Luxembourg: How Brexit Will Affect Treaty Dispute Resolution (Part 2)

Last Updated: 12 September 2017
Article by Laurent Engel

Most Read Contributor in Luxembourg, August 2018

The EU Arbitration Convention is currently used, with great effect, to improve how treaty disputes are settled in the EU. However, with Britain poised to leave the bloc, treaty disputes between the UK and the EU stand to become more complex and problematic. Read part 1 of this 2-part series about the new UK/EU business relationship and the issues on the horizon, or continue reading for part 2, in which I discuss how BEPS and the Multilateral Instrument can be used to help solve treaty disputes post-Brexit.

The Multilateral Instrument: centrepiece of the BEPS Action Plan

On 7 June 2017, over 70 Ministers signed the so-called "Multilateral Instrument" (MLI), which offers governments concrete solutions for closing gaps in existing international tax rules by transposing parts of the OECD/G20 BEPS Project into bilateral tax treaties. It also—notably for our purposes in this article—implements minimum standards for improving dispute resolution mechanisms. Both Luxembourg and the UK have signed it.

Set to be ratified within the next months and years, the MLI modifies the application of thousands of bilateral tax treaties that eliminate double taxation. It is a challenge to read because, rather than providing for a consolidated text of the concerned treaties (CTAs), it must be read next to the relevant CTA.

The Tinder approach

The MLI works a bit like the Tinder dating app: if both parties "like" a particular provision it will be included; if not, it won't be. Indeed, the MLI usually starts with a substantive provision of the Convention, i.e. one or more paragraphs reflecting one of the BEPS measures. These paragraphs generally duplicate the language of the provisions of the OECD Model Tax Convention, developed during the BEPS Project. Unlike Tinder, most provisions are "liked" by default; in other words, if neither party objects (technically "enters a reservation") then the provision is accepted. In other cases, both parties must actively "like" the same provision, i.e. opt in, to have it included.

How the MLI will affect tax dispute resolution

Regarding dispute resolution, the relevant substantive provisions of the MLI are articles 16, 17, and 18.

Art. 16 is an application of the "traditional" intergovernmental agreement. In substance, a taxpayer who foresees that he/she will suffer tax in a way that is not in accordance with the CTA can appeal to the competent authority of his/her state of residence. This authority will then examine whether the complaint is justified and, if it is, present the case to the competent authority of the other contracting state. The two competent authorities will then endeavour to resolve the case using an intergovernmental mutual agreement procedure (MAP).

Art. 17 is the equivalent of the existing Art. XXV (3) of the CTA between the UK and Luxembourg: if the tax authorities of one state adjust a taxpayer's profit in that country and, as a result of that adjustment, that portion of profit is made subject to tax in both countries, "then that other Contracting Jurisdiction shall make an appropriate adjustment to the amount of the tax charged therein on those profits". This is assuming that the profits "would have accrued to the enterprise of the first-mentioned Contracting Jurisdiction if the conditions made between the two enterprises had been those which would have been made between independent enterprises". In determining such an adjustment, "due regard shall be had to the other provisions of the Covered Tax Agreement and the competent authorities of the Contracting Jurisdictions shall if necessary consult each other".

The future of UK-Luxembourg tax dispute resolution

The UK and Luxembourg have not made any reservations to these articles, and it is therefore expected for these to replace the existing provisions (art XXV of the existing treaty). Both countries have also "liked" art. 18 of the MLI. This provision entitles the taxpayer who presented the case to the competent authority to demand that the dispute be resolved through arbitration if the states have failed to reach a mutual agreement within two years.

All of this makes arbitration an integral part of the Luxembourg/UK MAP. The arbitration is not designed to replace domestic courts (contrary to commercial arbitration): it merely supplements the intergovernmental negotiations. Therefore, only the contracting states—not the taxpayers—are parties to the proceedings.

While the practical effects of the MLI are not yet known (given that it is not in force yet), it can still be expected that, as far as the relationship between the UK and Luxembourg is concerned, it will be substantially similar to the EU Arbitration Convention from which the UK is about to withdraw. To quote T. S. Eliot: "The end is where we start from."

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.

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