On 7 June 2017 Luxembourg and more than 70 other jurisdictions signed the multilateral instrument (“MLI”) to integrate base erosion and profit shifting (“BEPS”) measures into double tax treaties.
The MLI implements the treaty related anti-tax avoidance measures of the BEPS project in bilateral tax treaties and has already been enacted since 1 July 2018 in five jurisdictions, i.e. Austria, Isle of Man, Jersey, Poland and Slovenia. MLI will gradually enter into force in the OECD countries 3 months from the filing of the ratification instrument with the OECD. After its ratification, its application to a covered tax agreement (“CTA”) (i.e. double tax treaties for which the MLI will apply) will depend on the ratification by the other contracting state and on the type of tax concerned, i.e. withholding tax or other taxes.
In Luxembourg, the bill of law n°7333 (the “Bill”) for ratification of the MLI was submitted on 3 July 2018 by the Luxembourg Government to the Parliament (Chambre des députés). The Bill takes over the main provisional choices and reservations notified by Luxembourg to the OECD during the negotiation that took place in June 2017 in Paris.
Based on the provisional list of choices mentioned below, it should be noted that Luxembourg opted for a rather conservative approach. The Bill contains a summary of the rules chosen by Luxembourg and an explanatory note clarifying these choices.
1. MLI measures adopted by Luxembourg
First, each jurisdiction implementing MLI has to adopt compulsory rules such as minimum standard measures to counter treaty abuse, i.e. the so-called “principal purpose test” (the “PPT”), to improve dispute resolution in tax matters and to introduce a new preamble into double tax treaties to ensure they do not lead to double non-taxation.
Beyond these provisions, Luxembourg issued some optional rules. In particular Luxembourg has chosen to apply optional provisions of the MLI in connection with transparent entities, the application of methods for eliminating double taxation, the artificial avoidance of permanent establishment status through specific activity exemptions and the arbitration procedure. Several reservations on other MLI provisions have however been made by Luxembourg on dual resident entities, real estate-rich companies and dividend transfer transactions.
The list of choices made by Luxembourg is still subject to amendment that may be adopted during the discussion currently pending before the Parliament.
2. PPT rule
One of the most important changes that will impact Luxembourg double tax treaties is the implementation of a PPT rule, which may however create some uncertainty as to what situation would be considered as mainly tax driven.
The objective of the PPT rule is that a tax authority may deny the benefits of a tax treaty if obtaining such benefits is one of the principal purposes of an arrangement or transaction, taking all facts and circumstances into consideration, unless it is in accordance with the object and purpose of the relevant provisions of the tax treaty.
Luxembourg is one the 26 jurisdictions that opted for a competent authority relief provision. Based on this provision, when a benefit provided in a CTA is denied to a person, the competent authority of the contracting jurisdiction denying the benefits could review its position upon request from that person and, after consideration of the relevant facts and circumstances, could still grant the benefits of the CTA if such competent authority determines that the benefits would have been granted to that person in the absence of the transaction or arrangement. The competent authority of the contracting jurisdiction to which a request has been made shall consult with the competent authority of the other contracting jurisdiction before rejecting the request. Besides, this provision can be inserted in the CTA only if the other contracting party opted for the same provision.
A PPT analysis will occur on a case by case basis and refer to the purpose of an arrangement or transaction (distinct from a substance test). Within the context of a double tax treaty, it will therefore be highly recommended to document and demonstrate the genuine economic purpose of a transaction to avoid the structure being challenged by the relevant tax authority.
3. Effective date
In order for the measures adopted within the context of the MLI to apply to double tax treaties concluded with Luxembourg, the other contracting state must not only ratify the MLI but also must have chosen the MLI as one of the CTA and must have, in most cases, opted for the same optional provisions (this last condition might be relaxed under specific circumstances).
Both countries that have concluded a double tax treaty must henceforth give particular attention to the provisions adopted by each but also to the date of ratification of the MLI in order to determine the date of entry into force of (i) the MLI in each country on the one hand and (ii) the adopted MLI provisions on the other hand.
The time limit for entry into force of the MLI runs from the date the second covered treaty contracting state has filed its instrument of ratification with the OECD. The MLI will then come into effect the first day of the month following the end of the three months as of the date of filing of the ratification instrument.
4. Entry into force
One must distinguish two situations depending on the taxes in question.
For taxes withheld / at source:
MLI provisions will be applicable on 1 January 2019 (when the event giving rise to withholding tax would occur on or after the first day of the following calendar year during which the MLI enters into force).
For all other taxes:
MLI provisions will be applicable on 1 January 2020 (for the taxes levied with respect to a taxable period beginning on or after the expiry of 6 months during the year in which the MLI enters into force between both covered tax treaty parties).
The ratification process of the MLI in Luxembourg is however surrounded by some uncertainty due to the current political context. The forthcoming legislative election in October will lead to the dissolution of the current Parliament. Even though the ratification timeline remains unclear at this stage, one may still expect the MLI to be effective for Luxembourg double tax treaties as of 1 January 2019 for both withholding taxes and all other taxes.