The first Double Tax Treaty (“DTT”) entered into between Luxembourg and the UK dates back to 1967 and has been amended three times since. As the last formal amendment dates back to 2009 and the last indirect modification took place through the Multilateral Instrument (“MLI”) in 2019, the tax treaty has been renegotiated to reflect the changing circumstances between these two countries (e.g. BREXIT) and the evolving tax environment. As a result, a new double tax treaty has been negotiated and was finally signed on 7 June 2022, which contains the following notable changes:
Resident
The notion of resident is expanded to include “states”, “political subdivisions” and “pension funds” which are defined as, 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 »).
This also includes, 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.
In addition, the DTT now provides for the mutual agreement procedure to be applied to solve double tax residency issues for companies, by the contracting states, taking into account the place of effective management, the place of incorporation as well as all other pertinent factors. In the case that no agreement can be reached by the contracting states, no treaty entitlement will arise for the taxpayer in question.
Taxation of capital gains
According to the OECD model, capital gains are taxed exclusively in the jurisdiction in which the seller is resident. In line with the real estate rich clause foreseen by the OECD model, the new DTT includes an exception regarding the gains derived from real estate rich companies (i.e. who derive 50% or more of their gross value, directly or indirectly, from immovable property located in the jurisdiction) where the taxing right is no longer absolute. Indeed, the capital gain derived from the indirect sale of real estate located in one of the contracting states, made by a resident of the other contracting states, is taxed in the state where the assets are located.
Dividends
The former DTT created a maximum rate of withholding tax of 5% on dividend distributions for companies and of 15% for individuals. This is now reduced to 0%, irrespective of whether they are paid to an individual or a company, but excluding payments made by Real Estate Investment Trusts (so called “REITs”). In that case, a 15% maximum withholding tax rate will apply.
Interests and royalties
While taxation rights on interest payments are only granted to the recipient’s country, as was previously the case, the same now also applies to royalty payments made to beneficial owners resident in the other contracting state (previously 5%).
Miscellaneous items
While part of the arbitration procedure included in the previous DTT post application of the MLI has not been retained in the DTT, an entitlement to benefits clause stating that a person or entity will not be granted the benefits of the new DTT, if an analysis of the circumstances leads 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”, has been agreed upon.
Investment funds
While the new DTT foresees in its protocol, that tax opaque collective investment vehicles (encompassing UCITS, Part II UCIs, SIFs, RAIFs as well as any other investment fund, arrangement or entity established in Luxembourg which the competent authorities of the contracting states agree to regard as a collective investment vehicle) established in Luxembourg are to be treated as an individual resident in Luxembourg for the purposes of the DTT; it nonetheless foresees an anti-treaty shopping rule to avoid misuse by third country investors. Indeed, treaty entitlement and beneficial ownership will only arise if equivalent beneficiaries own the collective investment vehicle, i.e. residents of Luxembourg or of any other jurisdiction with which the UK has arrangements, that provide for effective and comprehensive information exchange and that would be entitled under a double tax treaty to a tax rate on income, that is at least as low as the rate claimed under the new DTT by the collective investment vehicle. If at least 75% of the beneficial interests in the collective investment vehicle are owned by equivalent beneficiaries (as defined above), or if the collective investment vehicle is a UCIT within the meaning of Directive 2009/65/CE, the collective investment vehicle shall be treated as a resident of Luxembourg and as the beneficial owner of all of the income it receives.
Entry into force
The new DTT will enter into force as from 1 January of the year following the exchange of notification between the contracting states. In Luxembourg the ratification of the new DTT requires a law, the draft of which (No. 8160) was submitted to the Luxembourg Parliament (Chambre des Députés) on 24 February 2023. The entry into force of said law is expected in the course of the year, so that the new DTT would likely enter into force as of 1 January 2024.
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