June 2014

Double Tax Treaty between Luxembourg
and Sri Lanka

Tax Alert

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On 14 June 2013, Luxembourg ratified the first Income and Capital Tax Treaty with Sri Lanka, signed on 31 January 2013. The Treaty and its Protocol have entered into force on 11 April 2014. They will be applicable from 1 January 2015 onwards.

The main features of the Treaty are described hereafter. The provisions of the Treaty are applicable to collective investment vehicles.

Permanent establishment

The Treaty definition of permanent establishment includes a dredging project, a drilling rig or ship used for the exploration or development of natural resources, and also “service permanent establishments” in line with the 2011 United Nations Model Double Taxation Convention between Developed and Developing Countries (UN Model)[1].

Business profits

The Treaty includes various restrictions regarding the deduction allowed for certain expenses incurred by a permanent establishment in line with the UN Model[2].

 Dividends

The Treaty provides that the withholding tax on dividends will be limited to 7.5% provided that the beneficial owner of the dividends is a company (other than a partnership) which holds directly at least 25% of the capital of the company paying the dividends. In other cases, the withholding tax will be limited to 10%.

This Treaty grants a lower rate than:

  • the Sri Lankan domestic law which levies 10% withholding tax on dividends; and
  • the Luxembourg domestic law which levies 15% withholding tax on dividends. However, under Luxembourg domestic law, dividends distributed by Luxembourg companies to companies in treaty jurisdictions are exempt from withholding tax under certain conditions[3].

 Interest 

  • The Treaty provides that the withholding tax on interest will be limited to 10%.
  • In principle, Luxembourg does not levy withholding tax on interest under its domestic law[4]. Consequently, this provision will not impact interest payments made by a Luxembourg taxpayer.
  • Sri Lanka levies 10% withholding tax on interest under its domestic law.

Royalties

  • The Treaty provides that the withholding tax on royalties will be limited to 10%.
  • In principle, Luxembourg does not levy withholding tax on royalties under its domestic law[5]. Consequently, this provision will not impact royalties’ payments made by a Luxembourg taxpayer.
  • Sri Lanka levies 10% withholding tax on royalties under its domestic law.

Capital gains

In line with the UN Model, the Treaty provides that gains derived by a resident of a Contracting State from the alienation of shares or other corporate rights participating in profits of a company more than 50% of the value of which is derived directly or indirectly from immovable property situated in the other Contracting State, may be taxed in that other State.

However, the Treaty explains that the aforementioned provision does not apply to gains derived from the alienation of shares:

  • Quoted on a recognized stock exchange of one of the States; or
  • Alienated or exchanged in the frame work of a reorganization of a company, of a merger, of a scission, or of a similar operation; or
  • 75% or more of the value of which is derived from immovable property through which the company carries out its activity; or
  • Owned by a person who owns directly less than 75% of the capital of the company of which the shares have been alienated.

Elimination of double taxation

The first part of the article provides for an exemption method to avoid double taxation in Luxembourg. In addition, the Treaty provides that dividends received by a Luxembourg company from a Sri Lankan company are exempt from Luxembourg income taxes if the Luxembourg company holds at least 10% in the Sri Lankan company since the beginning of the accounting year and if the Sri Lankan company is subject to income tax in Sri Lanka.

A similar exemption (with a slightly different holding requirement[6]) applies under Luxembourg domestic law. However, this treaty exemption applies even if the Sri Lankan company is exempt from tax or is taxed at a reduced rate under the Sri Lankan legal provisions for tax incentives.

The second part of the article provides for a credit method to avoid double taxation in Sri Lanka.

Exchange of information

The Treaty contains an exchange of information provision in line with article 26 of the OECD Model Convention.

Entry into force

The provisions of the Treaty will enter into effect as from 1 January of the year following the year in which the Treaty entered into force, i.e., from 1 January 2015.

 

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[1] The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue within the country for a period or periods aggregating more than 183 days within any twelve month period.”

[2] Article 7(3) “In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes business of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission, for specific services performed or for management, or except in the case of banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices.”

[3] The parent company has to be fully subject to tax corresponding to Luxembourg income tax, and has to hold, or commit to hold, at least 10% of the share capital or a participation with an acquisition cost of at least EUR 1.2 million for at least 12 months.

[4] A 15% withholding tax is due in Luxembourg on certain types of bonds issued by a Luxembourg company.

[5] A 10% withholding tax is due in Luxembourg on revenue derived by non-Luxembourg resident taxpayers from some literary, artistic and sportive activities carried out in Luxembourg.

[6] Please refer to footnote number 3.