Luxembourg - Tax
Luxembourg – Germany Double tax Treaty amendment
On 20 September 2023, the Luxembourg Government issued a bill of law (the “Law”) amending the Double Tax Treaty between Luxembourg and the Germany, (the “DTT”) dated 23 April 2012, and ratifying the Protocol related to the DTT, signed on 6 July 2023. (the “Protocol”). The Law was ratified by the Luxembourg Parliament on 14 December 2023.
The most relevant amendments are related to the treatment of certain investment vehicles and to dividend distribution made by and to such vehicles. In addition, the Law introduces provisions for capital gains taxation and the principal purpose test.
Clarifications on tax transparent investment vehicles
On the one hand, an entity that is considered as wholly or partially tax transparent by both contracting states will not have access to the DTT.
On the other hand, non-tax transparent collective investment vehicles established in one of the contracting states and deriving income from the other contracting state, that are considered as beneficial owner of such income, may be entitled to DTT benefits.
The Law confirms that dividends distributed through a transparent entity should be considered as directly distributed to the investors for the application of the provisions of the DTT. Consequently, a reduced dividend withholding tax rate may apply for investors residing in one of the contracting states.
Withholding tax on dividend distributions
The DTT already provided for a reduced withholding tax rate from 15% to 5% for the dividend whose beneficial owner is a company owning directly at least 10% of the share capital of the company paying dividends.
The Law provides that dividends distributed by a German Real Estate Investment Trust (REIT), or a real estate entity located in Luxembourg that is similar for tax purposes to a REIT, will be subject to a maximum 15% withholding tax in the distribution state.
The same rate will apply to dividends received by collective investment undertakings, defined in the Law as follows:
- In Germany: investments funds incorporated under the German Law on Investment Tax – Investmentsteuergesetz – unless they are tax transparent entities; and
- In Luxembourg: Undertakings for Collective Investment (UCI), Specialised Investment Funds (SIF) and Reserved Alternative Investment Funds (RAIF), unless they are tax transparent entities.
Contracting states may include further investment vehicles in this definition, to the extent they meet the following conditions:
- They are widely held;
- They own (directly or indirectly) a diversified portfolio of securities or real estate properties securing regular rental income; and
- Are subject to investor protection rules in the state of incorporation, being either Luxembourg or Germany.
Step-up in basis for capital gains taxation
The Law introduces a provision allowing for a step-up in basis in case an individual resident of one contracting state migrates to the other contracting state, triggering exit taxation in the first state and thereafter sells shares situated in another contracting state. Based on the new rule, the latter state should use the same value for calculation of the taxable base as the first contracting state used for the exit taxation, to the extent that value does not exceed the fair market value.
Principal purpose test
The principal purpose test is an anti-abuse provision that already applies to the DTT further to the multilateral instrument (MLI). The principal purpose test denies the benefits of the DTT if it is reasonable to conclude that obtaining of the DTT benefit is one of the principal purposes of the party seeking to apply the DTT provisions. Such denial will, however, not take place if granting of the DTT benefits is in accordance with the object and purposes of the DTT. The Law now introduces such anti-abuse rule within the actual text of the DTT itself.
Unconstitutionality of the minimum net wealth tax
On 10 November 2023, the Constitutional Court of Luxembourg has declared the fixed minimum net wealth tax of EUR 48151, in certain circumstances, unconstitutional and discriminatory to the entities in comparable situations, which is against the constitutional principle of taxation according to the paying capacity of the taxpayer assessed on the economic reality.
The provision concerns the minimum net wealth tax in the amount of EUR 4,815 for entities with a total balance sheet superior to EUR 350,000 but below EUR 2,000,000 and with a sum of financial fixed assets, transferable securities, receivables from affiliated undertakings, and cash exceeds 90% of their total balance sheet.
In all other cases, the minimum net wealth tax is calculated on a basis of the progressive scale as depicted below2:
This decision has impact on the entities with total balance sheet between EUR 350,000 and EUR 2,000,000 that were until now subject to EUR 4,815 and should, based on the decision be subject to only EUR 1,605 of minimum net wealth tax.
The Constitutional Court indicates that until the law is amended to be aligned with the constitutional provisions, the determination on the basis of the progressive scale is applicable (point b) to taxpayers subject to point a) when it is more favourable.
1 : Point a) of paragraph 8 (2) of the Vermögensteuergesetz
2 : Point b) of paragraph 8 (2) of the Vermögensteuergesetz
Pillar 2 Law amended and enacted
On 13 November 2023, an amended to the draft law implementing the Pillar 2 Directive1 has been published by the Luxembourg government. On 20 December 2023, Luxembourg Parliament passed the amended draft law (the “Pillar 2 Law”).
In comparison to the initial draft law published on 2 August 2023 described in our Q3 quarterly update available here, the amendment provides for several clarifications and incorporates certain technical rules as included in the OECD GloBe administrative guidance of 17 July 2023.
The Pillar 2 Law is to a large extent aligned with the provisions of the Pillar 2 Directive and is applicable as of 1 January 2024, save for the Undertaxed Profit Rule that should, in principle, apply as of 1 January 2025.
1 : Council Directive (EU) 2022/2523_ of 14 December 2022 on ensuring a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the Union
Luxembourg – United Kingdom Double Tax Treaty
On 22 November 2023, an amended tax treaty for avoidance of double taxation between the United Kingdom and Luxembourg entered into force. The provisions of the updated treaty are effective in Luxembourg as of 1 January 2024. More about the provisions of the amended treaty in Quarterly Update Q2 2023.
VAT treatment on director’s fees
On 21 December 2023, the Court of Justice of the European Union (the “Court”) issued a ruling in respect of VAT treatment of the fees of directors acting as independent members of the board of Luxembourg companies.
The Court ruled by way of a preliminary ruling on two questions raised by the Luxembourg District Court:
(i) Can the activity of an individual acting as a member of the board of directors of a public limited company to be considered as carrying out economic activity within the meaning of the Article 9(1) the EU VAT Directive1 and, in particular, if the fees received by that director are to be considered as remuneration for services provided to the company; and
(ii) Can it be considered that the individual acting as a member of the board of directors of a public limited company carries out his economic activity independently, as per the EU VAT Directive.
With respect to the first question, the Court confirmed that the activity of the director may be considered as an economic activity to the extent the director receives consideration for his activity and the activity is performed on permanent basis.
With respect to the second question, the Court concluded that the member of a board of directors of a Luxembourg public company does not bear any economic risk of its activities personally, but those risks are born by the company itself. Consequently, it may not be concluded that director’s activities are to be considered as carried out independently. This results in the services provided by these independent directors not to be subject to VAT.
Practical impact
The Luxembourg District Court is expected to issue its final decision in the case at hand, taking in consideration the binding nature of the preliminary ruling of the Court.
Prior to this ruling, the VAT treatment of director’s fees was described in a Circular2 issued by the Luxembourg VAT authorities. According to the Circular, the activity of the director of a company shall be considered as an economic activity subject to Luxembourg VAT, regardless if the director is an individual or an entity.
Further to the above described judgement, on 22 December 2023 Luxembourg VAT authorities issued a new Circular3 stating that the previous circular is suspended until the final decision of the Luxembourg District Court. In addition, the VAT authorities confirmed that any VAT unduly paid in the previous years, subject to the statute of limitation (i.e. 5 years) should be recovered.
The position taken by the Court is very welcome and it may result in deregistration for VAT purposes of the directors established in Luxembourg and registered for Luxembourg VAT purposes.
The entities that paid these directors fees and were registered for Luxembourg VAT purposes (e.g. holding/financing entities and management entities, etc.) and suffered a non-deductible VAT in respect to these directors fees will no longer suffer this VAT leakage and any VAT leakage incurred should be recovered for the unduly paid VAT (subject to the statute of limitation of 5 years).
1 : Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax
2 : Circular n° 781 issued on September 30, 2016
3 : Circular 781-1 issued on December 22, 2023