The new Treaty is of particular importance and may therefore be of particular interest to asset managers as well as real estate investors / promoters in view of changes relating to collective investment vehicles and pension funds and changes pertaining to the allocation of taxing rights to shares in “real estate rich” companies.
Following the publication of the Luxembourg law of 18 September 2023 in the Luxembourg official gazette on 4 October 2023, the new tax treaty between Luxembourg and the United Kingdom (the “Treaty”) can now enter into force and develop its effects as from 2024, as planned in Article 29. The UK already completed its own ratification process in 2022.
This means that the Treaty will commence its application as follows:
For Luxembourg:
- With respect to withholding taxes, to income derived on or after 1 January 2024.
- In respect of other taxes on income or capital, for any tax year beginning on or after 1 January 2024.
For the UK:
- With respect to withholding taxes, to income derived on or after 1 January 2024.
- In respect of income and capital gains tax, for any year of assessment as from 6 April 2024.
- In relation to corporation tax, for any financial year beginning on or after 1 April 2024.
The Treaty is in line with the new international tax tendencies that seek to ensure a fairer tax system and tackle aggressive tax planning, and contains, amongst other things, the following changes:
- Granting treaty benefits to collective investment vehicles (under certain conditions) and recognized pension funds.
- Cancelling the withholding tax on dividends and royalties (with some exceptions.
- Introducing a ‘real estate rich’ clause for capital gains on shares of real estate companies.
- Detailing and formal inclusion of transfer pricing (especially adjustments), a mutual agreement procedure, the exchange of information, assistance in the collection of taxes and entitlement to Treaty benefits.
Please find below a summary of the most relevant changes:
Collective investment vehicles (CIVs) and recognized pension funds (Article 3 and Protocol)
CIVs established and treated as a body corporate for tax purposes are formally included in the notion of ‘resident’ for the Treaty’s application, to the extent that it is an undertaking for collective investment in transferrable securities (UCITS) within the meaning of EU Directive 2009/65/EC, or 75% owned by equivalent beneficiaries (for Luxembourg CIVs, the notion of ‘equivalent beneficiaries’ means being a resident of Luxembourg, or a resident of any other jurisdiction with which the UK has arrangements that provide for information exchange who would be entitled under a tax treaty with the UK, to a rate of tax that is at least as low as the rate claimed under this Treaty by the collective investment vehicle with respect to that item of income).
In other cases, Luxembourg CIVs, including specialized investment funds (SIFs) and reserved alternative investment funds (RAIFs), will be treated as individuals who are residents of Luxembourg and beneficial owners of the income received, if they are held by equivalent beneficiaries.
The Treaty expressly includes now recognized pension funds in the notion of resident, this notion being defined in the Protocol.
Dividends and royalties (Articles 10 and 12)
Under the former treaty, a reduced withholding tax of 5% applies to dividend distribution if the company receiving the dividends holds more than 25% of the voting powers in the distributing company; otherwise, a maximum withholding tax of 15% can be levied by the source State.
The new Treaty now provides a general exemption of withholding tax on dividends. However, this exemption does not apply for dividends 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 exempt from tax. In this case, the tax charged will not exceed 15%. However, the exemption continues to apply where the beneficial owner of the dividends is a recognized pension fund.
Currently, royalties can be subject to a maximum withholding tax of 5% in the source State. The new Treaty now provides that royalties are not subject to withholding tax in the source State.
Real estate (Article 13)
Another major change in the new Treaty is the introduction of a ‘real estate rich’ clause. Capital gains generated via the alienation of shares or comparable interests, such as any interest in a partnership or trust, that derive more than 50 per cent of their value directly or indirectly from immovable property located in a contracting State may be taxed in that State.
Transparent entities (Article 1)
The Treaty gives some consideration to transparent entities, confirming that income or gains derived by or through an entity or arrangement that is treated as being wholly or partly fiscally transparent under the tax law of either contracting State will be considered to be income or gains of a resident of a contracting State but only to the extent that the income or gain is treated, for the purposes of taxation by that State, as the income or gain of a resident of that State.
Concept of ‘resident’ (Articles 4 and Protocol)
The Treaty excludes from the concept of ‘resident’ any person who is liable to tax in a contracting State in respect only of income or capital gains from sources in that State or capital situated therein. UK resident non-domiciled individuals are now expressly excluded from the Treaty’s benefits.
The term ‘resident’ in the Treaty also includes an organization that is established and operates exclusively for religious, charitable, scientific, cultural, or educational purposes (or for more than one of those purposes) and that is a resident of that State according to its laws, notwithstanding that all or part of its income or gains may be exempt from tax under the domestic law of that State.
Where a person other than an individual is a resident of both contracting States, the Treaty provides now that the tax residency of entities will be determined by mutual agreement between the contracting States, considering relevant factors such as the place of effective management or place of incorporation. In the absence of such a mutual agreement, the entities will not be entitled to any relief or exemption from tax provided by the Treaty. In contrast to the current tax treaty, the entity will thus not be deemed to be resident in the State where its place of effective management is located.
The Protocol provides that where a company has been resident in both Luxembourg and the UK before the Treaty’s entry into force, and the status of that company has been determined in accordance with the current tax treaty, then Luxembourg and the UK will not seek to revisit that determination so long as all the material facts remain the same.
Permanent establishment, associated enterprises and transfer pricing (Articles 5 and 9)
Regarding the concept of permanent establishment, the Treaty provides that a building site, a construction, installation or dredging project constitutes a permanent establishment only if it lasts more than twelve months, whereas 6 months are sufficient in the current tax treaty.
Transfer pricing adjustments are also more precisely determined in the Treaty compared to its current version.
The Treaty includes a new article about associated enterprises, which provides specific adjustments that can be made when transactions do not comply with the arm’s length principle.
Entertainer or a sportsperson (Article 16)
Where income in respect of personal activities exercised by an entertainer or a sportsperson acting as such accrues not to the entertainer or sportsperson but to another person, the new Treaty expressly provides that this income may be taxed in the State in which the activities of the entertainer or sportsperson are exercised.
Pensions and other similar remuneration (Article 17)
The Treaty now provides that pensions and other similar remuneration arising in a contracting State and paid to a resident of the other contracting State may be taxed in the first-mentioned State; whereas the current treaty in force provides that, except for pensions paid under the social security legislation of a contracting State (taxable in that State only), pensions and other similar remuneration paid to a resident of a contracting State in consideration of past employment are taxable only in that State.
Regarding second pillar pension scheme, the Treaty provides that pensions and other similar remuneration (including lump-sum payments) arising in Luxembourg and paid to a UK resident will be taxable only in Luxembourg, provided that such payments derive from contributions paid to or from provisions made under a complementary pension scheme by the recipient or on his behalf and to the extent that these contributions, provisions, or the pensions or other similar remuneration have been subjected to tax in Luxembourg under the ordinary rules of its tax laws).
Methods to avoid double taxation for Luxembourg (Article 22)
Regarding Luxembourg residents, the Treaty still provides the exemption method for avoiding double taxation but provides the credit method for the following income dividends, gains realized on the transfer of land-rich entities, the income of an entertainer or sportsperson and the income of a member of the regular complement of a ship or aircraft, which is exercised aboard a ship or aircraft operated in international traffic.
Entitlement to benefits (Article 28 and Protocol)
The Treaty includes an article about entitlement to benefits, which is the formal incorporation of the ‘principal purpose’ test of the Multilateral Instrument already in force.
If you wish to discuss these topics, please contact: Tiberghien Luxembourg S.à r.l.
