Tax residence (art. 4 DTT and Protocol)
DTT access for collective investment vehicles
Under the Luxembourg-UK treaty currently in force, Luxembourg collective investment vehicles (“CIVs") could not claim treaty benefits when receiving income arising in the UK.
In contrast, based on Paragraph 2 of the Protocol, the DTT will grant the same benefits as those available to Luxembourg resident individuals under the DTT to Luxembourg CIVs such as Luxembourg UCITS, UCIs part II, SIFs and RAIFs (of the SIF-type) which are established and treated as body corporates (S.A., SCA, S.à r.l.), to the extent their beneficial interests are held by “equivalent beneficiaries". Based on the DTT, “equivalent beneficiaries" means taxpayers that are resident of Luxembourg or of any other jurisdiction with which the UK has arrangements that provide for the exchange of information and who would be entitled to a rate of tax with respect to an item of income that is at least as low as the rate claimed under the DTT.
If the CIV is a UCITS, or if at least 75% of its beneficial interests are held by “equivalent beneficiaries", the CIV is considered as a resident of Luxembourg and the beneficial owner of the all of the income it receives.
Clarifications on the tie-breaker rule
The current Luxembourg-UK treaty in force provides for the classic tie-breaker rule whereby a person (other than an individual) having its seat of incorporation in a jurisdiction and its place of effective management in the other jurisdiction should be considered as resident in the other jurisdiction. The DTT, in line with the 2017 OECD Model Tax Convention, provides that mutual agreements between the UK and Luxembourg must be reached to determine the tax residency of a person.
The Protocol provides for the following non-exhaustive list of factors to consider in light of the application of the tie-breaker rule:
- where the senior management of the person is carried on;
- the location of the board meetings;
- the location of the entity's headquarters;
- the extent and the nature of the economic nexus of the entity with respect to each jurisdiction;
- whether the determination of the residency of the entity in one jurisdiction rather the other jurisdiction would carry the risk of an improper use of the DTT or inappropriate application of the domestic law of either jurisdiction.
For entities whose residency was determined based on the current treaty in force, so long as all the material facts remain the same, the UK and Luxembourg authorities should not seek to revisit that determination.
Dividend withholding tax (art. 10 DTT)
Significant beneficial changes for taxpayers have been made to the treatment of dividends.
The DTT now provides a full exemption of withholding tax on dividend distributions to the extent the recipient is the beneficial owner of the income, without further requirements.
This full exemption is however not provided for distributions by investment vehicles which annually distribute most of their income and whose income including gains derives from immovable property that is tax exempt (e.g., UK REITs). In such a case, the DTT provides for a 15% withholding tax rate on the gross amount of the dividends, unless the beneficiary is a recognised pension fund, in which case the full exemption remains available.
Capital gains: introduction of a land-rich clause (art. 13 DTT)
The DTT introduces a land-rich clause attributing the right to tax capital gains arising out of the alienation of shares in entities deriving more than 50% of their value directly or indirectly from immovable property1 located in Luxembourg or the UK to the jurisdiction where these assets are located.
For instance, the UK will be entitled to tax capital gains on the sale by Luxembourg investors of shares in an entity holding UK real estate assets.
Elimination of double taxation (art. 22 DTT)
With respect to Luxembourg residents, the exemption method (exemption with progression) remains the general principle regarding the elimination of double taxation.
However, the DTT specifies inter alia that Luxembourg will apply the credit method in relation to (i) dividends subject to withholding tax in the UK based on the DTT (e.g., from a UK REIT) and (ii) capital gains derived from land rich companies taxable in the UK2.
Next steps: entry into force (art. 29 DTT)
Upon ratification of the DTT by both jurisdictions, the latter will become applicable:
- In the UK:
- In respect of taxes withheld at source: to income derived on or after 1 January of the calendar year next following the year in which this DTT enters into force;
- In respect of income tax and capital gains tax: for any year of assessment beginning on or after 6 April of the calendar year next following the year in which this DTT enters into force;
- In respect of corporation tax: for any financial year beginning on or after 1 April of the calendar year next following the year in which this DTT enters into force;
- In Luxembourg:
- In respect of taxes withheld at source: to income derived on or after 1 January of the calendar year next following the year in which the DTT enters into force.
- In respect of other taxes on income and taxes on capital: to taxes chargeable for any taxable year beginning on or after 1 January of the calendar year next following the year in which the DTT enters into force.
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1 As defined in art. 6 of the new DTT
2 Art. 22, para. 4, b) of the Luxembourg-UK DTT