UK - Luxembourg double tax treaty: Ratified by both Luxembourg and UK particular significance for UK real estate holding structures

The United Kingdom and Luxembourg signed an updated double tax convention and protocol (DTT) in July 2022 which entered into force on 22 November 2023. The DTT will become effective for UK income and capital gains tax purposes in April 2024 and 1 January 2024 for income withheld at source. While a new DTT between these jurisdictions has been on the cards for some time, particularly following the implementation by the UK of a non-resident capital gains tax on disposals of UK property rich entities, confirmation that the change is now imminent may have a potential knock-on effect for the way in which UK real estate is held.

The most significant change to the DTT is to the capital gains tax article, which now contains a “land-rich company” provision allowing capital gains on the disposal of shares, or comparable interests (such as partnership interests or trusts), deriving more than 50% of their value directly or indirectly from real estate to be taxed in the country where the real estate is located. The UK domestic tax is only imposed if 75% or more of the value derives from UK real estate, so in practice, if a Luxembourg holding company were to dispose of its investment in a Luxembourg property company, deriving more than 75% of its value from UK real estate, any gain on the share disposal is now firmly within the scope of UK corporation tax on chargeable gains. The change is one which now brings the UK-Luxembourg DTT into line with the OECD model tax convention and most of the UK’s other double tax treaties in this respect.

Importantly, the DTT does not allow for a “rebasing”, meaning that the usual UK corporation tax rules for non-UK resident investors disposing of their interests in UK property rich entities, would apply. These rules tax any gain which has accrued since April 2019 (or, if higher and an election is made, the original historic cost base). 
In addition to the amendments to the capital gains tax article, there are other changes to the existing treaty. Currently, the DTT allows withholding tax at 15% on dividends, reduced to 5% if the recipient holds at least 25% of the shares in the payer. The new treaty prohibits all withholding tax on dividends provided the beneficial owner of the dividends is resident in the other contracting state. There is one exception to this which allows the UK to retain withholding tax on property income distributions (PIDs) from real estate investment trusts (REITs), capped at 15% (except for pension fund recipients of PIDs who are entitled to be paid without withholding). Withholding tax on interest paid by a resident of one contracting state to a resident of another remains at 0%, and withholding tax on royalties in similar situations has been reduced from 5% to nil (provided in both cases that the amounts are arm’s length).

Importantly, the benefits of the new treaty may be available to certain collective investment vehicles (CIVs). In particular, Luxembourg collective investment vehicles (UCITS, SIFs or RAIFs) treated as corporate bodies for Luxembourg tax purposes will now benefit from the new DTT to the extent they are held by equivalent beneficiaries. In simple terms, equivalent beneficiaries can be residents of Luxembourg, or of any other jurisdiction with which the UK has arrangements that provide for information exchange and at least equivalent benefits. If the CIV is a UCITS, or its unitholders are composed of at least 75% of equivalent beneficiaries, the CIV will be treated as a resident of Luxembourg and as the beneficial owner of all the income it receives.

The DTT entered into force on 22 November 2023 and will become effective for UK income and capital gains tax purposes in April 2024 (with an earlier 1 January date in respect of income withheld at source).  Anyone considering a disposal of, or investing in, a UK property rich entity, should be mindful of this change to the treaty.