New protocol to the Luxembourg-Poland Double Tax Treaty
On June 7, 2012, Poland and Luxembourg signed a protocol (the Protocol) amending the double tax treaty (DTT) initially signed in 1955. The key provisions of the Protocol are outlined below. The Protocol will bring changes regarding the structuring of investments into Polish real estate as Keith O’Donnell and Samantha Nonnenkamp explain below.
Change in the taxation of capital gains derived from real estate companies
The current DTT allocates the right to tax capital gains on shares in companies to the state of residence of the seller. In line with the current OECD Model Tax Convention (“MTC”), the Protocol introduces new rules for the taxation of capital gains derived from the disposal of shares in real estate companies and allocates the taxing right to the state where the immovable property is located. Real estate companies are those deriving more than 50% of their value, directly or indirectly, from immovable property. As a direct consequence, gains derived by Luxembourg companies on the disposal of shares in Polish real estate companies will become taxable in Poland. So far, these gains were only taxable in Luxembourg (country of the seller) and could benefit from an exemption based on the participation exemption regime.
Reduction of the withholding tax rates on dividends, interest and royalties
Under the current DTT, dividends trigger a 15 % withholding tax (“WHT”) rate, reduced to 5% provided a 25% stake is held in the share capital of the paying company. The Protocol replaces the reduced rate with a WHT exemption. The exemption applies to dividends paid to a company which is the beneficial owner of the income and which directly holds at least 10% in the share capital of the paying company for a minimum and uninterrupted period of 24 months preceding the date of payment.
The WHT rate on interest and royalties is decreased from 10% to 5%.
These changes are positive developments but the positive impact will be rather limited as the domestic regimes on dividends, interest and royalties are often more beneficial than the provisions of the new Protocol.
Avoidance of double taxation: expanded scope for the tax credit method
The exemption method with progression remains the rule for both Luxembourgish and Polish residents. The Protocol however expands the scope of the tax credit method and thus limits the cases where the exemption method will apply.
For Luxembourg residents, the tax credit method will now apply to capital gains on shares of real estate companies and to income of sportsmen and artists in addition to dividends, interest and royalties, under the current DTT.
For Polish residents, the tax credit method will apply to dividends, income of artists and sportsmen and capital gains besides to interest and royalties. This means that Polish residents will lose the benefit of the exemption of Luxembourg source dividends, such exemption being replaced with a tax credit.
Limitation on benefits
The Protocol denies DTT benefits in case of:
- income connected to artificial arrangements;
- persons taking advantage of laws, regulations and administrative practices that are qualified as a harmful tax measure by the EU Code of Conduct Group for Business Taxation.
Exchange of information
The Protocol amends the provisions on exchange of information to bring them in line with the OECD MTC. Only information foreseeably relevant to secure the application of domestic tax legislation or of the DTT is allowed to be exchanged.
Entry into force
The Protocol will enter into force upon the exchange by both contracting states of their respective instruments of ratification.
It will apply to income and wealth taxes due from the 1st January of the calendar year following the entry into force (i.e. 1st January 2013 at the earliest). Provisions on WHT will apply to revenues allocated as from the 1st day of the 2nd month which will follow the entry into force.
As a positive change, the Protocol reduces the WHT rates applicable to certain types of income. The positive impact of this measure will however in most cases be rather limited given the more favourable rules already applicable at domestic and EU level under certain conditions. The Protocol further aligns the exchange of information provisions to the current OECD MTC. Finally, it may impact negatively investments in Polish real estate and the taxation of Luxembourg source dividends in Polish residents’ hands. We recommend that taxpayers carefully review their investment structures in Polish real estate and in Luxembourg companies to mitigate any adverse tax consequence.