Luxembourg and Germany concluded on 23rd of April 2012 a new Double Tax Treaty replacing the former treaty signed in 1958. The new treaty follows mainly the OECD Model convention on income and capital but it contains a number of new anti-abuse provisions to tackle situations where double non taxation may arise.

Here below are the salient changes of the provisions of the treaty:

  • Under the new treaty, the reduced withholding tax for dividends is lowered to 5% when the parent company holds 10% of the share capital of the paying subsidiary. The standard rate of 15% for portfolio and partnership dividends remains unchanged. For interests, the treaty provides for a 0% withholding rate whereas royalties are subject to a reduced withholding tax of 5 %.
  • The treaty attributes the taxing rights to the source State for capital gains on disposal of shares of Real Estate companies deriving more than 50 % of their value directly or indirectly from immovable property situated therein. With this provision, the sale of shares of a German real estate company through Luxembourg companies becomes taxable in Germany.
  • Hybrid instruments and entities are covered by the protocol to the new treaty which attributes the taxing rights to Germany in respect of income from profit participating loans or bonds, and income from silent partnerships where the said income have been deducted from the profits of the issuer. For Luxembourg tax purpose, the treaty reclassifies the aforementioned income from debt instruments or silent partnerships as dividends.
  • Investment funds such as SICAV, SICAF or SICAR are expressly entitled to treaty benefits, namely they can take advantage from the reduced withholding tax rate for interest and dividends. Contractual investment funds such as FCP are also entitled to treaty benefits provided that they are held by persons resident in the country where the FCP is established.
  • The treaty expressly provides that both states may rely on their domestic anti-abuse provisions. Germany for instance grants the exemption to mitigate double taxation only where the underlying income in the source state is derived from "active business income" defined under the German tax law. In practice the exemption is granted if the income is subject to tax in Luxembourg. If the exemption is not granted, Germany will apply the credit method.
  • The new treaty will enter into force as of January 1st of the year following the ratification in both countries. The treaty shall probably apply to taxes due after January 2013.

Conclusion

The treaty introduces some clarity namely in the field of investment funds by allowing their access to treaty benefits in accordance with the OECD principles. However the treaty impacts the current German Real Estate structures held through Luxembourg companies. Investors should restructure their holdings or realize capital gains on the German companies prior to the entry into force of the new treaty. Lastly the reliance on domestic anti-abuse law subject to the requirements of EU law, highlight the growing importance of the substance of companies in Luxembourg.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.