|Keith O'Donnell and Samantha Merle, ATOZ – Taxand|
Luxembourg has recently ratified 13 double tax treaties (DTTs) and protocols with the first objective to align Luxembourg standards with the OECD standards on exchange of information in tax matters and Luxembourg keeps on expanding its DTT network with eight additional DTTs signed or initialed. While an expansion of the DTT network is good news, as it makes Luxembourg more attractive for foreign inbound or outbound investments, some new DTTs introduce changes which may refrain investors from performing certain investments in Luxembourg as these investments will now become less attractive from a tax point of view. Here, reference can be made to the changes introduced for Luxembourg companies investing in real estate in Germany, Kazakhstan, Poland and Russia or to the anti-abuse provisions included in certain DTTs and drafted in such general terms that they may create some legal uncertainty for taxpayers. These DTTs include however also positive changes, such as reductions of withholding tax rates or provisions granting DTT benefits to collective investment vehicles, which is great news for the Luxembourg investment fund industry. Here, we will focus on the new rules for the taxation of gains on real estate investments and DTT benefits for investment funds.
New rules for the taxation of gains on real estate investments
The new DTTs with Germany, Kazakhstan, Poland and Russia include a specific provision, according to which capital gains derived by a resident of a contracting state from the alienation of shares (or similar rights for some of these DTTs) in real estate companies are taxable in the source country (country in which the real estate is located). In other words, these gains are now, in line with the OECD Model Tax Convention, taxed at source, whereas in the past they were treated as gains on the sale of movable property, meaning that they were only taxable in the country of the seller.
This change is of importance for many real estate investment structures, especially for Luxembourg companies investing in real estate in Germany, Kazakhstan, Poland or Russia via a local property company. So far, the capital gains were only taxable in Luxembourg (country of the seller) and could benefit from an exemption based on the participation exemption regime. Now, there will be a potential taxation of the gains in the country in which the real estate is located (to the extent the local legislation provides for such taxation).
Luxembourg companies which invest in real estate in these countries should therefore carefully review their investment structure to mitigate any adverse tax consequence.
DTT benefits for investment funds
The protocol to the DTT signed between Luxembourg and the Czech Republic states that the term "resident of a contracting state" also includes a fiscally non-transparent person (including a collective investment vehicle, (CIV)) that is established in that state according to its laws even in the case where the income of that person is taxed at a zero rate in that state or is exempt from tax there. This provision means that Luxembourg SICAVs and SICAFs benefit from the DTT provisions. FCPs, since they are fiscally tax transparent, should not.
Under the new DTTs with Jersey, Guernsey and the Isle of Man, body corporate CIVs are considered as residents and beneficial owners of the income received while transparent CIVs are considered as individual residents and beneficial owners of the income received. This means that SICAVs/SICAFs will be able to benefit from the same reduced withholding tax rates as ordinary fully taxable Luxembourg Companies while for FCPs, since they are tax transparent, the maximum rate applicable to individuals (which is higher), will apply. For investments performed by Luxembourg CIVs, this distinction should however not have any impact since these three jurisdictions do not levy withholding taxes on dividend distributions.
The same provision is included in the DTT with the Seychelles.
Finally, the Protocol to the new Tajikistan-Luxembourg DTT provides that undertakings for collective investment are considered as residents and beneficial owners of the income they earn. Here, no distinction is made between SICAVs/SICAFs and FCPs.
The recent developments in respect of DTTs are positive as regards countries with which Luxembourg did not have any DTT so far as they should increase business flows between Luxembourg and these countries. Luxembourg should, however, remain vigilant when negotiating DTTs as some provisions may have negative impacts on certain sectors which are key for Luxembourg as a business friendly location, like the real estate sector, where the implementation of provisions on the taxation of capital gains on real estate companies will rather refrain investments and may have a negative impact in the middle and longer term. Positive developments are the inclusion of specific provisions granting DTT benefits for collective investment funds, in line with the recent OECD commentaries in this respect. We expect that Luxembourg will in future systematically require from its DTT partners the inclusion of such provision in order to remove the tax barriers that often exist when CIVs invest abroad.
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