On June 7 2022, the Luxembourg government announced the signing of a new Double Tax Treaty (“DTT”) and a Protocol with the United Kingdom that will replace the existing DTT concluded in 1967. The new DTT introduces a number of significant changes, including an exemption from dividend withholding tax and a “real estate rich” company clause for capital gains. The new DTT shall enter into force upon ratification by both Luxembourg and the UK.
Resident (Article 4 of the new DTT)
The new resident articles adopts the new tie-breaker rule included in the OECD’s 2017 model convention which provides that dual residency cases shall be resolved via the mutual agreement procedure for dual resident companies.
Amendments to resident definition
The definition of resident is also extended to “state and any political subdivision or local authority” as well as “recognised pension fund” which according to the Protocol to the New DTT includes in the case of Luxembourg: pension savings companies with variable capital (SEPCAV); pension savings associations (ASSEP); pension funds subject to supervision and regulation by the Insurance Commissioner and the social security compensation fund (SICAV-FIS).
Further, treaty access is granted to Collective Investment Vehicles (CIVs) according to §2 of the Protocol which foresees that CIV established and treated as a body corporate for tax purposes in Luxembourg and which receive income from the UK shall be treated as a resident for the purpose of the new DTT, provided that the investors in the CIV are “equivalent beneficiaries”. Equivalent beneficiary is defined as a resident of Luxembourg, or a resident of another jurisdiction with which the UK has a comprehensive and effective information exchange and a rate of tax with respect to the item of income that is at least as low as the rate claimed under the new DTT by the CIV. For the purposes of the DTT the following entities are considered as CIVs:
- UCITS subject to law of 17 December 2010
- UCIs subject to Part II of the law of 17 December 2010
- Specialised Investment Funds (SIF)
- Reserved Alternative Investment Funds (RAIF)
Dividend Withholding tax (Article 10 of the new DTT)
Pursuant to Article 10(2)(a) of the new DTT a full withholding tax exemption shall apply to dividends paid by a company resident of a contracting state provided that the receiving company is the beneficial owner of the dividend. This is a welcome improvement since, as a result of Brexit, UK corporate tax payers are not entitled to the EU Parent Subsidiary Directive and may only rely on the current DTT which provides for a reduced 5% withholding tax.
The withholding tax exemption does not apply to distributions from real estate investment funds like UK REITs which under Article 10(2)(b) of the DTT are subject to a maximum 15% withholding tax (i.e. dividends paid out of income (including gains) derived directly or indirectly from immovable property by an investment fund which distributed most of its income annually and whose income is exempted from tax). If the recipient is a recognised pension fund (as defined in the Protocol), no withholding tax will apply.
The new DTT adopts a new rule regarding capital gains resulting from the sale of shares in “real estate rich companies”, in line with the OECD’s Model Convention. According to this new provision, gains derived by a resident of a Contracting state on the sale of shares deriving more than 50% of their value directly or indirectly from immovable property situated in another contracting state may be taxed in that other State. Under the current DTT, gains from the sale of shares are exclusively taxable in the state of residence of the alienator.
Elimination of double taxation
In general, Luxembourg will continue to apply the exemption method of eliminating double taxation for most types of income. In certain situations like dividends and gains on disposal of real estate rich companies, Luxembourg will apply the credit method. However, concerned taxpayers may nevertheless rely on the domestic participation exemption provided they meet the conditions.