Luxembourg and the United Kingdom signed a new double tax treaty on 7 June 2022, together with a Protocol providing more details.
The main changes are the addition of (i) a so-called “real estate-rich clause” and (ii) the principal purpose test. Further, the situations in which dividend and interest withholding taxes are narrowed. The above-mentioned protocol adds details on which investment vehicles will be regarded as residents for tax-treaty purposes.
1. REAL ESTATE-RICH CLAUSE
One of the, if not the, most notable modification is the addition of the real estate-rich clause. This new clause provides for the taxation of gains deriving directly or indirectly from real estate located in a Contracting State.
In the current treaty, any gain realised by a Luxembourg-resident company on the disposal of shares held in a Luxembourg subsidiary holding UK properties is taxable in Luxembourg only. Also, since such gain usually benefits from the Luxembourg participation exemption regime, it is thus not taxed in Luxembourg. However, the mere triggering of this clause should not suffice to trigger any UK tax liability. Indeed, local UK rules (such as the so-called NRCGT rules) also need to be complied with.
We note that the addition of a real estate-rich clause is also foreseen in the current OECD double tax treaty model.
2. PRINCIPAL PURPOSE TEST
The principal purpose test is a result of the BEPS works. As such, the new treaty also contains such test. This test provides that treaty benefits are denied in case of treaty shopping.
The preamble of the treaty states that the purpose of the latter is to eliminate double taxation, without creating possibilities for tax evasion or tax avoidance. The protocol, which has also bene signed, states that the new treaty shall not prevent the application of CFC rules for Luxembourg tax purposes.
3. RESIDENCY CONCEPT
The new treaty includes a number of changes to the scope of residence, as well as some important clarifications. In particular, the place of corporate residence tie-breaker has been replaced with a provision requiring the competent authorities to agree residence (in line with the BEPS recommendations).
Tax benefits are also extended to collective investment vehicles which are incorporated under a form which is tax opaque from a Luxembourg perspective (i.e. a SARL, SA or SCA). Yet, other conditions regarding the concept of “equivalent beneficiaries” also need to be met. Such an “equivalent beneficiary” means a Luxembourg or a resident of any other jurisdiction which has an information exchange agreement with the UK and which would further be entitled to, at least, the same tax rate for the relevant income received by the CIV under the corresponding tax treaty.
The following Luxembourg CIVs are included:
- UCITS and UCIs subject to the law of 17 December 2010, as amended
- SIFs subject to the law of 13 February 2007, as amended
- RAIFs subject to the law of 23 July 2016, as amended
- ASSEP and SEPCAVs (pension funds)
- UK pension schemes
- Any other Luxembourg investment fund, arrangement or entity to which both (Luxembourg and UK) tax authorities agree should be included
4. ENTRY INTO FORCE
The next step consists in the ratification of the new treaty by each jurisdiction. Such ratification then must be notified to the other party. The new rules regarding withholding taxes and income taxes could come into force at different moments.
The provisions regarding the withholding taxes will apply on or after 1 January after the year following the year in which the treaty enters into force. Thus, if both Contracting States ratify & notify the treaty this year still, these rules could come into force on 1 January 2023 at its earliest.
Considering that the UK and Luxembourg have different fiscal years, the rules regarding income taxes will apply as follows:
- Luxembourg: taxes chargeable for any taxable year beginning on or after 1 January of the calendar year following the year in which the treaty enters into force (thus 1 Janaury 2023 at the earliest)
- UK: taxes chargeable for the financial year or year of assessment beginning on or after 1 Apriil (regarding companies paying corporation tax) or 6 April (for other taxpayers) of the calendar year following the year in which the treaty enters into force (thus 1 April 2023 at the earliest)