On 7 June 2012, Luxembourg and Poland signed a Protocol amending the Double Tax Treaty concluded between the two countries on 14 June 1995. The main new measures are relating to (i) withholding taxes on dividends, interest and royalties, (ii) taxation of capital gains, (iii) methods to avoid double taxation, (iv) exchange of information and (v) introduction of anti-abuse provisions.
- Withholding tax on dividends, interest and royalties:
The Double Tax Treaty currently provides for the application of a 5% withholding tax on dividends paid to a beneficial owner who is a company (other than a partnership) holding directly at least 25% of the capital of the paying company. No minimum holding period is required to benefit from this reduced rate.
The Protocol abolishes this clause and provides that a 0% withholding tax rate applies on dividends paid to a beneficial owner who is a company (other than a partnership) (i) holding a direct participation of at least 10% of the capital of the paying company and (ii) holding such minimum participation for an uninterrupted period of at least 24 months preceding the dividend payment date.
A Luxembourg company would however rather rely on Luxembourg domestic tax law as article 147 of the Luxembourg Income Tax Law provides for an exemption of withholding tax on dividends under less stringent conditions. Indeed, no withholding tax applies on dividends paid to an EU company (including a Polish company) which at the date of dividend payment (i) holds a participation in a Luxembourg company of at least 10% or the acquisition cost of which is of at least EUR 1.2 million and (ii) holds or undertakes to hold such a minimum participation for at least 12 months.
If the conditions to benefit from the withholding tax exemptions based on the Luxembourg domestic tax law or the Protocol are not complied with, a withholding tax of 15% is levied on dividend payments.
Withholding tax on interest is reduced from 10% in the Double Tax Treaty to 5% in the Protocol.
A Luxembourg company paying interest to a Polish one would also rather rely on Luxembourg domestic tax law which does not provide for any withholding tax (except in limited circumstances) on interest.
Regarding interest paid by a Polish company, the Protocol offers a significant advantage compared to the 20% domestic withholding tax rate. In addition, an exemption of withholding tax will also be available starting from 1 July 2013 if interest is paid to an affiliated Luxembourg company in the meaning of Directive 2003/49/EC .
Withholding tax on royalties is reduced from 10% in the Double Tax Treaty to 5% in the Protocol.
A Luxembourg company paying royalties to a Polish one would also rather rely on Luxembourg domestic tax law which does not provide for any withholding tax (except in limited circumstances) on royalties.
Regarding royalties paid by a Polish company, the Protocol offers a significant advantage compared to the 20% domestic tax rate. In addition, an exemption of withholding tax will also be available starting from 1 July 2013 if royalties are paid to an affiliated Luxembourg company in the meaning of Directive 2003/49/EC.
As a reminder, royalties received by a Luxembourg company from a Polish company could (under certain conditions) benefit from a 80% exemption based on Luxembourg domestic tax law.
- Capital gains
The Protocol introduces a new provision in the Double Tax Treaty in line with the OECD Model Convention. It provides that capital gains realised on the disposal of shares deriving, directly or indirectly, more than 50% of their value from immovable properties situated in one State are subject to taxation in that State.
As a result, capital gains realised by a Luxembourg company on shares held in a Polish company holding immovable properties in Poland under the conditions described above would be subject to taxation in Poland.
There are some open questions as to the application of this clause. One may wonder whether it applies in complex groups where capital gains are realised on the disposal by a Luxembourg company of shares in another Luxembourg company holding real estate assets in Poland through a Polish company. In addition, there might be possibilities to mitigate the consequences of this rule before the Protocol is applicable. Finally, there are some uncertainties as to the intentions of the contracting States on the scope of application of this new clause. Drafted as such, it should only apply to shares and not to gains from the alienation of interests in other entities that do not issue shares (such as e.g. Polish real estate investment funds). Reading through the comments on article 13.4 of the OECD Model Convention gives an indication of uncertainties relating to the interpretation of this clause. Clarifications may be given in the future by the two countries.
- Methods to avoid double taxation
For Luxembourg residents, the exemption method with progression remains the general rule. The credit method is applicable to income and gains which have suffered taxation in Poland regarding dividends (art. 10), interest (art. 11), royalties (art. 12), capital gains on shares in a real estate company (art. 13.4) and income of artists and sportsmen (art. 17).
Article 24.1.d) of the Double Tax Treaty providing for an exemption of dividends received by a Luxembourg company from a Polish company under the condition that the Luxembourg company holds a shareholding of at least 25% in the Polish company from the beginning of the tax year is abolished. Luxembourg companies can however rely on the exemption provided for by Luxembourg domestic tax law (art. 166 of the Luxembourg Income Tax Law). Luxembourg individuals receiving dividends from a Polish company could also benefit from a 50% exemption under certain conditions (art. 115-15a of the Luxembourg Income Tax Law).
For Polish residents, the exemption method with progression remains the general rule. The credit method is however broader as it applies to business income (art. 7), dividends (art. 10), interest (art. 11), royalties (art. 12), capital gains (art. 13) and income from independent activities (art. 14). The exemption of dividends received by Polish residents (individuals and companies) from a Luxembourg company currently applicable under the Double Tax Treaty will no longer be available under the Protocol.
- Exchange of information
The Protocol introduces an Exchange of Information clause in line with art. 26 of the OECD Model Convention. As in other treaties, the exchange of information procedure is subject to specific rules contained in this new clause and in an "Additional Protocol to the Treaty" indicating which details a request of exchange of information has to contain in order to be valid. In addition, "fishing expeditions" are not allowed and only exchange of information foreseeably relevant to secure the correct application of the provisions of the convention or of the domestic laws of the contracting States is allowed. Comments on the OECD Model Conventions as well as recent decisions of the Luxembourg courts have shown that the exchange of information is not automatic and has to follow specific rules in order to be actually applied. This is due to the necessity to protect the right to privacy of the taxpayers.
- Limitation of benefits
The Protocol includes an anti-abuse clause which provides that the advantages of the Double Tax Treaty (as amended by the Protocol) do not apply to income paid or received in connexion with an artificial arrangement. The terms used are vague and precisions will be needed as to the scope of this article.
The Additional Protocol also indicates that this clause denying the application of the Double Tax Treaty can also apply to persons taking advantage of legislations, regulations or administrative practices which are considered as harmful by the EU Code of Conduct (which relates to business taxation).
- Entry into force - Application
The Protocol will enter into force once both countries have exchanged the instruments of ratification.
The Protocol will be applicable to residents of Luxembourg and Poland as of taxes due for any tax year starting on 1 January (or after this date) in the calendar year following the entry into force of the Protocol. There is thus no certainty as to whether the Protocol will apply as of 1 January 2013 or 2014.
Regarding taxes withheld at source (such as dividends, interest and royalties), the Protocol will be applicable to income attributed on (or after) the first day of the second month following the entry into force of the Protocol.
The Protocol introduces advantageous withholding tax rates on dividends, interest and royalties which will particularly reduce the tax burden applicable to payments made from Poland to Luxembourg. Regarding payments from Luxembourg to Poland, domestic tax rules normally remain more favourable than the provisions of the Double Tax Treaty.
Regarding other clauses, the contracting States have introduced new rules which are compliant with the OECD Model Convention (exchange of information, capital gains on real estate rich companies) or with recent trends (anti-abuse rules).
The result thereof is that Luxembourg and Poland will have a Double Tax Treaty more in line with the ones which have been recently adopted or modified. Taxpayers (especially those investing in the Polish real estate market via Luxembourg) will thus need to adapt their existing investment structures in order to comply with the new rules and/or to avoid tax burdens which were not expected based on the current provisions of the Double Tax Treaty.