On 19 July 2023, the new convention for the elimination of double taxation (the “New Convention”) between Luxembourg and the United Kingdom (the “Contracting States”) and its protocol were ratified by the Luxembourg Chamber of Representatives. The New Convention reflects the last development of the OECD standards in relation to base erosion and transparency. In this regard, the preamble of the New Convention specifically recalls that the latter should not create opportunities for tax evasion or avoidance. Here is an overview of the most important provisions of the New Convention.


Residency

The New Convention expands the definition of resident to include in its scope Recognized Pension Funds (as described hereafter) and certain Luxembourg collective investment vehicles treated as body corporate for tax purpose (“CIVs”). From a Luxembourg perspective, Recognized Pension Funds include ASSEP (association d'épargne-pension), SEPCAV (société d'épargne-pension à capital variable) and any other pension funds subject to supervision of the insurance commissioner. Under the protocol of the New Convention, CIVs receiving UK income shall be treated as tax residents of the New Convention for, and be considered beneficial owners of, such income but only proportionally to the rights or participations in the CIVs that are held by “equivalent beneficiaries” (and to the extent that a Luxembourg resident deriving that income under the same circumstances would have been treated as the beneficial owner of such income). Equivalent beneficiaries are defined as residents of Luxembourg or of country with which the UK has an arrangement providing exchange of information and which, per application of a double tax treaty concluded between their state or residence and the UK, would be entitled to a tax rate not higher than that applicable to the CIV under this New Convention if they had received the income in respect of which the benefits of the New Convention are claimed by the CIV. If CIVs are held by at least 75% of equivalent beneficiaries, or where they are UCITS within the meaning of Directive 2009/65/CE, they are even treated as tax residents and beneficial owners for all the income they receive (to the extent that a Luxembourg resident deriving that income under the same circumstances would have been treated as the beneficial owner of such income).

For the purpose of the New Convention, CIVs cover:

  • UCITS subject to Part I & Part II, SIFs, and RAIFs (except RAIFs with SICAR regime); as well as
  • any other investment fund, arrangement or entity established in Luxembourg whose the competent authorities of the Contracting States agree to regard as a CIV.

The protocol of the New Convention also includes new tie-breaker rules for dual resident companies. Article 4 of the New Convention does indeed no longer provide for the sole “place of effective management” criteria but lists additional factors, without being exhaustive, that competent authorities of both Contracting States should mutually take into account in such context. They notably comprise the location of the senior management and of the board of director as well as the economic nexus with both Contracting States.


Permanent establishment

The new provision corresponds nearly to the current wording of the OECD Model.

A building site, a construction, installation or dredging project will constitute a permanent establishment only if it lasts more than 12 months (6 months in the current treaty).

With respect to dependent agent, contrary to the OECD Model the New Convention does not refer to a person who “habitually plays the principal role leading to the conclusion of contracts” but instead keeps the wording used in the current convention which mentions a person who has “the authority to conclude contract”.


Income

Dividends

With respect to dividends, the New Convention provides for a full withholding tax (“WHT”) exemption for payments to the beneficial owner while the current treaty provides for a 15% WHT rate which may under conditions be reduced to 5%.

However, if the dividend distribution is made by investment vehicles directly or indirectly deriving most of their income from immovable property, such as real estate investment trusts (REITs) or other investment vehicles benefiting from a special tax regime, the WHT will be of 15%. To be noted, that if the beneficial owner of such income is a Recognized Pension Fund, no WHT will apply.

Interests

Both the current and New Convention provide for no WHT on interest.

Royalties

Under the current convention, a WHT of 5% applies whereas the New Convention intends to align the WHT rate on the Luxembourg legislation and provides for a full exemption.

Capital gains

The New Convention will introduce a real estate rich clause according to which gains from the alienation of shares or comparable interests, such as interests in a partnership or trust, deriving more than 50 per cent of their value directly or indirectly from immovable property, will be taxed in the jurisdiction where the real estate is located.


Compliance and agenda

Double taxation

Luxembourg will generally apply the exemption method to eliminate the double taxation. However, the credit method will be of application in some specific situation as for income derived from dividends or capital gains on disposal of real estate rich companies. In the latter case, the deduction will not exceed the part of the tax, as computed before the deduction is given, which is attributable to such items derived from the UK.

Anti-abuse

Article 28 of the New Convention provides for a principal purpose test similar to the one provided by the Multilateral Instrument. In addition, the protocol states that the convention cannot prevent the application of the control foreign company rules provided for in article 164ter of the Luxembourg income tax law or any similar future provision.

Entry into force

Once the agreement ratified by both countries, it will enter into force, and it will become effective in the year following the exchange of ratification instruments between the two countries:

  • In Luxembourg, from the 1st January of the calendar year following the year in which the convention enters into force;
  • In the UK, (i) from the 1st January of the calendar year following the year in which the convention enters info force for WHT (the “Reference Year”), (ii) from 1st April of the Reference Year for corporate taxes and (iii) from 6 April of the Reference Year for income and capital gain taxes.