Background
On 7 June 2022, a new Double Tax Treaty (the “DTT”) has been signed between Luxembourg and the United Kingdom (UK) to reflect the most recent OECD tax standard. An additional protocol will replace the tax treaty signed in 1967. The entry into force is still pending, waiting for the completion of the ratification processes in both jurisdictions.
Below are summarized the important changes:
The Content of the Project
Tax Residence and New Tie–Breaker Rule
The new DTT expands the definition of “resident of a Contracting State” that can be defined as any person who is liable to “tax therein by reason of its domicile, residence, place of management, place of incorporation, place of registered office or any other criterion of a similar nature”.
Under specific conditions, Luxembourg collective investment vehicles (“CIVs”), such as Luxembourg UCITS, UCIs part II, SIFs, and RAIFs, are considered to be Luxembourg residents and can benefit from tax treaties.
If a person is a resident of both the UK and Luxembourg, according to the definition of the DTT provisions, the “effective management” place is no longer considered to be the definitive tie–breaker rule. The tie–breaker provision is now aligned with the OECD model convention provision under which the competent tax authorities shall determine, by mutual agreement and regarding to the place of effective management, where it is incorporated or constituted and any other relevant factors. The taxpayers benefiting from the tie–breaker rule under the current treaty are not affected by the mutual agreement procedure prescribed by the new DTT, subject to the condition the material facts remain unchanged.
Dividends
The current tax treaty provides for a 5% withholding tax at a source subject to specific conditions while the new DTT mentions that dividend distributions from a company resident in one Contracting State, to a beneficial owner resident in the other Contracting State shall not be subject to withholding tax in the source jurisdiction.
Royalties
While the current tax treaty allows the source state to levy a 5% withholding tax on royalty payments, the new DTT indicates that the residence jurisdiction of the beneficial owner has the exclusive right to tax royalty payments.
Capital gains and land–rich clause
A land–rich clause has been introduced by the new DTT. Gains deriving from a Contracting State’s resident as a result of the alienation of shares or comparable interests, such as interests in a partnership or trust, deriving more than 50% of their value directly or indirectly from ACTIVE/117620490.1 immovable property, may be taxed in the State where the immovable property is located. As such, the UK will be able to tax gains realized by Luxembourg investors on shares or interests in companies holding UK real estate.
Entitlement to benefits/Principal purpose test (art. 28)
The principal purpose test provided by the Multilateral Instrument (MLI) has been incorporated in the new DTT, which means that a benefit under the DTT should be denied 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; except if it is established that granting that benefit in these circumstances would respect the objective and purpose of the relevant provisions of the DTT.
Next steps
The new DTT will enter into force after its ratification by both the UK and Luxembourg. As it introduces numerous changes, Luxembourg taxpayers should start considering those provisions in depth to assess potential implications on their existing structures (in particular if UK properties are involved) and anticipate the entry into force of the new DTT for the future.
Sami Ayadi was a contributing author to this insight.