Luxembourg-based investment funds looking to invest in the UK have good news: a new Luxembourg-UK double tax treaty will take effect in 2024. The treaty grants Luxembourg corporate collective investment vehicles access to treaty benefits, either as a Ucits or through a beneficial ownership test. It also closes a tax loophole that allows Luxembourg structures to sidestep taxes on UK real estate investments.
“From a Luxembourg perspective, it will improve the tax position of certain corporate investment funds investing into the UK,” said Mark Stapleton, a London-based partner with law firm Dechert LLP. “From a UK perspective, it will improve the position of certain UK shareholders of Luxembourg entities. It will also widen the scope of the UK’s taxing rights with respect to Luxembourg entities making gains on UK real estate.”
“This should increase foreign investment and flows of capital between the UK and Luxembourg,” said Stapleton. “This may therefore be beneficial and offset any reduction in withholding tax collections.”
“In a post-Brexit world, this is a helpful development as separately there are potential EU tax developments aimed at simplifying withholding tax management, but this will not apply to EU-UK relationships,” he said.
Equivalent beneficiaries
The treaty will cover any Ucits fund, along with collective investment vehicles (CIVs) where “equivalent beneficiaries” hold 75% or more of the beneficial interests in the fund. It includes Luxembourg corporate forms such as the SA, S.á.r.l., SCA, as well as those regulated as Ucits, Part II Funds, SIFs Raifs, Assep, Sepcav and Luxembourg-supervised pension funds.
Equivalent beneficiaries under the treaty are residents of Luxembourg or other jurisdictions with which the UK has a treaty providing for effective and comprehensive information exchange.
A Lexology post dated 29 August authored by Stapleton and three other Dechert partners explained that “this change could enable certain Luxembourg credit funds to avoid UK withholding tax on interest payments from UK borrowers for the first time without the need for listed notes or other downstream entities subject to their specific investor mix from 1 January 2024.”
One of the UK’s HM Revenue & Customs’ key objectives was to sort out a real estate taxation issue that emerged after 2019. Since then, explained Stapleton in an email interview “non-residents have become liable to tax on gains generated from UK real estate and this also includes indirect holdings through ‘land-rich’ companies”, those predominantly holding real estate.
Closing a tax loophole
However, he said, “the existing Luxembourg treaty could override these provisions as taxing rights are exclusively with Luxembourg.” This raised the prospect, he said, of funds seeking to hold UK real estate indirectly through Luxembourg structures to avoid such tax.
The new treaty allows the UK to apply the non-resident charge to profits made by “land-rich” companies. It allocates taxing rights to the state containing the land, where the shares or other interests get 50% of their value from land.
Stapleton suggested that existing structures “may wish to trigger any accrued gains ahead of the change to avoid such gains being captured in the UK tax net in relation to a sale after the new treaty has taken effect.» No grandfathering provisions will apply, he said.
No more withholding
The treaty generally eliminates withholding tax on dividends. Stapleton characterised this as “a welcome reduction from the current treaty that imposes withholding at 5 percent for companies or 15 percent for individuals.” It will impact dividends paid from Luxembourg to UK shareholders, as the UK does not generally impose withholding tax on dividends.
The exemption does not apply to dividends paid out of income/gains derived directly from immovable property by an investment vehicle distributing most of this income annually and whose income from immovable property is exempt from tax. It would include UK REITs, and withholding tax of up to 15% will apply, unless the beneficial owner is a recognised pension fund.
The new treaty comes with other developments on the Luxembourg-UK post-Brexit relations front, such as the opening of the Luxembourg bar to UK lawyers. Stapleton said he sees it as an updating of legal clauses in both countries, characterising this as “a widening/strengthening of the relationship between Luxembourg and the UK.”
He explained that the treaty follows lengthy political discussions over a number of years. It also helps to implement OECD model tax convention provisions.
The new treaty will apply in Luxembourg from 1 January 2024. In the UK, the withholding tax elements will apply from the same date, with those relating to direct tax coming in on 1 April.