Russia to terminate Double Tax Treaty with the Netherlands

01/06/21

The Russian Federation and the Netherlands have been renegotiating the current Double Tax treaty. The current state of affairs is that the negotiations are in an impasse.

The controversy between the Netherlands and Russia is over the higher withholding tax rates that Russia wants to impose on interest, royalty and dividend payments and the more strict conditions Russia wants to apply to companies in order to be eligible for the treaty benefits. However, if the negotiations do not result in a new agreement, this will also have consequences for all other taxable activities between Russia and the Netherlands.

These consequences include amongst others the position of cross-border workers and secondment of personnel, the recognition and tax treatment of permanent establishments and, more in general, business investments between the two countries.

General

The Russian Federation and the Netherlands have been renegotiating the current Double Tax treaty between the two countries which already dates from 1996 now for quite some time. According to an informative letter from the Dutch Ministry of Finance to the Dutch Parliament (Tweede Kamer) of April this year, initially Russia and the Netherlands came to a draft agreement for a new tax treaty already early 2020. However, after that Russia has re-opened negotiations in respect of the applicable rates for withholding taxes on interest, royalties and dividends and the conditions upon which companies are eligible to treaty benefits.

The current state of affairs is that the Netherlands do not accept these new demands from Russia, meaning that the negotiations are now in an impasse. In the meantime Russia has started the national procedure to terminate the current Double Tax treaty with the Netherlands, by adopting a law that makes this termination possible. It is important to note that the termination of the Double Tax treaty does not just concern interest, royalty and dividend payments between Russia and the Netherlands, but any taxable activities between the countries, such as:

Secondment of employees
Business investments between the countries
Recognition of Permanent Establishments

The Netherlands have not yet received the formal notification from the Russian Federation to terminate the treaty, as described in Article 31 of the Treaty. Should the Russian government issue this notification still in 2021, then the Treaty will be terminated as of tax years or tax periods starting on or after 1 January 2022.

What does this mean for your organisation?

Please note that hereafter we make only some general remarks about a number of tax consequences that a cancellation of the Double Tax treaty between Russia and the Netherlands may have in respect to certain types of income and in certain situations. At the moment it is impossible to give a complete overview of all tax consequences that may arise. Possibly the Dutch and/or Russian legislators may issue new unilateral rules in order to mitigate negative effects outside the sphere of international (tax) treaty law.

Investments from the Netherlands into Russia

Russian subsidiary held by a Dutch company

In the current situation, the Netherlands in most cases do not levy any corporate income tax in respect of dividend income received from a Russian subsidiary, assuming that the participation exemption is applicable. The same goes for any capital gains realised upon the sale and transfer of (the) shares of a Russian subsidiary. After cancellation this situation will most likely not change.

Russia in its turn generally levies withholding tax on dividends paid by Russian companies to its shareholders. The Russian statutory withholding tax rate in respect of dividends is 15%. Under the current Double tax Treaty, Russia is allowed a 5% or a 15% withholding tax rate in respect of dividends, as the case may be. Please note that in general (Russian and other) withholding tax on dividends is not recoverable in the Netherlands in situations that the participation exemption is applicable in respect of a (Russian) subsidiary.

Interest and royalty payments are under the current tax treaty not subject to Russian withholding tax. However, the Russian statutory withholding tax rate is for interest and royalties 20% and may become applicable if the Double Tax treaty is eventually cancelled.

After the termination of the current Double Tax Treaty, a tax credit may be granted for the Russian withholding tax under the Dutch Unilateral Decree for the Avoidance of Double Taxation. This, however, will only be the case if Russia is designated by the Dutch Government or the OECD as a developing country within the meaning of the Dutch Unilateral Decree for the Avoidance of Double Taxation. It is yet unclear whether the Dutch government will indeed add Russia to this list of developing countries.

Russian permanent establishment (‘PE’) of a Dutch resident enterprise

Under the current Double Tax Treaty, the question whether a Dutch resident enterprise carries on its business by means of a PE will be assessed according to the definition of a PE in the Double Tax Treaty. Profits of a PE in Russia will be exempt under Dutch domestic law (corporations) or under the Double Tax Treaty (sole proprietorship).

After the termination of the current Double Tax Treaty, the question whether a Dutch resident enterprise carries on its business by means of a PE will be assessed according to the definition of a PE in the domestic Dutch law.

In addition, under the current Double Tax Treaty a building site or construction or installation project will only constitute a PE in Russia if it lasts more than 12 months. After the termination of the current Double Tax Treaty a building site or construction or installation project will constitute a Russian PE immediately.

Profits of a PE in Russia will be exempt under Dutch domestic law (corporations) or under the Dutch Unilateral Decree for the Avoidance of Double Taxation (sole proprietorship).

Investments from Russia into the Netherlands

Netherlands subsidiary held by a Russian company

The Netherlands levies withholding tax on dividends paid by Netherlands resident companies to its shareholders. The Dutch statutory withholding tax rate in respect of dividends is 15%. Under the current Double tax Treaty, the Netherlands is allowed a 5% or a 15% withholding tax rate in respect of dividends, as the case may be. In case of Russian corporate shareholders, a withholding exemption (‘inhoudingsvrijstelling’) may apply to the dividend withholding tax. After the termination of the current Double Tax Treaty, this withholding exemption will no longer apply.

The question whether Dutch withholding tax on dividends may be credited after the current Double Tax Treaty has been terminated, depends on Russian domestic tax law. Please note that in general (Dutch and other) withholding tax on dividends is not recoverable in Russia in situations that the (Russian version of) the participation exemption is applicable in respect of a (Dutch) subsidiary.

Permanent establishment (‘PE’) in the Netherlands of an enterprise resident in Russia

Under the current Double Tax Treaty, the question whether an enterprise resident in Russia on its business by means of a PE in the Netherlands will be assessed according to the definition of a PE in the Double Tax Treaty. After the termination of the current Double Tax Treaty, the question whether an enterprise resident in Russia carries on its business by means of a PE in the Netherlands will be assessed according to facts and circumstances.

Cross-border workers

Tax residents of the Netherlands that are working in Russia, may become earlier liable to personal income tax and/or payroll taxes in Russia. The so-called 183-rule in the current Double Tax Treaty will no longer apply, after the termination of the Double Tax Treaty. In specific situations this may lead to a higher tax burden or even double taxation. On the other hand the Netherlands may grant relief for double taxation under the Unilateral Decree for the Avoidance of Double Taxation.

Tax residents of Russia that are working in the Netherlands, may also become earlier liable to personal income tax and/or payroll taxes in the Netherlands. Whether Russia will grant relief for double taxation for these employees depends on Russian domestic tax law.

Tax consequences for cross border workers as well as the compliance obligations in both countries depend on the actual situation of a certain case. It is important to review the tax positions of the individuals concerned and the payroll tax registration and filing position of your company, in order to be prepared in case the Double Tax Treaty would no longer apply for income received as of 1 January 2022.

Webinar

PwC the Netherlands and PwC Russia will organise a client-webinar on this topic, in which the main consequences and practical implications for clients will be discussed in detail. The webinar will take place on June 22 between 4pm and 530pm CEST. More information see our webpage: Consequences of the termination of the double tax treaty between the Netherlands and Russia.