New double tax treaty signed between Luxembourg and the UK

In detail

Business profits/Permanent establishment (articles 5 and 7 of the DTT)

Profits of a company located in one contracting state shall be taxable only in that state, except when the company carries on business activities in the other contracting state through a permanent establishment situated therein. 

The definition of a permanent establishment under article 5 of the new DTT follows generally the OECD model conventions, with the exception to paragraphs 7 to 9, which do not seem to follow the recommendations made by the OECD Action Plan 7 (“Preventing the Artificial Avoidance of Permanent Establishment Status”). Now, the PE attribution rules concern broader transfer pricing principles, instead of the more prescriptive wording used previously. 

Withholding taxes on dividends (article 10 of the DTT)

The new DTT provides a 0% withholding tax (compared to 5% under the current DTT) which shall apply to dividends paid by a company resident in one contracting state to a company resident in the other contracting state provided the receiving company is the beneficial owner of the dividend payment. 

Exception is made through Article 10.2 b) which allows for dividends paid by a UK real estate investment trust (REIT) or similar entities to be subject to a WHT that does not exceed 15%, in line with most other UK DTTs, unless the REIT dividends’ beneficial owner is a recognised pension fund, in which case the 0% rate applies.

In addition, the definition of the term “dividend” as applicable for this article is now aligned between both contracting states, whereby it refers to “income from shares, or other rights, not being debt-claims, participating in profits, as well as any other item which is treated as income from shares by the taxation laws of the State of which the company making the distribution is a resident”. Under the DTT currently applicable, the definition was referring to both UK and Luxembourg concepts and was subject to interpretation. This new definition may therefore provide more clarity in its application.

Withholding taxes on interest (article 11 of the DTT)

Cross-border interest payments are taxable only in the contracting state where the beneficial owner is a resident. 

Paragraph 4 of the article provides however that the above is limited to the “arm’s length” portion of the interest. In other words, in cases where the interest rate would be considered as excessive as a result of special relationships between the parties, the exceeding part of the interest (compared to the rate that would have been agreed in absence of such special relationship) remains taxable in accordance with the domestic law of each contracting state and other provisions of this DTT.

Capital gains (article 13 of the DTT)

The general rule is that capital gains should only be taxed in the contracting state where the person is resident. However, the following are some exceptions to this rule:

• Immovable property situated in the other contracting state;

• Movable property allocated to a permanent establishment in the other contracting state;

• Shares of a “real estate rich” company, i.e. shares (or comparable interest such as interests in a partnership or trust) deriving, directly or indirectly, more than 50% of their value from immovable property situated in the other contracting state.

The introduction of the real estate rich company provision was expected, and Luxembourg taxpayers should therefore anticipate changes in effective taxation upon disposal of companies holding (and deriving their value predominantly from) directly /indirectly immovable property in the UK. 

Elimination of double taxation (article 22 of the DTT)

For Luxembourg residents, the general principle will remain exemption with progression. 

However, with respect to certain income, such as dividends and gains on disposal of “real estate rich” companies, which may be taxed in the UK, the tax credit method has been retained as a method to eliminate double taxation outcome, rather than an exemption method, as it has been introduced in other tax treaties. It should be noted though that Luxembourg taxpayers should still be able to enjoy corporate income tax and municipal business tax exemption upon disposal of the shares in a subsidiary provided the conditions of the domestic Luxembourg participation exemption regime are met.

Entry into force

The tax treaty will enter into force once the ratification process is completed by both parties.

Once this happens, the treaty’s provisions will be effective as follows:

In the United Kingdom:

• In respect of taxes withheld at source, to income derived on or after 1 January of the calendar year next following the year in which this Convention enters into force;

• In respect of income tax and capital gains tax, for any year of assessment beginning on or after 6 April of the calendar year next following the year in which this Convention enters into force;

• In respect of corporation tax, for any financial year beginning on or after 1 April of the calendar year next following the year in which this Convention enters into force.

In Luxembourg:

• In respect of taxes withheld at source, to income derived on or after 1 January of the calendar year next following the year in which the Convention enters into force;

• 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 following the year in which the Convention enters into force.