On 7 June 2022, the governments of Luxembourg and the United Kingdom (the “UK”) signed a new double tax treaty (the “New Treaty”) replacing the treaty of 1967 (the “Current Treaty”), as amended.
The New Treaty contains significant amendments, not all of which are in line with the 2017 OECD Model Tax Convention (the “OECD MTC”).
The most notable amendments concern (i) Article 10 on dividends, which now includes an exemption from withholding tax in most cases; (ii) Article 13 on capital gains, which now includes the so-called “land-rich provision” and (iii) the New Treaty’s application to Luxembourg collective investment vehicles under certain conditions (Article 4 and the Protocol to the New Treaty (the “Protocol”)).
The New Treaty will enter into force once Luxembourg and the UK have completed their respective ratification and notification processes.
The main amendments and noteworthy information regarding corporate taxpayers can be summarised as follows:
Article 4: resident
The term “resident” now includes the states and any political subdivisions or local authorities thereof, as well as recognised pension funds.
Recognised pension funds are defined in the Protocol. In Luxembourg, this includes (i) pension-savings companies with variable capital (SEPCAV), (ii) pension-savings associations (ASSEP), (iii) pension funds subject to supervision and regulation by the Insurance Commissioner, and (iv) the Social Security Compensation Fund SICAV-FIS. In the UK, this includes pension schemes (other than a social security scheme) registered under Part 4 of the Finance Act 2004, including pension funds or pension schemes arranged through insurance companies and unit trusts where the unit holders are exclusively pension schemes.
The Protocol also provides that Luxembourg collective investment vehicles (“Luxembourg CIVs”) established and treated as a body corporate for tax purposes are treated as individuals who are residents of Luxembourg and beneficial owners of the income they receive, where their beneficial interests are owned by equivalent beneficiaries. An equivalent beneficiary can be a resident of Luxembourg, or a resident of any other jurisdiction with which the UK has arrangements that provide for information exchange as well as at least equivalent benefits (i.e., with respect to the rate of tax applicable to the relevant item of income).
Luxembourg CIVs can be (i) undertakings for collective investment in transferable securities (UCITS) subject to Part I of the law of 17 December 2010, (ii) undertakings for collective investment subject to Part II of the law of 17 December 2010, (iii) specialised investment funds (SIFs) subject to the law of 13 February 2007 or (iv) reserved alternative investment funds (RAIFs) subject to the law of 23 July 2016.
Where the Luxembourg CIV is a UCITS within the meaning of EU Directive 2009/65/EC, or at least 75% of its beneficial interests are owned by equivalent beneficiaries, it will as a rule be treated as a resident of Luxembourg and as the beneficial owner of the income it receives.
With respect to the tie-breaker rule, the New Treaty provides that, in line with the OECD MTC, Luxembourg and the UK must, by mutual agreement, determine the tax residence of an entity having regard to certain factors, such as the place of effective management or the place where it is incorporated. The Protocol also provides a non-exhaustive list of relevant factors, such as where the senior management of the person is carried on, or where the meetings of the board of directors or equivalent body are held.
Articles 5 & 7: permanent establishment, business profits
The provisions on permanent establishment and the allocation of taxing rights with respect to business profits between Luxembourg and the UK have been modified to align to some extent with the OECD MTC. In particular, they include provisions that deal with the treatment of transfer pricing adjustments.
It is, however, worth noting that the updated provisions on dependent agents depart from the OECD MTC. Under the New Treaty, where a person is acting on behalf of an enterprise (e.g., one resident in Luxembourg) and has exercised, and habitually exercises, in the other state (e.g., the UK), an authority to conclude contracts on behalf of the enterprise, that enterprise will be deemed to have a permanent establishment in the UK in respect of these activities. In the OECD MTC, a permanent establishment is deemed to already exist in the other country as soon as the dependent agent habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.
The provisions on independent agents remain the same and do not adopt the stricter approach of the OECD MTC.
Article 10: dividends
This article contains one of the most significant changes in the treaty provisions. The Current Treaty provides for a reduced withholding tax rate of 5% where the beneficial owner is a company controlling at least 25% of the voting power of the subsidiary, and a 15% withholding tax rate in all other cases.
The New Treaty provides a general withholding tax exemption for dividends.
There is an exception: a 15% withholding tax will apply to dividends paid out of income (including gains) derived directly or indirectly from immovable property (as defined in Article 6) by an investment vehicle which distributes most of this income annually and whose income from such immovable property is exempted from tax (e.g., a UK REIT). However, such dividends paid to recognised pension funds will remain withholding tax exempt.
Article 11: interest
Interest income remains taxable only in the state of residence of the beneficial owner; i.e., no withholding tax applies.
Article 12: royalties
Royalties will become taxable only in the state of residence of the beneficial owner; i.e., the provisions no longer allow a 5% withholding tax to be levied. The impact of this in Luxembourg is limited, as there is generally no withholding tax on royalties.
Article 13: capital gains
The new provisions include another major change to the Current Treaty, largely inspired by the OECD MTC. The New Treaty now includes a so-called land-rich provision which means, for instance, that gains derived by a Luxembourg company from the sale of shares (or comparable interest such as partnership / trust units), which derive more than 50% of their value directly or indirectly from real estate assets located in the UK, may be taxed in the UK.
Article 22: elimination of double taxation
For Luxembourg residents, the exemption method (with progression) remains the main method for eliminating double taxation. The credit method will notably apply to gains related to the land-rich provision.
Article 26: assistance in the collection of taxes
The New Treaty includes a completely new article on assistance in the collection of taxes between the two countries, which appears to be broadly in line with the OECD MTC.
Article 28: entitlement to benefits
The New Treaty incorporates the so called “principal purposes test” provisions (or anti-tax treaty abuse provisions), which were already included in the Current Treaty following implementation of the Multilateral Instrument (refer to our Newsflash_ for more details on the Multilateral Instrument and its implementation).
These provisions deny the granting of benefit under the New Treaty if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the New Treaty.
It is also worth mentioning that, based on point 5 of the Protocol, Luxembourg will be entitled to apply its domestic controlled foreign company (CFC) provisions regardless of the New Treaty provisions.
Article 29: entry into force
Once Luxembourg and the UK have completed their ratification and notification processes (i.e., when the New Treaty enters into force), the new provisions will generally have effect as follows:
a) in the UK:
(i) in respect of taxes withheld at source, to income derived on or after 1 January of the calendar year after the year in which the New Treaty enters into force;
(ii) in respect of income tax and capital gains tax, for any year of assessment beginning on or after 6 April of the calendar year after the year in which the New Treaty enters into force;
(iii) in respect of corporation tax, for any financial year beginning on or after 1 April of the calendar year after the year in which the New Treaty enters into force;
b) in Luxembourg:
(i) in respect of taxes withheld at source, to income derived on or after 1 January of the calendar year after the year in which the New Treaty enters into force;
(ii) in respect of other taxes on income, and taxes on capital, to taxes chargeable for any taxable year beginning on or after 1 January of the calendar year after the year in which the New Treaty enters into force.
Next steps
The New Treaty is now subject to the ratification and notification processes in both countries before it enters into force.
While this date remains uncertain, Luxembourg taxpayers are strongly advised to start reviewing and assessing the potential impact that the New Treaty may have on their existing or new operations and investments, in particular where UK real estate investments are involved.
ERIC FORT - Partner - Tax Law
ALAIN GOEBEL - Partner - Tax Law
THIERRY LESAGE - Partner - Tax Law
VINCENT MAHLER - Partner - Tax Law
JAN NEUGEBAUER - Partner - Tax Law
