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04 September 2018 Luxembourg publishes draft law ratifying Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS On 3 July 2018, the Luxembourg Government submitted the draft law (Draft Law) ratifying the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI), which was signed on 7 June 2017,1 to the Luxembourg Parliament. The list of tax treaties in force that Luxembourg would like to designate as Covered Tax Agreements (CTAs), i.e., to be amended through the MLI, as per the Draft Law corresponds to the list submitted at the time of signature of the MLI. The MLI will not modify those treaties, but it will apply in parallel to them and modify their application to ensure the application of the Base Erosion and Profit Shifting (BEPS) measures. Some provisions will apply instead of those of a CTA, others will apply to or modify an existing provision of a CTA, or will apply in absence of such provision of a CTA. The Draft Law also confirms the partial or full reservations against a number of the articles of the MLI that Luxembourg made at the time of the signature of the MLI, as well as the options chosen by Luxembourg where the provisions of the MLI allowed for a choice to be made. The Draft Law provides for one additional reservation on arbitration, being the exclusion of the tax treaty with Switzerland from those provisions, given that this tax treaty already provides for mandatory binding arbitration of unresolved issues arising from a mutual agreement procedure case. The comments to the Draft Law explain that the reservations were made mainly against provisions for which an impact assessment appeared difficult and which can still be adopted at a later stage in the framework of bilateral negotiations. The list of CTAs provided by Luxembourg contains all of the 81 tax treaties concluded by Luxembourg that are currently in effect. It does not include the tax treaty with Cyprus, which was concluded shortly before signature of the MLI and already contains the minimum standards required by the MLI. An existing CTA will however only be modified by the MLI if the other Contracting Jurisdiction also designated the treaty with Luxembourg as a CTA. Part II of the MLI (Articles 3 to 5) of the MLI introduces provisions which aim to neutralize certain of the effects of hybrid mismatch arrangements based on the recommendations made in the BEPS Action 2 and Action 6 final reports released in October 2015. The provisions cover hybrid mismatches related to: (i) transparent entities; (ii) dual resident entities; and (iii) elimination of double taxation. These provisions are all not minimum standard provisions and therefore Contracting Jurisdictions have the right to opt to not apply these provisions to their covered tax treaties. Article 3 addresses the situation of hybrid mismatches as a result of entities that one or both Contracting Jurisdictions treat as wholly or partly transparent for tax purposes. It guarantees that the benefits of a CTA are not granted when none of the Contracting Jurisdictions treats, based on its domestic legislation, the income of an entity as being attributable to one of its residents. The provision will apply in all cases in which all the parties to a CTA agree on its application. Luxembourg decided to apply paragraph 1 of Article 3, which clarifies that income derived by or through an entity or arrangement that one of the Contracting Jurisdictions considers as wholly or partly fiscally transparent will be treated as income of a resident of a Contracting Jurisdiction, to the extent it is treated as income of a resident of that Contracting Jurisdiction for taxation purposes in that Contracting Jurisdiction. Luxembourg-source dividends, for example, that are derived by a foreign partnership would be able to benefit from the withholding tax reduction under a tax treaty provided the partners of the partnership are subject to tax on the Luxembourg-source dividend in the other Contracting Jurisdiction. The inclusion of this paragraph in Luxembourg treaties may be welcomed as it clarifies that look-through treatment may also be applied for tax treaty purposes. Its application to a specific CTA will require the other Contracting Jurisdiction to have made the same choice. Since Luxembourg made a reservation against Article 11 of the MLI (Application of Tax Agreements to restrict a Party's Right to Tax its Own Residents), an additional sentence has to be added at the end of paragraph 1 according to which the provisions of this paragraph do not affect the right of a Contracting Jurisdiction to tax its own residents. Luxembourg reserved its right not to apply paragraph 2 of Article 3. That provision would result in CTAs not providing relief for double taxation where the other state's tax is levied solely on the basis of residence (of the partners). There may be situations where this results in unrelieved double taxation which may explain Luxembourg's reservation. This provision would replace the current tie-breaker rules applicable to dual-resident companies (which typically consider the country where the place of effective management is situated as the residence country) by a mutual agreement process. Luxembourg has made a full reservation against this article. As stated in the Draft Law, Luxembourg prefers to continue using, as it is currently the case, the criterion of place of effective management to solve issues of dual residency. Article 5 allows signatories to choose between applying one of three different options, but also allows them to choose to apply none of the options. Where contracting states to a CTA choose different options, the option chosen by a Contracting Jurisdiction would apply to its own residents. Luxembourg has chosen option A, according to which Luxembourg would not grant an exemption otherwise foreseen in the CTA where the other Contracting Jurisdiction applies the provisions of the CTA to exempt such income or capital from tax or to limit the rate at which such income or capital may be taxed. Instead, Luxembourg would grant a tax credit for the foreign tax on the income or capital (within the ordinary limits that apply to tax credits in Luxembourg). As stated in the Draft Law, this approach is motivated by the fact that option A is based on Article 23A (4) of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital (Model Convention), which is already included in a large number of Luxembourg tax treaties. By choosing this option Luxembourg appears to address situations where income is subject to double non-taxation, such as income attributable to a "hybrid" permanent establishment (PE), i.e., an arrangement treated as giving rise to a PE in one country but not in the other (source) country, that is not subject to tax in the source country but derives interest income from the source country. Luxembourg has also reserved the right not to permit Contracting Jurisdictions that have chosen option C, to apply this option. Option C provides, in relation to income or capital that may be taxed in a Contracting Jurisdiction, that the other Contracting Jurisdiction applies the credit method to avoid double taxation, rather than the exemption method. Luxembourg believes that the replacement of the exemption method by the credit method constitutes a major change that should be the subject of bilateral negotiations. Part III of the MLI (Articles 6 to 11) contains six provisions related to the prevention of treaty abuse, which correspond to changes proposed in the final report on BEPS Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances). In particular, the Report contains provisions relating to the so-called "minimum standard" aimed at ensuring a minimum level of protection against treaty shopping (Articles 6 and 7 of the MLI). All treaties concluded by Luxembourg (with the exception of the treaty with Senegal, which already has an equivalent provision) will be amended to include the following preamble text: 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). This provision is a minimum standard and no reservations could be made against it. It is a significant change compared to current tax treaties, which apply (in the absence of specific exclusions) also to situations where a double taxation is merely possible, without the need for there to be actual double taxation. At the same time, to what extent this amendment will result in an actual change in a specific situation will have to be analyzed on a case-by-case basis. According to the Draft Law, this declaration of the purpose of a CTA is important for the interpretation and application of tax treaties, as the Vienna Convention on the Law of Treaties2 foresees that a treaty needs to be "interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose" (Article 31 (1) Vienna Convention). According to Article 31 (2) of the Vienna Convention, the context of the treaty also includes its preamble. In addition to the above change, Luxembourg also opted to include in all of its agreements specific language referring to a desire to develop an economic relationship or to enhance cooperation in tax matters. This part of sentence will inserted in the new preamble text if the other Contracting Jurisdiction has made the same choice. All treaties concluded by Luxembourg (with the exception of the treaty with Senegal, which already has an equivalent provision) will be amended to include a "principal purpose test" (PPT). It is not possible to make a complete reservation against this provision and countries could only choose between: (i) the PPT; (ii) a detailed limitation on benefits (LOB) provision modeled on the one contained in the United States (US) Model Tax Treaty supplemented by specific rules targeting conduit financing arrangements; or (iii) or a combination of PPT and a simplified or detailed LOB provision. The PPT targets transactions and arrangements based on subjective criteria, while the LOB relies on objective criteria. A PPT analysis will therefore be very case-specific. It is not a substance test, but refers to the purpose of an arrangement or transaction. Where treaty access is relevant, it will therefore be important to document the purpose and intention of a transaction. Where the other Contracting Jurisdiction has not opted for the PPT, but for a detailed LOB provision, the MLI would not result in a direct change of the relevant tax treaty and the two states "shall endeavor to reach a mutually satisfactory solution" that meets the BEPS minimum standard. Furthermore, where the other Contracting Jurisdiction has opted for a combination of PPT and a simplified LOB provision, Luxembourg does not permit the other Contracting Jurisdiction to apply the simplified LOB provision. As a result, only the PPT would be applicable. Notwithstanding any provisions of a CTA, a benefit under the CTA shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement. Luxembourg further opted to include a competent authority relief provision, under which a person that is denied the benefits of a CTA on the basis of the PPT may still be granted the benefits of the CTA as a result of a decision by the competent authority, upon request of that person and after consideration of the relevant fact and circumstances, "if such competent authority […] determines that such benefits would have been granted to that person in the absence of the transaction or arrangement." Rejecting the request in these circumstances requires prior consultation with the competent authority of the other Contracting Jurisdiction. This provision is intended to deal with abuse in relation to dividend withholding tax exemptions or reductions by among other things introducing a minimum holding period to benefit from such exemption or reduction. Luxembourg has made a full reservation against this article. No particular explanation is given in the commentaries to the Draft Law, but possibly it was felt that the amendment to the preamble together with existing safeguards were sufficient to deal with such transactions. The article requires approval by both Contracting Jurisdictions, which means that no change to the dividend withholding tax provisions of Luxembourg tax treaties is expected as a result of the MLI. Luxembourg has made a full reservation against the amendment of existing provisions of CTAs that allocate the right to tax capital gains from shares in "real estate-rich companies" to the country where the real estate is situated. Article 9 would allocate the right to tax such gains if a relevant value threshold is met at any time during the 365 days preceding the sale, and would require that the rule is expanded to apply to shares or comparable interests such as interests in a partnership or trust. As a result of the Luxembourg reservation, the existing provisions will remain in place and will not be amended to include reference to partnership interests or trusts. Luxembourg has also not opted to include a specific rule for real estate-rich companies in those CTAs that currently do not contain such clause. This would have been an "opt-in" provision, which Luxembourg decided not to pursue. The reason for this may be that the relevant existing tax treaties have already been amended or are in process of being amended to address land-rich companies. This provision deals with situations where an enterprise of one Contracting Jurisdiction has a PE in a third country to which income from the other Contracting Jurisdiction is allocated and exempt from tax in the first-mentioned state (triangulation situations). If the income is taxed at a low rate (less than 60% of the tax that would be imposed in the jurisdiction of the head office), the benefits of the treaty will not apply. Instead, the income remains fully taxable according to the domestic law of the other Contracting Jurisdiction. The provision is modeled on the "triangulation clause" found in US treaties. Luxembourg, as a jurisdiction applying the exemption method, reserved its right not to apply this provision. Luxembourg reserved its right not to apply the provision of Article 11, according to which a tax treaty would not restrict the rights of Luxembourg to tax its own residents, with certain exceptions. Part IV of the MLI (Articles 12 to 15) describes the mechanism by which the PE definition in existing tax treaties may be amended pursuant to the BEPS Action 7 final report to prevent the artificial avoidance of PE status through: (i) commissionaire arrangements and similar strategies (Article 12); (ii) the specific activity exemptions (Article 13); and (iii) the splitting-up of contracts (Article 14). Article 15 of the MLI provides the definition of the term "closely related to an enterprise," which is used in Articles 12 through 14. Luxembourg made reservations on most of the changes dealt with in Part IV. Without these reservations, the threshold for the recognition of a PE would have been significantly lowered. As regards more specifically the provision of Article 13 dealing with specific activity exemptions, Luxembourg chose option B. Article 13 relates to paragraph 4 of Article 5 of the OECD Model Convention, which lists a certain number of activities that do not create a PE despite the fact that they are exercised in a fixed place of business. Option B provides that a specific list of activities that was deemed not to constitute a PE in the CTA (prior to the MLI) will also not create a PE as a result of the MLI. This is irrespective of whether that activity is of a preparatory or auxiliary character (unless explicitly provided to the contrary in the relevant CTA). Luxembourg's choice for option B is in line with how Luxembourg has so far interpreted Article 5 paragraph 4 of the OECD Model Convention. Article 13 also foresees an anti-fragmentation rule aiming to avoid that companies split their activities in order for them not to be considered as creating a PE. Luxembourg reserved its right not to apply this rule. Article 14 of the MLI provides for an anti-abuse rule on the splitting-up of contracts as to fall under the threshold laid down for a construction or assembly site to be considered as a PE. Luxembourg also reserved its right to not apply this provision. According to the Draft Law, the PPT rule already allows for addressing the abusive splitting-up of contracts. Since Luxembourg has not opted for any provision that encompasses the definition of "person closely related to an enterprise" as set forth by Article 15 of the MLI, it has made a full reservation on this article as well. As part of the options contained in the MLI, jurisdictions can opt into mandatory binding arbitration, an element of BEPS Action 14 on dispute resolution, Luxembourg being among those jurisdictions. If the other Contracting Jurisdiction also opted for mandatory arbitration, the Luxembourg tax treaty with that state would be amended to include mandatory arbitration, which would allow a person to request that a case on which the competent authorities are unable to reach mutual agreement under the mutual agreement procedure be submitted to arbitration. Luxembourg has not chosen to extend the deadline for submission to arbitration from two to three years. However, if the Contracting Jurisdiction has chosen this option, the three-year period also applies to the tax treaty concluded by Luxembourg with this state, if the tax treaty is a CTA. Luxembourg chose to not extend this possibility to those cases where a decision on the issue in question has been rendered by a court or tribunal of either Contracting Jurisdiction before the arbitration decision. Luxembourg also chose to apply a provision that would allow the competent authorities to reach a different decision than the arbitration decision if such provision is reached within three months of the delivery of the arbitration decision. This provision will however only apply if the other Contracting Jurisdiction has made the same choice. Article 26 of the MLI regulates in its first paragraph the interaction between the provisions of Part VI of the MLI and existing arbitration provisions in the CTAs. Luxembourg has notified all of its tax treaties3 (except the tax treaty with Switzerland, see below) that contain arbitration provisions. As a result, and if the other Contracting Jurisdiction has made the same notification, the provisions of Part IV of the MLI will replace the existing provisions. One change has been made as regards the positions initially taken by Luxembourg at the time of signature of the MLI: Luxembourg excludes the tax treaty with Switzerland from the CTAs to which mandatory arbitration will apply, on the grounds that the current tax treaty already provides for mandatory arbitration. As a consequence, the existing provisions on arbitration in the tax treaty with Switzerland will continue to apply and will not be replaced by the provisions of Part VI of the MLI. The MLI entered into force on 1 July 2018. The entry into force followed the deposit of the fifth instrument of ratification by Slovenia on 22 March 2018. With respect to a specific bilateral tax treaty, the MLI will have effect after Luxembourg and the other party to the relevant CTA have deposited their instrument of ratification, acceptance or approval of the MLI and a specified time has passed. The timing differs for different provisions. With respect to taxes withheld at source on amounts paid or credited to nonresidents, the provisions will have effect where the event giving rise to such taxes occurs on or after the first day of the calendar year that begins on or after the latest of the dates on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA. For example, if the last date of entry into force for the Contracting Jurisdictions to a CTA is on 1 October 2018, the provisions of the MLI relating to withholding taxes will have effect where the event giving rise to such taxes occurs on or after 1 January 2019. With respect to all other taxes levied by a Contracting Jurisdiction, the first taxes for which provisions will enter into effect are those which are levied with respect to taxable periods beginning on or after the expiration of a period of six calendar months from the latest of the dates on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA. The Draft Law does not include the option given by the MLI to foresee a shorter period than six months between the entry into force and the effective date of the MLI in a bilateral situation. For example, if the date of entry into force in a Contracting Jurisdiction is 1 June 2018, and the date of entry into force in the other Contracting Jurisdiction is 1 October 2018, the date of the latest entry into force is 1 October 2018. The provisions of the MLI will then be applicable to all taxes not withheld at source with respect to taxable periods beginning on or after 1 April 2019 (i.e. six months after the latest date of entry into force). Where the financial year corresponds to the calendar year, the provisions would apply to financial years beginning on or after 1 January 2020. With regard to Part VI (Arbitration), the provisions will have effect with respect to cases presented to the competent authority of a Contracting Jurisdiction, on or after the later of the dates on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA. With respect to cases presented to the competent authority of a Contracting Jurisdiction prior to the later of the dates on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA, the provisions will have effect on the date when both Contracting Jurisdictions have notified the Depositary that they have reached mutual agreement. Luxembourg has reserved the right for Part VI to apply to a case presented to the competent authority of a Contracting Jurisdiction prior to the later of the dates on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA only to the extent that the competent authorities of both Contracting Jurisdictions agree that it will apply to that specific case. The MLI is a key milestone in the implementation of the treaty-based BEPS recommendations. At this stage, it is expected that over 1,200 tax treaties will be modified in accordance with the matching positions and reservations of Contracting Jurisdictions toward a specific CTA. Many jurisdictions are expected to finalize their ratification procedures of the MLI during the course of 2018. The definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI, while during the ratification procedures the decisions of countries in relation to their rights to reserve on certain parts of the MLI (a reservation or opt-out) may change. Even though Luxembourg has made a number of reservations, the introduction of a PPT and a number of other changes will still result in an unprecedented wave of amendments to Luxembourg tax treaties. The entry into force of these changes in a bilateral context will not depend on the entry into force of the MLI in Luxembourg as well as the other Contracting Jurisdiction. 1 See EY Global Tax Alert, 68 jurisdictions sign the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, dated 7 June 2017. 2 Vienna Convention on the law of treaties signed at Vienna 23 May 1969, ratified by Luxembourg on 4 April 2003. 3 The countries are Estonia, Germany, Guernsey, Hong Kong, Isle of Man, Jersey, Liechtenstein, Mauritius, Mexico, San Marino, the Seychelles and Uruguay.
Document ID: 2018-6032 |
