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New Double Tax Treaty signed between Luxembourg and the United Kingdom (UK)

09/06/22

In brief

On 7 June 2022, the Luxembourg Government signed a new Double Tax Treaty (“the new DTT”) with the United Kingdom. The entry into force is subject to completion of the ratification processes in both jurisdictions. 

The new DTT introduces an exemption from withholding tax on dividend payments as well as the so called “real estate rich” company clause, with however certain particularities further detailed below. 

In detail

Resident (article 4 of the DTT)

The new DTT expands the definition of resident to include “state and any political subdivision or local authority”, as well as “recognised pension fund” of each contracting state. The protocol further defines “recognised pension fund” as included:

  • In the case of Luxembourg: (i) pension-savings companies with variable capital (sociétés d’épargne-pension à capital variable: SEPCAV), (ii) pension-savings associations (associations d’épargne-pension: ASSEP), (iii) pension funds subject to supervision and regulation by the Insurance Commissioner (Commissariat aux assurances) and (iv) the Social Security Compensation Fund (Fonds de Compensation de la Sécurité Sociale) SICAV-FIS;

  • In the case of the UK: 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. 

  • It further stipulates that the competent authorities may agree to include pension schemes of identical or substantially similar economic or legal nature which are introduced by way of statute or legislation in either contracting state after the date of signature of the new DTT. 

The tie-breaker provision has been also updated and is now aligned with the OECD model convention provision under which mutual agreement between the contracting states shall be reached to determine the tax residency of a person other than an individual that would be resident of both contracting states. 

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”) and proposed adjusted wording. 

Withholding taxes 

Dividends (article 10 of the DTT)

  • 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.

  • The new DTT provides in its article 10 (2) a) that no withholding tax 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. 

The current DTT is providing only for a reduced 5% withholding tax rate under the same condition so this new provision is rather welcomed, especially since the UK has left the EU and does not benefit anymore from the Parent-Subsidiary Directive.

  • It also provides under article 10 (2) b) that withholding tax shall not exceed 15% where dividends are paid out of income (including gains) derived directly or indirectly from immovable property by an investment vehicle which distributes most of this income annually and whose income from such immovable property is exempted from tax (e.g. entities benefiting from the UK REIT regime). This provision shall however not apply where the beneficial owner of the dividend is a recognized pension fund established in the other contracting state, and for which the withholding tax exemption under article 10 (2) a) shall apply.  

Interest and royalties (article 11 and 12 of the DTT)

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

Paragraph 4 of both articles 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.

As regards royalties, under the current DTT, reduced withholding tax of 5% was applicable to royalty payments arising in one contracting state to a resident of the other  provided it was the beneficial owner of the royalties. Hence the provisions of the new DTT seems to be more beneficial in this respect. 

We however note  that under Luxembourg domestic tax law, there is generally no withholding tax on interest and royalty payments (except for limited exceptions), hence changes to the above articles may have limited effect from a pure Luxembourg perspective.

Capital gains (article 13 of the DTT)

Following the OECD model, the new DTT foresees, as a general rule, that capital gains shall be taxed only in the contracting state where the alienator is a resident. Some exceptions, however, allow the taxation of the capital gains in the other contracting state (where the asset is located), for:  

  • immovable property situated in the other contracting state; 

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

  • 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.

  • rights to assets to be produced by the exploration or exploitation of the seabed and its sub-oil situated in the UK. 

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 item of income such as dividends and gains on disposal of “real estate rich” companies, which may be taxed in the UK, it seems that 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.

Denial of tax treaty benefits (article 28 of the DTT)

In line with the commitments taken within the framework of the Multilateral Instrument (MLI) initiative for implementing BEPS in DTTs, the new DTT contains a Principal Purpose Test (PPT). According to the PPT, a benefit under this DTT shall not be granted in respect of an item of income or capital or capital gain, if it is reasonable to conclude 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 this DTT.

Access to the treaty for CIVs (paragraph 2 of the Protocol)

The protocol provides that a Collective Investment Vehicles (CIV) established and treated as a body corporate for tax purposes in Luxembourg and which receives income arising in the UK shall be treated as resident of Luxembourg and beneficial owner of such income for purposes of applying the provision of the new DTT to such income if the beneficial interests in the CIV are owned by equivalent beneficiaries.

Equivalent beneficiaries are referring to Luxembourg residents or residents of countries having signed a convention with the UK that provides effective and comprehensive information exchange and a rate of tax with respect to the item of income at stake that is at least as low as the rate claimed under the new DTT by the CIV with respect to that item of income. 

It is worth mentioning that 75% of the beneficial interests in the CIV are held by equivalent beneficiaries, or when the CIV is an undertaking for collective investment in transferable securities (UCITS) within the meaning of EU Directive 2009/65, the CIV shall be treated as a resident of Luxembourg and as the beneficial owner of all the income it receives (e.g. interest income). 

Entry into force (article 30 of the DTT)

The tax treaty will enter into force once the ratification process is completed by both parties. Then, the treaty’s provisions will be effective as follows:

1. As far as the UK is concerned:

  • for withholding taxes, to income derived on or after 1 January of the calendar year next following the year in which the new DTT enters into force;
  • for 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 the new DTT enters into force;
  • for corporation tax, for any financial year beginning on or after 1 April of the calendar year next following the year in which the new DTT enters into force.

2. As far as Luxembourg is concerned:

  • for withholding taxes, to income derived on or after 1 January of the calendar year next following the year in which the new DTT enters into force; 
  • for 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 new DTT enters into force.

Takeaway

While the date of the entry into force of the new DTT is still uncertain (as relying on the ratification process in both jurisdictions), we recommend Luxembourg taxpayers to start reviewing the provisions of the new DTT in depth to assess potential implications on their existing structures (in particular structures implying investments in UK properties held through subsidiaries which may be affected by the “real estate rich” companies clause) as well as anticipate the entry into force of the new DTT (including favourable dividends withholding tax exemption provisions) for new investment opportunities.

Contact us

Alexandre Jaumotte

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 5380

Fabien Hautier

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 3004

Alina Macovei

Alternatives Tax Partner, PwC Luxembourg

Tel: + 352 49 48 48 3122

Iryna Sansonnet-Matsukevich

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 3185

Thierry Braem

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 5106

Ming-Huey Lim

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 3025

Cécile Menner

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 3140

Mourad Garouche

Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 4855

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