New UK–Luxembourg Double Taxation Convention enters into force

An updated UK-Luxembourg Double Taxation Convention (DTT) and Protocol were signed on 7 June 2022, the full texts of which have been published on the UK government's website here.

Following the completion of ratification processes by both countries in 2022 and 2023, the DTT and Protocol formally entered into force on 22 November 2023, although most of the key changes will not take effect until 1 January 2024 at the earliest (and there will be later start dates for some taxes covered by the treaty, as noted below – in particular 1 April 2024 for UK corporation tax and 6 April 2024 for UK income tax and capital gains tax). Below is a non-exhaustive summary of notable changes for financial investors:

1.       Introduction of capital gains property-rich clause - Article 13 (Capital Gains) now includes Article 13(2), which allows gains from the sale of shares in a property-rich company (or comparable interests e.g. partnership or trust interests) to be taxed in the jurisdiction where the immovable property is situated. ‘Property-rich’ is defined as an entity deriving more than 50 per cent of its value directly or indirectly from immovable property.

2.       Royalty withholding tax (WHT) - Article 12 (Royalties) of the new DTT reduces the current 5% withholding tax on royalty payments to 0%. (Note that Luxembourg does not apply WHT to royalties in domestic law).

3.       Dividend WHT - Article 10 (Dividends) is shorter and simpler than previously. Under the new article, in most cases, residents may claim a 0% withholding tax on dividends under the treaty (whereas currently the treaty provides for a 15% withholding tax on dividends in general, reducing to a 5% WHT limit where the recipient has at least 25% of the voting power in the company paying the dividend; noting that for dividends paid by a Luxembourg company the domestic participation exemption may reduce the WHT to 0% in any event in certain cases). However, Article 10(2)(b) allows for dividends paid by REITs or similar entities to be subject to a withholding tax not exceeding 15%, in line with most other UK DTTs (unless the beneficial owner of the REIT dividends is a recognised pension fund in which case the 0% rate applies). This provision should likewise apply in the event that Luxembourg introduces a REIT regime in future. Note for completeness that Article 22 regarding the elimination of double taxation in respect of dividends (among other items) has also been slightly reworded - – while not a ‘new’ provision, we note that the tax credit method has been retained in Article 22 as the method for eliminating double taxation on dividends as well as ‘property-rich’ disposal gains.

4.       Company residence tiebreaker - Article 4(4) of the new DTT includes a competent authority/mutual agreement dual-residency tiebreaker. This replaces the current ‘place of effective management’ tie-breaker. Note that Article 3 of the new Protocol to the DTT sets out additional factors for the competent authorities to have regard to in this respect. It also includes a grandfathering clause for dual residents whose status "was determined in accordance with paragraph 3 of Article IV of the prior Convention" [...] "so long as all the material facts remain the same". 

5.       Treaty access for Luxembourg collective investment vehicles - Article 2 of the new Protocol to the DTT has specific rules for Luxembourg-incorporated collective investment vehicles receiving income arising in the UK which, depending on their ownership and/or the nature of the beneficial owners, can allow the vehicles to be treated for DTT purposes as a Luxembourg-resident individual and the beneficial owner of the income it receives. The applicable definition of collective investment vehicle includes Undertakings for Collective Investment in Transferable Securities (UCITS), Specialised Investment Funds (SIFs) and Reserved Alternative Investment Funds (RAIFs) (note that unlike the other vehicles UCITS within the meaning of EU Directive 2009/65 are not subject to the aforementioned beneficial ownership test, and so are treated as Luxembourg resident without regard to their ownership). Unlike the Luxembourg vehicles mentioned here, note that no UK entity types are specifically referenced by the Protocol.

6.       Permanent establishment (PE) definition changes:

• Specific activity exemptions - There are changes to the specific activity exemptions within Article 5 ('Permanent Establishment'). Article 5(5) and 5(6) introduces the BEPS-style anti-fragmentation rule. Article 5(4)(e), relating to activities of a preparatory or auxiliary character, has changed. Article 5(4)(f), relating to combination of activities with an overall preparatory or auxiliary character, has been added.
• Construction site - Article 5(3) states that "a building site, a construction, installation or dredging project constitutes a permanent establishment only if it lasts more than twelve months". This replaces the current treaty reference to a "building site or construction or assembly project which exists for more than six months".

7.       Business profits - Article 7 (Business Profits) is shorter and less prescriptive than its predecessor, and more in line with the OECD model article (in particular, the permanent establishment attribution rules have more regard to broader transfer pricing principles, as opposed to the more prescriptive wording used previously).

8.       Arbitration procedures - Article 24 (Mutual Agreement Procedure) continues to include a mandatory binding arbitration provision - see Article 24(5). This single paragraph is much shorter than the current synthesised treaty text’s seven-plus pages of prescriptive provisions on arbitration, based on Part VI of the BEPS MLI. Article 24(5) instead requires the competent authorities to settle the mode of application of the arbitration paragraph by mutual agreement.

9.       New collection of taxes provision - the new Convention includes Article 26 (Assistance in the Collection of Taxes). The current treaty does not contain such an article. Article 26 resembles the OECD model tax convention article of the same name, except for the addition of 26(8)(e) here, which clarifies that a Contracting State is under no obligation to provide assistance if that State considers that the taxes with respect to which assistance is requested are imposed contrary to generally accepted taxation principles.

10.    Entitlement to benefits - the new Convention includes Article 28 (Entitlement to Benefits) which introduces a principle purpose test for accessing treaty benefits (note: the same test is already in force under the current treaty as a result of the MLI, but has now been included as an article in the treaty itself in this revised version).

Entry into effect

The DTT and protocol entered into force on 22 November 2023 following the completion of both countries’ ratification and notification processes. Article 29 of the DTT sets outs the dates on which the various core provisions of the DTT and protocol enter into effect including: 

• In the UK:
  • withholding taxes – from 1 January 2024 (for income derived on or after 1 January 2024);
  • corporation tax (including corporation tax on chargeable gains) – from 1 April 2024; and
  • income tax and capital gains tax – from 6 April 2024.
• In Luxembourg
  • withholding taxes – from 1 January 2024 (for income derived on or after 1 January 2024); and
  • other taxes on income and capital – from 1 January 2024.