On 7 June 2022, Luxembourg and the United Kingdom (UK) signed a new double tax treaty (“DTT”) and a supplementary Protocol that will replace the previous DTT signed in 1967. The new treaty conforms with the latest international tax standards agreed upon by the OECD and includes positive changes that will be beneficial for Luxembourg’s collective investment vehicles (“CIVs”) and pension funds.
The treaty has not yet entered into force and is still to be ratified by Luxembourg and the UK. The earliest date that the below provisions in respect of withholding taxes are expected to become effective is the 1st of January 2023. The new DTT could apply as soon as 2023 depending on the efficiency of the Luxembourg and UK internal ratification process.
The Previous Double Tax Treaty’s Position on Luxembourg Collective Investment Vehicles
The previous DTT did not allow Luxembourg CIVs to claim treaty benefits. Circular L.G.-A. n° 61 issued by the Luxembourg Tax Authorities specifically confirmed that although a DTT is in place between the UK and Luxembourg, these states have refused to apply the treaties to CIVs.
Circular L.G.-A. n° 61 dated December 2017 clarifies the conditions under which CIVs could obtain Luxembourg tax residence certificates. The issuance of certificates of residence is of crucial importance for CIVs to prove their eligibility for favourable tax treatments. Foreign tax authorities usually require a certificate of residence to determine whether a CIV is a Luxembourg tax resident and is potentially entitled to treaty benefits. Under the previous DTT, Luxembourg CIVs were denied the issuance of tax certificates that facilitate DTT reclaims to the UK.
The New Treaty’s Affect on Luxembourg Collective Investment Vehicles and Pension Funds
Remarkably, the new DTT, based on Paragraph 2 of the Protocol, deviates from this position as Luxembourg CIVs treated as body corporates will be afforded treaty access provided certain conditions are met. Under Paragraph 2 of the Protocol of the new treaty, a Luxembourg CIV will be considered as a resident of Luxembourg and the beneficial owner of the income it received provided a minimum of 75% of the CIV’s shares are owned by equivalent beneficiaries, or the CIV qualifies as an Undertakings for the Collective Investment in Transferable Securities (“UCITS”) under EU Directive 2009/65.
“Equivalent beneficiaries” refers to underlying beneficiaries that are either residents of Luxembourg or residents in a country with an information exchange agreement with the UK and which are entitled to a tax rate that is at least as low as the rate claimed under the DTT by the CIV.
Luxembourg CIVs that could potentially access treaty benefits include UCITS, funds set up under Part II of the Luxembourg Law of 17 December 2010 on undertakings for collective investment (“UCIs”), Specialised Investment Funds (“SIFs”), and Reserved Alternative Investment Funds (“RAIFs”), excluding a RAIF, established as a Société d’investissement en capital à risqué (“SICAR”). Luxembourg Société d’investissement à Capital Variable (“SICAV”) funds will thus have access to benefits under the new DTT.
Recognised pension funds are also explicitly considered tax residents under Article 4 of the new treaty and will qualify for treaty benefits.
Dividends and Interest Provisions in the New Treaty
There typically is no withholding tax on dividends paid by UK companies under domestic law, although 20% withholding tax generally applies to distributions paid by a real estate investment trust (“REIT”) from its tax-exempt rental profits. Therefore, the provisions that deal with REIT distributions will be of particular importance to Luxembourg tax residents.
The dividends article in the new treaty stipulates that, an exemption from withholding tax is introduced (Article 10.2.b of the DTT) if the beneficial owner of the dividends is a recognized pension fund. In cases where the beneficial owner is not a pension fund, the DTT provides for a maximum withholding tax of 15%. Provided that the UK levies withholding tax at a rate of 20% on REIT distributions, the new DTT will afford Luxembourg CIVs the opportunity to recover 5% of the withholding tax back on these distributions, while pension funds could potentially recover the full 20% withholding tax.
The treatment of interest remains unchanged under the new DTT. Article 11 of the DTT provides that interest is exempt from withholding tax in the source country. The UK withholds tax on interest at a rate of 20% which means that qualifying Luxembourg CIVs will be able to reclaim the full withholding tax levied on interest from the UK under the new DTT.
Practical Implications of the New Treaty for Luxembourg Investment Funds
The above changes to the treaty spell good news for Luxembourg corporate CIVs, particularly SICAVs, that will now be granted treaty access and qualify for withholding tax refunds, where previously these vehicles were not afforded treaty access. Withholding tax reclaims can now be submitted on the level of the Luxembourg CIV by an authorised representative, provided that the fund qualifies for DTT access. In addition, pension funds are formally included under the resident definition in the new treaty and can benefit from a full exemption from withholding tax on dividends.
WTax monitors the situation and effective dates regularly to ensure that withholding tax reclaims will be filed on a timely basis for current and prospective clients. Contact us today to stay on top of all the latest developments in international dividend withholding tax and maximise the returns of your investments.