13th February 2023
UK-Luxembourg Double Taxation Agreement
On 20 January 2023, the Council of Government of Luxembourg approved the long-awaited updated UK-Luxembourg Double Taxation Agreement, which aligns the treaty with the majority of other countries, in particular in relation to the taxation of capital gains on indirect disposals of UK real estate. With the UK government having already ratified the new treaty on 12 October 2022, the treaty will now become effective once the ratification instruments have been exchanged.
The key changes are:
- Capital gains on disposals by a Luxembourg company of shares in a company which derives more than 50% of its value from UK real estate can be taxed in the UK (and vice versa). This brings disposals by Luxembourg companies into the scope of the UK non-resident capital gains tax rules for disposals of UK property rich companies which derive more than 75% of their value from UK real estate.
- Withholding Tax ("WHT") on interest, royalties and dividends is reduced to 0%, other than for REIT Property Income Distributions which the treaty reduces to 15%.
With final approval granted by the Council of Government of Luxembourg in 2023, the changes to WHT will apply from 1 January 2024 and to Corporation Tax from 1 April 2024 (and for individuals, to income tax from 6 April 2024).
Key implications for UK real estate investors:
- Investors who hold their UK real estate investments in corporate structures, and where a company is sold by a Luxembourg holding company, that holding company will pay tax on the disposal of such companies from 1 April 2024. The tax will be applicable to the increase in the value of the shares from 5 April 2019 (i.e. a valuation of the shares as of 5 April 2019 factoring in the property revalued to its 5 April 2019 value – if higher than the original cost).
- The test in the treaty which allows for disposals of a company which derives more than 50% of its value from UK real estate to be taxed in the UK does not override the UK domestic law which applies to companies which derive 75% of their value directly or indirectly from UK real estate. As such if between 50% and 75% of the value of the company is derived from UK real estate, UK Corporation Tax does not apply to the share disposal under current UK rules (albeit it could in future if the UK rules are amended).
- Such investors may look to divest their holdings prior to 1 April 2024 given the significant tax charge that would arise after this date. We note that where investors satisfy the requirements under the original targeted anti-avoidance rule which included anti-forestalling measures to prevent investors from moving their holding structure to Luxembourg after the UK tax changes were originally announced on 22 November 2017. We would not expect any further anti-avoidance to apply, as long as no artificial measures are taken to accelerate the tax point of the transaction prior to 1 April 2024. Note that where there is an unconditional transaction, tax on the capital gain is triggered at the point of exchange, and not completion, if the two are different, and documents should be reviewed in detail and considered further where a transaction straddles this period.
- In relation to WHT on dividends, although there are currently exemptions under domestic legislation, this may be useful for distributions by Luxembourg entities to the UK where the participation exemption would not be available (i.e. if a UK corporate held less than 10% of the share capital for less than 12 months) and as such avoid the need to structure to get the UK domestic exemption. This may be helpful in the future when there is a joint venture between an investor investing via a Luxembourg platform and UK joint venture partners such as asset managers, who often have a small holding.
Please get in touch with FTI.Tax@fticonsulting.com if you would like to discuss further the implications of these changes.
FTI Consulting Tax Team
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