The United Kingdom and Luxembourg have signed a new double tax treaty on 7 June 2022 (the “New Treaty”). The text of the New Treaty and its protocol (the “Protocol”) is accessible here (HMRC’s website).
The key takeaway is that the New Treaty will significantly impact investments by Luxembourg vehicles in UK real estate by the introduction of “property rich” clauses for the allocation of taxing rights on capital gains and dividends.
The New Treaty also introduces an exemption of dividend withholding tax, extends the notion of “resident of a Contracting State” and its protocol grants collective investment vehicles (“CIVs”) access to the benefits of the New Treaty under certain conditions.
The most notable changes introduced by the New Treaty and the Protocol, compared to the UK-Luxembourg double tax treaty of 24 May 1967 (the “Current Treaty”), are the following:
- Resident (art. 4): the notion of “resident of a Contracting State” is extended to include that State and any political subdivision or local authority thereof, as well as a recognised pension fund of that State. A mutual agreement procedure in the tax residency tie-breaker rules is also introduced to reflect the current OECD Model Tax Convention.
- Dividends (art. 10): the New Treaty provides that no withholding tax shall apply to dividends paid by a company resident in one Contracting State to a company resident in the other Contracting State provided the receiving company is the beneficial owner of the dividend payment. In comparison, the Current Treaty provides for a reduced rate of withholding tax of 5% under the same conditions.
However, where dividends are 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 tax-exempt (e.g. entities benefiting from the UK REIT regime), a withholding tax of maximum 15% may be levied on such dividends.
Finally, the New Treaty also aligns the definition of “dividend” between both States, whereas the Current Treaty is referring to both Luxembourg and UK concepts which were subject to interpretation.
- Capital gains (art. 13): as foreseen, capital gains on the disposal of shares of a “property rich” company, i.e. shares (or comparable interest such as interests in a partnership or trust) deriving, directly or indirectly, more than 50% of their value from immovable property situated in the other Contracting State, shall be taxable in that other Contracting State.
Given that, under UK tax law, capital gains on the disposal of UK property rich vehicles (in this case, deriving at least 75% of their value from UK real estate) are taxable in the UK, this new provision may have a significant impact on existing structures.
From a Luxembourg point of view, capital gains realised by a UK resident on the disposal of shares in a company holding Luxembourg real estate should in most cases not be affected by this provision.
- Denial of tax treaty benefits (art. 28): a benefit under the New Treaty shall not be granted in respect of an item of income or capital or capital gain, 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, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the New Treaty. This provision reflects the principal purpose test under the Multilateral Instrument.
- Access to the treaty for CIVs (§2 of the Protocol): according to the Protocol, a CIV established and treated as a body corporate for tax purposes in Luxembourg and which receives income arising in the UK shall be treated as resident of Luxembourg and beneficial owner of such income under the New Treaty, provided that the beneficial interests in such CIV are owned by “equivalent beneficiaries”.
Equivalent beneficiaries means Luxembourg residents (or residents of countries having an arrangement with the UK for the effective and comprehensive information exchange) who would, if they received the particular item of income for which benefits are being claimed under the New Treaty, be entitled under an income tax convention with the UK, to a rate of tax with respect to that item of income that is at least as low as the rate claimed under the New Treaty by the CIV with respect to that item of income.
When 75% of the beneficial interests in the CIV are held by equivalent beneficiaries, or when the CIV is an undertaking for collective investment in transferable securities (UCITS) within the meaning of EU Directive 2009/65, the CIV shall be treated as a resident of Luxembourg and as the beneficial owner of all the income it receives (provided that a resident of Luxembourg receiving the income in the same circumstances would have been considered to be the beneficial owner thereof).
The New Treaty will enter into force once both countries will have ratified the text and exchanged their respective ratification instruments. Provisions on mutual agreement procedures and exchange of information shall have effect from the date of entry into force of the New Treaty without regard to the taxable period to which the matter relates. The date of effect of the other provisions of the New Treaty will depend on the contracting State and type of tax concerned:
- For the UK:
- in respect of withholding tax, to income derived on or after 1 January of the calendar year next following the year in which the New Treaty 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 the New Treaty 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 the New Treaty enters into force;
- For Luxembourg:
- in respect of WHT, to income derived on or after 1 January of the calendar year next following the year in which the New Treaty 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 New Treaty enters into force.