On 19 July 2023, the Luxembourg Parliament ratified the new double tax treaty between the United Kingdom and Luxembourg.
Having already been ratified by the UK, the new treaty will become effective as from 1 January 2024 for Luxembourg taxes covered under the treaty and as from 1 January 2024 for UK withholding tax purposes, 1 April 2024 for UK corporation tax purposes, and 6 April for UK income tax and capital gains tax purposes.
Overview of key changes
The new treaty includes amongst others:
- a so-called 'property-rich clause' for capital gains on shares in companies holding, directly or indirectly, immovable property.
- a further reduction of the withholding tax rate on royalties and on dividends in; and
- in the protocol signed along with the treaty, clarifications on the possibility for certain investment funds to qualify for treaty benefits.
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 taxing rights to both states in respect of a gain realised in the event of a sale of shares or corporate interests in an entity deriving more than 50% of its value directly or indirectly from immovable property situated in the other state (a property-rich entity).
This differs from the current situation where, in case of a share deal involving a Luxembourg property company owning UK real estate, the taxing rights on the capital gain realised with respect to these shares was exclusively allocable to Luxembourg.
Reduction of withholding tax rates
With respect to dividends, the treaty provides for a full withholding tax exemption in the source country provided the recipient is the beneficial owner of the payment. No further conditions apply. This change allows Luxembourg distributing companies to bypass the domestic law test on comparable taxation or holding requirements of their UK shareholder(s).
By way of exception, the treaty does not accommodate a (withholding tax) exemption for distributions by investment vehicles that annually distribute most of their income and whose income or capital gains derived from real estate are tax exempt. The treaty permits a 15% withholding tax rate on dividends distributed by such investment vehicles, unless the beneficiary is a recognised pension fund.
As regards royalties, the new treaty foresees a full exemption from withholding tax instead of a reduced 5% rate.
Extension of treaty benefits to certain investment fund vehicles
Certain Luxembourg investment fund vehicles, even though not subject to corporate taxation but to the subscription tax only, will be able to qualify for treaty benefits subject to the following conditions:
- The vehicle shall have a corporate legal form: in Luxembourg, this would be a private limited liability company (SARL), a public limited company (SA) or a partnership limited by shares (SCA);
- The vehicle shall be a UCITS, an undertaking for collective investment (UCI) in scope of the 2010 law, a specialised investment fund (SIF) in scope of the 2007 law or a reserved alternative investment fund (RAIF) in scope of the 2016 law (other than a RAIF investing in risk capital and subject to article 48 of the 2016 law); and
- Except for UCITS, at least 75% of the beneficial interests in the vehicle are held by so-called "equivalent beneficiaries". These are, in summary, persons who would be entitled to a UK withholding tax rate no higher than the one to be applied under the new Luxembourg-UK treaty if they derived the UK-sourced income directly.
As a result, it may be no longer necessary for certain investment funds to set up special purpose vehicles for UK investments to protect the tax neutrality of the fund. The impact of this extension of treaty benefits will, however, need to be assessed on a case-by-case basis, as it largely depends on the investor base of the fund. This provision may also encourage certain managers to set up regulated funds with a corporate form – especially as master fund in master/feeder structures – as the typical special limited partnership (SCSp) fund vehicle still will not qualify for treaty benefits itself.
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.