Luxembourg ratifies new double taxation treaty with the United Kingdom

Having already been ratified by the UK, the new treaty will come into effect from 1 January 2024 for Luxembourg taxes covered by the treaty and from 1 January 2024 for UK withholding taxes, 1 April 2024 for UK corporation tax and 6 April 2024 for UK income tax and UK capital gains tax.

Overview of key changes

The new treaty includes, among others:

1. a so-called ‘property-rich clause’ for capital gains on shares in companies that own, directly or indirectly, real estate.
2. a further reduction in the withholding tax rate on royalties and dividends in; and
3. in the protocol signed together with the treaty, clarifications on the possibility that certain investment funds qualify for the benefits of the treaty.

Impact of the new ‘property-rich’ clause for the taxation of capital gains

The new treaty includes a so-called property-rich clause. This clause grants tax rights to both states with respect to a realized gain in the event of a sale of shares or corporate interests in an entity that derives more than 50% of its value directly or indirectly from real property located in the other state (a property-rich entity).

This differs from the current situation where, in the case of a share transaction involving a Luxembourg real estate company owning real estate in the UK, the tax rights on the realized capital gains in respect of these shares were allocated exclusively to Luxembourg.

Reduced Withholding Tax Rates

With respect to dividends, the treaty establishes a total exemption from withholding taxes in the country of origin, as long as the recipient is the final beneficiary of the payment. No further conditions apply. This change allows Luxembourg distribution companies to bypass the national law test on comparable tax or holding requirements of their UK shareholders.

Exceptionally, the treaty does not contemplate an exemption (tax withholding) for distributions by investment vehicles that annually distribute most of their income and whose income or capital gains derived from real estate are exempt from tax. The treaty allows a 15% withholding rate on dividends distributed by such investment vehicles, unless the beneficiary is a recognized pension fund.

Regarding royalties, the new treaty provides for a full exemption from withholding tax instead of a reduced rate of 5%.

Extension of treaty benefits to certain investment fund vehicles

Certain Luxembourg investment fund vehicles, although not subject to corporate tax but only subscription tax, may qualify for treaty benefits subject to the following conditions:

·The vehicle must have a corporate legal form: in Luxembourg, this would be a private limited liability company (SARL), a public limited company (SA) or a company limited by shares (SCA);

The vehicle will be a UCITS, Undertaking for Collective Investment (UCI) within the scope of the 2010 Law, Specialized Investment Fund (SIF) within the scope of the 2007 Law, or Reserved Alternative Investment Fund (RAIF) within the scope of the 2016 Law (other than a RAIF investing in venture capital and subject to Article 48 of the 2016 Law); and

·Except for UCITS, at least 75% of the real interest in the vehicle is in the hands of the so-called “equivalent beneficiaries”. These are, in short, people who would be entitled to no higher UK withholding tax rate than would apply under the new UK-Luxembourg treaty if they derive the UK-sourced income directly.

As a result, it may no longer be necessary for certain investment funds to establish special purpose vehicles for investments in the UK to protect the tax neutrality of the fund. However, the impact of this extension of treaty benefits will need to be assessed on a case-by-case basis, as it is highly dependent on the investor base of the fund. This provision may also encourage certain managers to establish regulated funds with a corporate form, especially as master funds in master/feeder structures, since the typical special limited partnership (SCSp) fund vehicle will still not qualify for treaty benefits.