The main changes in relation to the new double tax treaty (’’the new DTT’’) also include a provision, granting Luxembourg collective investment vehicles (‘’CIVs’’) treaty benefits under certain conditions as well as amendments to the tie-breaker rule.
The changes to the treaty have not yet been ratified and are likely to take effect from the following year. As set out below more comprehensively, the entry into effect dates for the different types of provisions differ.
The following aspects of the new double tax treaty between Luxembourg and the UK will be addressed:
1. Capital gains (Article 13)
In 2019 the UK Government implemented the so-called Non-Resident Capital Gains Tax (‘’NRCGT’’), which entails that non-UK residents are subject to tax on gains realised on the direct or indirect sale of UK real estate. The latter consists of the sale of a company which derives 75% or more of its gross value, directly or indirectly, from UK real estate (a UK property rich company).
As such, the current treaty between Luxembourg and the UK gives the taxing right to Luxembourg when it comes to gains realised on the disposal of indirect sales of UK real estate. Correspondingly, a Luxembourg resident disposing of a UK property rich company would be subject to Luxembourg tax (if applicable), and the UK NRCGT would not apply.
Under the new provision enshrined in article 13(2) of the new DTT, also referred to as the ’’land-rich provision’’, the treaty provides for a taxing right to UK or, as applicable, to Luxembourg on the sale of shares (or comparable interests, such as interests in a partnership or trust) deriving more than 50% of their value directly or indirectly from real estate in the jurisdiction in which the real estate is located. Consequently, the treaty will not override the UK NRCGT and therefore, a Luxembourg tax resident disposing of a UK property rich company will be subject to UK NRCGT on the gain.
2. Dividends (Article 10)
The new DTT provides that under article 10(2)(a) 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 that the company receiving the dividends is also the beneficial owner.
The exception to the withholding tax (‘’WHT’’) exemption is not applicable in cases 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. In such cases, dividends are subject to a WHT of 15%.
3. Royalties and Interest (Article 12)
Under the amended rules, only the state of residence of the beneficial owner has the right to tax cross-border interest and royalty payments.
In addition to that, the rate of withholding tax on royalties is reduced to 0% as opposed to the WHT rate of 5% under the existing treaty.
4. Residency (article 4 DTT)
The new DTT broadens the existing definition of resident to cover "state and any political subdivision or local authority" and "recognised pension fund".
As such, the definition of the recognised pension funds is contained in the additional Protocol and states as follows:
In the case of Luxembourg:
- Pension-savings companies with variable capital (sociétés d’épargne-pension à capital variable: SEPCAV);
- Pension-savings associations (associations d’épargne-pension: ASSEP);
- Pension funds subject to supervision and regulation by the Insurance Commissioner (Commissariat aux assurances); and
- 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.
Additionally, the new DTT provides with an updated version to the "place of effective management" rule (the so-called "tie-breaker" test) which in the existing treaty serves as a decisive criterion when there is an issue relating to double taxation, as a consequence of dual residency. The new treaty, in accordance with the OECD Model Tax Convention, states
that in case of such dispute, the mutual agreement procedure ("MAP") needs to be utilised.
5. Treaty access for CIVs (Protocol)
The new rules bring forth several cases in which CIVs, under certain conditions, could have access to the treaty.
The first case where a CIV could be treated as a Luxembourg resident and the beneficial owner of the income it receives, is where it is established and treated as a body corporate for tax purposes in Luxembourg (including UCITs/UCIs and SIFs/RAIFs), and where it receives income arising in the UK. This rule, however, is limited to the extent that the beneficial interests in the CIV are owned by equivalent beneficiaries (i.e. Luxembourg residents or residents of countries having a treaty with the UK that provide for effective and comprehensive information exchange and a rate of tax that is at least as low as the rate claimed under the new treaty).
Nonetheless, if 75% or more of the beneficial interests in the CIV are owned by equivalent beneficiaries, or if the collective investment vehicle qualifies as an UCITS under the EU Directive 2009/65, the CIV will be regarded as a Luxembourg tax resident and as the beneficial owner of all the income it receives.
6. Entry into force
The treaty will enter into force once the ratification process is concluded. Once the treaty is ratified, the provisions will take effect as follows:
With reference to the UK
- In relation to withholding taxes, to income derived on or after the following 1 January;
- In relation to corporation tax, for any financial year beginning on or after the following 1 April; and
- In relation to income and capital gains tax, for any year of assessment beginning on or after the following 6 April.
With reference to Luxembourg
- In relation to withholding taxes, to income derived on or after the following 1 January; and
- In relation to other taxes on income and capital, to taxes chargeable for any taxable year beginning on or after the following 1 January.
7. Our observations
While some amendments, such as the withholding tax exemption provision would be welcome after Brexit, some others, for instance the changes made to the decisive criterion when it comes to the tie-breaker rule for companies would cause a lot of uncertainty and discussions.
As the new treaty still has not been ratified, taxpayers are advised to assess the amended provisions, in particular the land rich clause, in order to anticipate how they will affect their existing structure as well as to foresee future investments.