advise you on restructuring options that may be available and recommended in light of the above mentioned provisions of the new Protocol.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Charles Savva
 
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