On 7 June 2017, Luxembourg together with 67 other jurisdictions, signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (“Multilateral Instrument” or “MLI“). One of the main purposes of the MLI is to update international tax rules and lessen the opportunity for tax avoidance by multinational enterprises by transposing the results from the BEPS project into more than 2,000 tax treaties worldwide.

On 3 July 2018, the Luxembourg Government submitted Bill of Law No. 7333 approving the MLI to the Luxembourg Parliament.

All 81 tax treaties concluded by Luxembourg that are currently in force (including the new treaty with Senegal) are designated as “Covered Tax Agreements” (“CTAs“). However, the extent to which these CTAs will be amended as a result of the MLI will depend on whether or not the other contracting state signed the MLI and on the reservations and options taken by the signatory contracting state.

The MLI contains agreed minimum standards to counter treaty abuse (BEPS Action 6) and to improve dispute resolution mechanisms (BEPS Action 14). It also contains a number of alternatives or optional provisions that will generally apply only if all contracting states to a CTA have chosen to apply that particular alternative or option.

Minimum Standards

Certain provisions of the MLI are mandatory as they were agreed by consensus and reflected in the BEPS report as minimum standards – notably on treaty abuse and dispute resolution.

To meet the BEPS minimum standard on treaty abuse, Luxembourg has opted to apply the principal purpose test (“PPT“) to all its CTAs instead of (i) the detailed limitation of benefits (“LOB“) provision or (ii) a combination of the PPT with a simplified LOB provision. According to the PPT, a benefit under a CTA shall not be granted if it is reasonable to conclude that one of the principal purposes of the arrangement or transaction is to obtain that treaty benefit, unless it can be established that granting that benefit in these circumstances is in accordance with the object and purpose of the relevant CTA. Where the other contracting state has not opted for the PPT, but for a detailed LOB provision, the MLI would not result in a direct change of the relevant CTA and the two states shall endeavour to reach a mutually satisfactory solution that meets the BEPS minimum standard.

With respect to dispute resolutions, Luxembourg has chosen to express no reservation and to apply the provisions of Articles 16 and 17 covering respectively the mutual agreement procedure (“MAP“) and corresponding adjustments. In particular, the new provisions will establish timelines within which a MAP can be requested, will permit the taxpayer to submit a request for MAP to either contracting state and confirm that domestic time limits cannot preclude a resolution reached under MAP from being implemented.

Luxembourg will also include a specific preamble in its CTAs that clarifies that the tax treaty is intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions).

Options

Apart from the minimum standards, Luxembourg accepted only a few optional rules.

On transparent entities, Luxembourg has decided to apply Article 3 (with the exception of Art. 3 (2)) of the MLI that addresses the situation of hybrid mismatches as a result of entities that one or both contracting states treat as wholly or partly transparent for tax purposes. This article provides that income derived by or through an entity that is treated as wholly or partly transparent under the tax law of either contracting state shall only be considered income of a resident to the extent that the income is treated, for purposes of taxation by that contracting state, as the income of a resident of that contracting state. This provision may be helpful, in particular for alternative fund vehicles.

For the application of methods for the elimination of double taxation, Luxembourg has chosen Option A. Under this option, Luxembourg will not grant an exemption with respect to income or capital that, pursuant to a CTA, is exempted or taxed favourably in the other contracting state. In the case of a favourable rate of taxation, Luxembourg will grant a tax credit for the foreign tax on the income or capital (within the ordinary limits that apply to tax credits in Luxembourg). This approach is motivated by the fact that most of Luxembourg CTAs already contain this provision.

To prevent artificial avoidance of Permanent Establishment (“PE“) status, Luxembourg has selected Option B for the specific activity exemption which refers to Article 5 paragraph 4 of the OECD Model Tax Convention. Option B makes explicit that the list of activities specifically excluded from the definition of a PE in the Covered Tax Agreement will also not create a PE as a result of the MLI, irrespective of whether that activity is of a preparatory or auxiliary character. It should be noted that Luxembourg has always interpreted Article 5 paragraph 4 of the OECD Model Tax Convention in this manner.

Finally, Luxembourg has decided to implement the arbitration procedure which can be launched in cases where the MAP does not resolve the issue at hand within two years.

Reservations

Luxembourg has made a full reservation and will thus not apply the following articles of the MLI:

  • Article 4 (Dual Resident Entities);
  • Article 8 (Dividend Transfer Transactions);
  • Article 9 (Capital Gains from the Alienation of Shares or Interests of Entities Deriving their Values Principally from Immovable Property);
  • Article 10 (Anti-abuse Rule for Permanent Establishments Situated in Third Jurisdictions);
  • Article 11 (Application of Tax Agreements to Restrict a Party’s Right to Tax its Own Residents);
  • Article 12 (Artificial Avoidance of Permanent Establishments through Commissionaire Arrangements and Similar Strategies);
  • Article 14 (Splitting-up of Contracts); and
  • Article 15 (Definition of a Person Closely Related to an Enterprise).

Timing

The entry into force of the MLI will be on the first day of the month following 3 calendar months after the date of deposit of the instrument of ratification, acceptance and approval by Luxembourg.

Once Luxembourg will ratify the MLI and deposit its instrument of ratification with the OECD, its effective application per CTA will depend on the date of entry into force of the MLI in the other contracting state and on the type of taxes.

With respect to a specific CTA, the MLI will then only enter into effect as follows:

  • With respect to withholding taxes, on the first day of the calendar year beginning after the date the MLI enters into force between all contracting states to a CTA – at the very earliest, this would be 1 January 2019 ; and,
  • For all other taxes, for taxable periods beginning on or after the expiration of six months after the date at which the MLI enters into force between all contracting states to a CTA – at the very earliest, this would be taxable periods beginning on 1 January 2020 for companies whose fiscal year coincides with the calendar year.

The MLI already entered into force for 8 jurisdictions with which Luxembourg has a CTA (i.e. Austria, Isle of Man, Jersey, New Zealand, Poland, Serbia, Slovenia, Sweden and the United Kingdom).