November 3, 2023
Luxembourg publishes draft legislation approving protocol amending tax treaty with Germany, improving taxation of funds
On 6 July 2023, the Luxembourg and German Ministers of Finance signed an amending protocol (the Amending Protocol) to the existing DTT dated 23 April 2012 and the related protocol. On 20 September 2023, the Luxembourg Minister of Foreign and European Affairs submitted to Parliament the Draft Law approving the Amending Protocol.
The Amending Protocol allows funds (as defined in the DTT) to utilize reduced withholding tax rates.
It also increases from 19 to 34 the number of days during which a resident of one Contracting State who is employed in the other Contracting State may work outside that other Contracting State (including in home office) without triggering taxation of the (pro-rata share of) salary in the State of residence.
Additionally, the Amending Protocol contains certain provisions aiming to resolve differences of interpretation that have arisen over the years between the competent authorities of Luxembourg and Germany.
This Tax Alert details some of the most relevant changes foreseen by the Amending Protocol.
Taxation of funds
The Amending Protocol introduces essential changes regarding the taxation of funds.
In the future, according to the Amending Protocol, Undertakings for Collective Investment (UCIs) established in a Contracting State and receiving income originating from the other Contracting State will be deemed to be resident for tax purposes in the Contracting State of their establishment. In addition, a UCI established in a Contracting State that receives income from the other Contracting State is to be considered as the beneficial owner of the income received. As a result, payments to UCIs as defined in the DTT can now benefit from the 15% reduced withholding tax rates under the DTT. This is mostly relevant for payments from German sources, as payments by Luxembourg UCIs are not subject to withholding tax.
UCIs as per the DTT are defined as follows: for Luxembourg, investment funds within the meaning of the law of 2016 on Reserved Alternative Investment Funds (RAIFs), the law of 2007 on Specialized Investment Funds (SIF) and law of 2010 on UCIs. The definition includes Luxembourg funds operating as Fonds Commun de Placement (FCP) but excludes investment funds in the form of partnerships. For Germany, the concept of UCI covers investment funds within the meaning of the German investment tax law (Investmentsteuergesetz) except if set up as a partnership.
The concept of a UCI may further cover any other undertaking as agreed by the competent authorities of Luxembourg and Germany, which can: be widely held; directly or indirectly hold a diversified portfolio of securities; invest, directly or indirectly, in immovable property for renting purposes; be subject to investor protection rules in the Contracting State in which it is established; and be established in one of the two Contracting States.
Withholding tax on dividends paid by a company subject to the German legislation on Real Estate Investment Trusts (REITs) or by a Luxembourg real estate company that is considered for tax purposes as being similar to a German REIT will be limited to 15%.
Finally, the protocol clarifies that dividends derived by a resident of one of the Contracting States through an entity that is considered as tax transparent by that State should be treated for withholding tax purposes as if that resident had received the dividends directly.
Taxation of individuals
The Amending Protocol also foresees changes to the taxation of employment income. Among other changes, the tolerance threshold for cross-border workers is increased from 19 to 34 days per calendar year. By introducing this de minimis rule, the State of residence waives its right to tax remunerations attributable to employment activity of a cross-border worker of up to 34 days carried out in its territory or the territory of a third State. A similar provision for employees of the public sector is included in the DTT in article 18. The Amending Protocol also specifies that the work activity will only be deemed to have been carried out on a working day in a State or territory if the person was working in this State for at least 30 minutes on the respective working day.
Moreover, the Amending Protocol amends the rules applicable to income earned by employees working in the transportation of goods or persons, such as professional bus or truck drivers, who cross the border several times per day by foreseeing a split of their salary. This provision applies to persons who are tax resident in one of the Contracting States and whose remuneration is borne by an employer who is resident in or by a permanent establishment located in one of the Contracting States. Their salary will be split between all the States (including third States) in which they work in equal parts (regardless of the amount of time spent in these States), and the State of residence of the employee will be entitled to tax the part of salary allocated to it and to any third State, whereas the State of residence of the employer will be entitled to tax the part of salary allocated to it. For example, a German resident truck driver working in Luxembourg, Belgium and Germany will have his daily salary taxed for 1/3 in Luxembourg and 2/3 in Germany.
The Amending Protocol also amends the wording of the existing clause on taxation of interest to align it with the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention by clarifying that interest can only be taxed in the State of residence of the recipient to the extent the recipient is the beneficial owner of the interest.
Moreover, the taxation of capital gains upon outbound migration as foreseen by article 13 of the DTT is amended. Upon transfer of tax residence from one Contracting State to the other, the exit State has the right to tax unrealized capital gains on shares held by the migrating resident. The other Contracting State will have to consider this taxation at the time the shares are effectively sold and thus to determine the taxable profit by reference to the valuation that was applied for determining the exit taxation.
In addition, certain options taken by both countries with respect to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (Multilateral Instrument or MLI) that were already applicable have now been inserted in the text of the DTT. In that regard, the Amending Protocol adapts the Preamble to include a reference to the elimination of double taxation without creating possibilities of non-taxation or reduced taxation by tax evasion or fraud (including through treaty-shopping arrangements).
Article 1 of the DTT on persons covered concludes with a paragraph on the taxation of tax-transparent entities or arrangements that ensures that the benefits of the DTT do not apply if none of the Contracting States considers under its domestic legislation the income of the tax-transparent entity or arrangement as being directly attributable for tax purposes to one of its residents.
The Amending Protocol also specifically introduces the principal purpose test of the MLI.
Finally, the Amending Protocol introduces the equivalent of Article 23 (4) of the OECD Model Tax Convention in Article 22 of the DTT. This provision aims to avoid the absence of taxation, which would result from disagreements between the State of residence and the source State on the facts of a specific case or on the interpretation of the provisions of the DTT.
Entry into force
Provided that Germany and Luxembourg enact the Amending Protocol and exchange the instruments of ratification before the end of the year, the amended provisions will apply beginning 1 January 2024.
The Amending Protocol will result in significant amendments to the DTT and the related protocol. Luxembourg taxpayers with connections to Germany and vice versa should liaise with their tax advisors to assess potential implications and opportunities.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Tax Advisory Services Sàrl, Luxembourg City
Ernst & Young LLP (United States), Luxembourg Tax Desk, Chicago
Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor