Double tax treaty UK-Luxembourg

Another fundamental aspect of the UK-Luxembourg Double Tax Treaty is the types of taxes it covers in both jurisdictions. Let’s take a closer look at the taxes subject to this agreement:

The Double Tax Treaty between the UK and Luxembourg has been in place since 1967, but a new agreement was signed on June 7, 2022, introducing significant updates. The new treaty came into effect for UK corporate taxes and capital gains taxes starting in April 2024, and for withholding taxes as of January 1, 2024. In Luxembourg, the treaty took effect for all taxes beginning January 1, 2024. We will go into the details of this new treaty a bit further in our article.

Under this method, the country of residence exempts the income already taxed in the country where it was generated. In other words, the resident country waives its right to tax certain foreign income. There are two variations of this method: full exemption and exemption with progression. In the first case, foreign income is entirely exempt from tax in the country of residence. For progressive method, the foreign income is not taxed directly, but it is considered when calculating the tax rate applied to other taxable income. While the exempt income is not taxed, it may affect the tax rate applied to the remaining income.

In this approach, the country of residence does not exempt foreign income but allows the taxpayer to deduct the taxes already paid abroad from the total taxes owed in their home country. This ensures that while all income is taxed, the country of residence recognizes taxes already paid abroad, thereby avoiding double taxation.

In some cases, double tax treaties, including the one between Luxembourg and the UK, apply a combination of both methods, depending on the specific type of income or benefits involved. For example, certain types of income, such as dividends or interest, may be subject to tax credits, while other types of income may qualify for exemptions. This approach offers flexibility to accommodate the specific nature of the income and the tax policies of both countries.

BEPS refers to tax planning strategies used by multinational companies to shift profits to low or no-tax jurisdictions, thereby eroding the tax base of the countries where they operate. This often leads to an unfair reduction in tax revenues and creates an uneven playing field for businesses.

In 2013, the OECD and the G20 started the BEPS Project to tackle these issues. The goal is to reform international tax rules to stop companies shifting profits to lower-tax regions. The BEPS Project outlines 15 actions to help countries fight tax avoidance. The UK-Luxembourg Double Tax Treaty incorporates these principles, ensuring that multinational enterprises cannot unduly reduce their tax burden by shifting profits.

What is PPT?

The PPT is an anti-abuse rule included in many international tax treaties, including the UK-Luxembourg Double Tax Treaty. As part of the OECD BEPS Action 6, the PPT aims to prevent treaty abuse, specifically when transactions or structures are designed solely or mainly to benefit from the tax advantages offered by the treaty.

Consider a multinational company based in the UK that sets up a subsidiary in Luxembourg, whose sole purpose is to receive dividends from other companies in the group located in various countries. 

The primary reason for establishing this subsidiary is to benefit from the reduced withholding tax rates on dividends provided by the Double Tax Treaty between the UK and Luxembourg.

If the tax authorities in the UK or Luxembourg determine that this structure was created mainly to take advantage of the treaty’s provisions, they can apply the PPT to deny the treaty benefits. 

In this case, the dividends would not be eligible for the reduced or exempt tax rates offered by the treaty.