Luxembourg continues to expand its Double Tax Treaty (DTT) network and has recently ratified a new double tax treaty with the three Crown dependencies: Jersey, Guernsey, and the Isle of Man. In the following article, we will present the main features of the Double Tax Treaty with Guernsey. This Double Tax Treaty, which generally follows the provisions of the OECD Model Tax Convention, entered into force on 8 August 2014 and became applicable on 1 January 2015.
By Jean-Michel Chamonard (Partner) and Samantha Schmitz-Merle (Director) at Atoz Tax Advisers
DTT benefits for collective investment funds
The Protocol to the DTT includes a specific provision on Collective Investment Funds (CIVs). Under the DTT, body corporate Collective Investment Funds (CIVs) are considered as residents and beneficial owners of the income they receive while CIVs in other forms are considered as individual residents and beneficial owners of the income received.
When applied to Luxembourg investment funds, this means that Luxembourg SICAVs/SICAFs are able to claim treaty benefits and as such, benefit on their investments in Guernsey from the same reduced withholding tax (WHT) rates as ordinary fully taxable Luxembourg companies (maximum of 5% WHT on dividends), while Luxembourg FCPs, since they are tax transparent, are subject to the WHT rate applicable to individuals (which is higher under the DTT: maximum of 15% WHT).
However, for investments performed by Luxembourg CIVs, this distinction is currently irrelevant since the internal tax rules currently in force in Guernsey do not subject dividend distributions to WHT. As a result, there is no need for a Luxembourg CIV to claim the application of the treaty rates.
Nevertheless, the fact that Luxembourg now almost systematically includes CIV-specific provisions in its new DTTs in order to clarify treaty benefits is positive as it will most probably increase the number of situations in which Luxembourg CIVs will be able to benefit from reduced DTT WHT rates when they invest abroad.
Maximum withholding tax rates
The maximum WHT rates applicable under the DTT are as follows:
As far as dividends are concerned, the standard maximum WHT rate is 15% and a reduced WHT rate of 5% applies in case of a company holding at least 10% in the company distributing the dividend. These are the maximum WHT rates that Luxembourg and Guernsey may levy on dividend distributions. However, since Luxembourg grants a WHT exemption under certain conditions and since Guernsey does not subject dividends to WHT, there will be no need to claim the application of the DTT rate in many cases.
As far as interest payments are concerned, they are not subject to WHT and are only taxable in the country of residence of the recipient.
As far as royalty payments are concerned, they are also not subject to WHT and are only taxable in the country of residence of the recipient.
Capital gains from real estate companies
The DTT deviates from the OECD Model Tax Convention in its current form because it does not provide for a land rich clause. This means that gains derived from the disposal of shares in real estate companies are treated as gains upon the sale of movable property and are therefore only taxable in the country of the seller (whereas under a land rich clause, these gains would be only taxable in the source country, i.e. the country in which the real estate is located).
If the seller is a Luxembourg company, gains will only be taxable in Luxembourg. Additionally, the Luxembourg company realising the gain may be able to benefit, under certain conditions, from the domestic exemption regime.
Avoidance of double taxation
Guernsey applies the credit method. Luxembourg applies the exemption method and as an exception, the tax credit method in respect to dividends.
In addition, Luxembourg is required to exempt dividends received from a company resident in Guernsey if the Luxembourg company holds at least 10% of the distributing company from the beginning of the year and if the distributing company is liable to a corporate income tax comparable to Luxembourg corporate income tax. The exemption remains applicable even if the subsidiary is exempt or taxed at a reduced rate, as long as the dividends are derived from activities in industry, agriculture, infrastructure or tourism in Guernsey.
Exchange of information
The provisions of the DTT on exchange of information are in line with the OECD provisions regarding exchange of information upon request.
Changes to the EU participation exemption regime
Amendments introduced to stop the use of certain hybrid instruments creating situations of double non-taxation.
The Parent Subsidiary Directive 2011/96/EU has been amended by Directive 2014/86/EU of 8 July 2014 in order to challenge certain hybrid financial instruments and consequently remove situations of so-called double non-taxation in an EU context. The new Directive has to be implemented by the EU member states by the end of 2015 at the latest.
Hybrid instruments are instruments which are given a different tax qualification by two different jurisdictions: for example, the jurisdiction of source (jurisdiction of the subsidiary) qualifies the instrument as a debt instrument and therefore treats the payment made under this instrument as a tax-deductible interest payment. The jurisdiction of the parent company qualifies the instrument as equity investment and therefore treats the payment received by the parent company as a dividend which can benefit from a tax exemption under certain conditions. This mismatch in the tax treatment can create a situation of so-called double non-taxation, i.e. no taxation in both the jurisdiction of source and the jurisdiction of residence of the parent company.
To avoid this, the EU Parent-Subsidiary Directive has been amended in such a way that if a payment made is tax deductible in the EU member state of the subsidiary, i.e. in the country of source, it will have to be taxed by the EU member state of the parent company. In other words, the EU parent company will only be able to obtain a dividend exemption under the participation exemption regime of the EU Directive if the payment made by its EU subsidiary is not tax deductible in the jurisdiction of the subsidiary. This restriction applies only to distributions/payments taking place between 2 EU companies, meaning that no such restriction applies in the case of payments/distributions between non-EU companies.
Introduction of a General Anti-Abuse Rule
An additional change to the EU Parent-Subsidiary regime has been introduced more recently with Directive 2015/121 of 27 January 2015 amending Parent Subsidiary Directive 2011/96/EU. The new Directive introduces a "de minimis" General Anti-Abuse Rule (GAAR) in the EU Parent-Subsidiary regime ("de minimis" meaning that EU member states can apply stricter national rules, as long as they meet minimum EU requirements).
According to the amendment, there will be no dividend exemption under the amended Directive in case of arrangement or series of arrangements that, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage which defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances. "Not genuine" means that they are not put into place for valid commercial reasons which reflect economic reality.
The new GAAR, as most GAARs generally do since they are a matter of many various interpretations, will create some legal uncertainty and will have to be defined more precisely by the European Court of Justice of the EU, which will most probably require some time. In the meantime, to reduce at maximum the chances of application of the GAAR, taxpayers will have to pay a lot of attention to economic substance when structuring their investments.
Given these two changes which the EU member states will be required to integrate into their internal law by the end of 2015 at the latest, and considering the ongoing BEPS work which will most probably require the adoption of similar measures at a global level in the near future, multinationals should now review their investment structures carefully and remain particularly prudent, seeking the advice of their tax advisor when structuring new investments.
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You can read the other articles from Ipes' Private Equity update (edition 17) at the following links: