Tax Alert

Luxembourg explains its positions on Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS

14 June 2017

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Executive summary

On 7 June 2017, Luxembourg (together with 67 other jurisdictions) signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the MLI). One of the main purposes of the MLI is to enable countries to meet the treaty-related minimum standards that were agreed as part of the final Base Erosion and Profit Shifting (BEPS) package, i.e., the minimum standard for the prevention of treaty abuse under Action 6 and the minimum standard for the improvement of dispute resolution under Action 14. The MLI also contains a number of alternatives or optional provisions that generally will apply only if all contracting states to a Covered Tax Agreement affirmatively choose to apply a particular alternative or option.

At the time of signature, signatories submitted a list of their tax treaties in force that they would like to designate as Covered Tax Agreements (CTAs), i.e., to be amended through the MLI. In addition, signatories submitted a preliminary list of their reservations and notifications (MLI positions) in respect of the various provisions of the MLI. The definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI.

Luxembourg has made partial or full reservations against a number of the articles of the MLI. These reservations are discussed in more detail below, together with the options chosen by Luxembourg where a provision of the MLI allowed for a choice to be made. The most important changes that will affect all of Luxembourg’s tax treaties relate to the introduction of a principal purpose test (PPT) and an amendment of the preamble that states that the relevant tax treaty is not intended to create opportunities for non-taxation or reduced taxation.

Luxembourg is one of only 25 countries that decided to apply mandatory binding arbitration.

Detailed discussion

Background

Luxembourg was one of 68 jurisdictions to sign the MLI during a signing ceremony hosted by the Organisation for Economic Co-operation and Development (OECD) in Paris on 7 June 2017. Eight other jurisdictions expressed their intent to sign the MLI in the near future. The signing ceremony marks another key milestone in the BEPS project, in particular with respect to the implementation of the treaty-related BEPS minimum standards. At the time of signature, signatories submitted a list of their tax treaties in force that they would like to designate as CTAs, i.e., to be amended through the MLI. In addition, signatories submitted a preliminary list of their MLI positions in respect of the various provisions of the MLI. The definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI. The OECD has published on its website the list of signatories and country-specific files containing an overview of the CTAs and reservations and notifications as filed as of 7 June by those countries.

One of the main purposes of the MLI is to enable countries to meet the treaty-related minimum standards that were agreed as part of the final BEPS package, i.e., the minimum standard for the prevention of treaty abuse under Action 6 and the minimum standard for the improvement of dispute resolution under Action 14. For the minimum standard provisions, the right to opt-out only exists to the extent the CTA already includes a similar minimum standard.

The MLI also contains a number of alternatives or optional provisions that generally will apply only if all contracting states to a Covered Tax Agreement affirmatively choose to apply a particular alternative or option. Many of these provisions are only applicable if both contracting states to a bilateral tax treaty do not make a reservation against the provision. However, for some specific articles, contracting states may choose different options resulting in an asymmetrical application of this provision.

This Alert summarizes the positions taken by Luxembourg. For more background on the MLI, see EY Global Tax Alert, OECD releases multilateral instrument to modify bilateral tax treaties under BEPS Action 15, dated 2 December 2016.

Covered Tax Agreements (CTAs)

The list of CTAs provided by Luxembourg contains all the 81 tax treaties concluded by Luxembourg that are currently in force.

Reservations and options taken by Luxembourg

Hybrid mismatches

Part II of the MLI (articles 3 to 5) introduces provisions which aim to neutralize certain of the effects of hybrid mismatch arrangements based on the recommendations made in the BEPS Action 2 and 6 Final Reports released in October 2015. The provisions cover hybrid mismatches related to transparent entities, dual resident entities and elimination of double taxation. These provisions are all not minimum standard provisions and therefore Contracting Jurisdictions have the right to opt to not apply these provisions to their covered tax treaties.

Transparent entities (article 3 MLI)

Article 3 addresses the situation of hybrid mismatches as a result of entities that one or both Contracting Jurisdictions treat as wholly or partly transparent for tax purposes. The provision will apply in all cases in which all the parties to a CTA agree on its application.

Luxembourg decided to apply paragraph 1 of article 3, which clarifies that income derived by or through an entity or arrangement that one of the contracting states considers as wholly or partly fiscally transparent will be treated as income of a resident of a contracting state, to the extent it is treated as income of a resident of that contracting state for taxation purposes in that contracting state. Luxembourg-source dividends, for example, that are derived by a foreign partnership would be able to benefit from the withholding tax reduction under a tax treaty provided the partners of the partnership are subject to tax on the Luxembourg-source dividend in the other contracting state.

The inclusion of this paragraph in Luxembourg treaties may be welcomed as it clarifies that look-through treatment may also be applied for tax treaty purposes. Its application to a specific CTA will require the other contracting party to have made the same choice.

Luxembourg reserved its right not to apply paragraph 2 of article 3. That provision would result in CTAs not providing relief for double taxation where the other State’s tax is levied solely on the basis of residence (of the partners). There may be situations where this results in unrelieved double taxation which may explain Luxembourg’s reservation.

Dual resident entities (article 4)

This provision would replace the current tie-breaker rules applicable to dual-resident companies (which typically consider the country where the place of effective management is situated as the residence country) by a mutual agreement process. Luxembourg is one of 40 countries that have made a full reservation against this article, which means that existing tie-breakers would continue to apply.

Methods for Elimination of Double Taxation (article 5)

Article 5 allows signatories to choose between applying one of three different options, but also allows them to choose to apply none of the options. Where contracting states to a CTA choose different options, the option chosen by a contracting state would apply to its own residents only.

Luxembourg has chosen option A (together with four other jurisdictions). Under that option, Luxembourg would not grant an exemption otherwise foreseen in the CTA where the other contracting state applies the provisions of the CTA to exempt such income or capital from tax or to limit the rate at which such income or capital may be taxed. Instead, Luxembourg would grant a tax credit for the foreign tax on the income or capital (within the ordinary limits that apply to tax credits in Luxembourg). This amendment would apply to all the 81 agreements that are currently in force.

By choosing this option Luxembourg appears to address situations where income is subject to double non-taxation, such as income attributable to a “hybrid” permanent establishment (PE), i.e., an arrangement treated as giving rise to a PE in one country but not in the other (source) country, that is not subject to tax in the source country but derives interest income from the source country. However, it may also result in the dividend exemption under Luxembourg tax treaties being denied. A number of tax treaties concluded by Luxembourg specifically provide that dividends are exempt from Luxembourg tax provided certain minimum holding requirements are met. This exemption would no longer apply as a result of option A, if the other contracting state has applied the same tax treaty to reduce the withholding tax applicable to such dividends. This would result in a difference compared to the Luxembourg domestic participation exemption, which applies irrespective of whether or not the foreign jurisdiction has applied withholding tax on the dividend. The domestic participation exemption may therefore become more relevant.

Luxembourg has also chosen to reserve the right not to permit certain identified contracting states to apply option C to treaties with Luxembourg. Option C provides in relation to income or capital that may be taxed in a contracting state that the other contracting state applies the credit method to avoid double taxation, rather than the exemption method. The list consists of CTAs with 20 countries, including Belgium, France, Germany, the Netherlands and Switzerland.1

Treaty abuse

Part III of the MLI (articles 6 to 13) contains six provisions related to the prevention of treaty abuse, which correspond to changes proposed in the Report on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances). In particular, the Report contains provisions relating to the so-called “minimum standard” aimed at ensuring a minimum level of protection against treaty shopping (article 6 and article 7 of the MLI).

Purpose of a CTA (article 6)

All treaties concluded by Luxembourg (with the exception of the treaty with Senegal, which already has an equivalent provision) will be amended to include the following preamble text:

“Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions).”

This provision is a minimum standard and no reservations could be made against it. It is a significant change compared to current tax treaties, which apply (in the absence of specific exclusions) also to situations where a double taxation is merely possible, without the need for there to be actual double taxation. At the same time, to what extent this amendment will result in an actual change in a specific situation will have to be analyzed on a case-by-case basis.

In addition to the above change, Luxembourg also opted to include in all of its agreements specific language referring to a desire to develop an economic relationship or to enhance cooperation in tax matters.

Prevention of treaty abuse (article 7)

All treaties concluded by Luxembourg (with the exception of the treaty with Senegal, which already has an equivalent provision) will be amended to include a “principal purpose test” (PPT). It is not possible to make a complete reservation against this provision and countries could only choose between (i) the PPT, (ii) a detailed limitation on benefits (LOB) provision modeled on the one contained in the US Model Tax Treaty supplemented by specific rules targeting conduit financing arrangements, or (iii) or a combination of PPT and a simplified LOB provision. Where the other contracting state has not opted for the PPT, but for a detailed LOB provision, the MLI would not result in a direct change of the relevant tax treaty and the two states “shall endeavor to reach a mutually satisfactory solution” that meets the BEPS minimum standard. If the other contracting state has opted for a simplified LOB provision, but Luxembourg does not affirmatively agree to the simplified LOB application by the other contracting state, only the PPT can be applied.

The PPT is worded as follows:

“Notwithstanding any provisions of a CTA, a benefit under the CTA shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”

Luxembourg opted to include a competent authority relief provision, under which a person that is denied the benefits of a CTA may still be granted the benefits of the CTA as a result of a decision by the competent authority, “if such competent authority […] determines that such benefits would have been granted to that person in the absence of the transaction or arrangement.” Granting treaty access in these circumstances requires consultation with the competent authority of the other contracting state.

A PPT analysis will be very case-specific. It is not a substance-test, but refers to the purpose of an arrangement or transaction. Where treaty access is relevant, it will therefore be important to document the purpose and intention of a transaction.

Dividend transfer transactions (article 8)

This provision is intended to deal with abuse in relation to dividend withholding tax exemptions or reductions by among other things introducing a minimum holding period. Luxembourg has made a full reservation against this article. No explanation is given, but possibly it was felt that the amendment to the preamble together with existing safeguards were sufficient to deal with such transactions. The article requires approval by both contracting states, which means that no change to the dividend withholding tax provisions of Luxembourg tax treaties is expected as a result of the MLI.

Capital gains from alienation of shares in “real estate-rich companies” (article 9)

Luxembourg has made a reservation against the amendment of existing provisions of CTAs that allocate the right to tax capital gains from shares in “real estate-rich companies” to the country where the real estate is situated. Article 9 would allocate the right to tax such gains if a relevant value threshold is met at any time during the 365 days preceding the sale, and would require that the rule is expanded to apply to shares or comparable interests such as interests in a partnership or trust. Luxembourg is one of 36 countries that have made a full or partial reservation to this article.

As a result of the Luxembourg reservation, the existing provisions will remain in place and will not be amended to include reference to partnership interests or trusts. Luxembourg has also not opted to include a specific rule for real estate-rich companies in those CTAs that currently do not contain such clause. This would have been an “opt-in” provision, which Luxembourg decided not to pursue. The reason for this may be that the relevant existing tax treaties have already been amended or are in process of being amended to address land-rich companies.

Third-country PEs (article 10)

This provision deals with situations where an enterprise of one contracting state has a PE in a third country to which income from the other contracting state is allocated and exempt from tax in the first-mentioned state (triangulation situations). If the income is taxed at a low rate (less than 60% of the tax that would be imposed in the jurisdiction of the head office), the benefits of the treaty will not apply. Instead, the income remains fully taxable according to the domestic law of the other contracting state. The provision is modeled on the “triangulation clause” found in US treaties.

Executive summary

On 7 June 2017, Luxembourg (together with 67 other jurisdictions) signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the MLI). One of the main purposes of the MLI is to enable countries to meet the treaty-related minimum standards that were agreed as part of the final Base Erosion and Profit Shifting (BEPS) package, i.e., the minimum standard for the prevention of treaty abuse under Action 6 and the minimum standard for the improvement of dispute resolution under Action 14. The MLI also contains a number of alternatives or optional provisions that generally will apply only if all contracting states to a Covered Tax Agreement affirmatively choose to apply a particular alternative or option.

At the time of signature, signatories submitted a list of their tax treaties in force that they would like to designate as Covered Tax Agreements (CTAs), i.e., to be amended through the MLI. In addition, signatories submitted a preliminary list of their reservations and notifications (MLI positions) in respect of the various provisions of the MLI. The definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI.

Luxembourg has made partial or full reservations against a number of the articles of the MLI. These reservations are discussed in more detail below, together with the options chosen by Luxembourg where a provision of the MLI allowed for a choice to be made. The most important changes that will affect all of Luxembourg’s tax treaties relate to the introduction of a principal purpose test (PPT) and an amendment of the preamble that states that the relevant tax treaty is not intended to create opportunities for non-taxation or reduced taxation.

Luxembourg is one of only 25 countries that decided to apply mandatory binding arbitration.

Detailed discussion

Background

Luxembourg was one of 68 jurisdictions to sign the MLI during a signing ceremony hosted by the Organisation for Economic Co-operation and Development (OECD) in Paris on 7 June 2017. Eight other jurisdictions expressed their intent to sign the MLI in the near future. The signing ceremony marks another key milestone in the BEPS project, in particular with respect to the implementation of the treaty-related BEPS minimum standards. At the time of signature, signatories submitted a list of their tax treaties in force that they would like to designate as CTAs, i.e., to be amended through the MLI. In addition, signatories submitted a preliminary list of their MLI positions in respect of the various provisions of the MLI. The definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI. The OECD has published on its website the list of signatories and country-specific files containing an overview of the CTAs and reservations and notifications as filed as of 7 June by those countries.

One of the main purposes of the MLI is to enable countries to meet the treaty-related minimum standards that were agreed as part of the final BEPS package, i.e., the minimum standard for the prevention of treaty abuse under Action 6 and the minimum standard for the improvement of dispute resolution under Action 14. For the minimum standard provisions, the right to opt-out only exists to the extent the CTA already includes a similar minimum standard.

The MLI also contains a number of alternatives or optional provisions that generally will apply only if all contracting states to a Covered Tax Agreement affirmatively choose to apply a particular alternative or option. Many of these provisions are only applicable if both contracting states to a bilateral tax treaty do not make a reservation against the provision. However, for some specific articles, contracting states may choose different options resulting in an asymmetrical application of this provision.

This Alert summarizes the positions taken by Luxembourg. For more background on the MLI, see EY Global Tax Alert, OECD releases multilateral instrument to modify bilateral tax treaties under BEPS Action 15, dated 2 December 2016.

Covered Tax Agreements (CTAs)

The list of CTAs provided by Luxembourg contains all the 81 tax treaties concluded by Luxembourg that are currently in force.

Reservations and options taken by Luxembourg

Hybrid mismatches

Part II of the MLI (articles 3 to 5) introduces provisions which aim to neutralize certain of the effects of hybrid mismatch arrangements based on the recommendations made in the BEPS Action 2 and 6 Final Reports released in October 2015. The provisions cover hybrid mismatches related to transparent entities, dual resident entities and elimination of double taxation. These provisions are all not minimum standard provisions and therefore Contracting Jurisdictions have the right to opt to not apply these provisions to their covered tax treaties.

Transparent entities (article 3 MLI)

Article 3 addresses the situation of hybrid mismatches as a result of entities that one or both Contracting Jurisdictions treat as wholly or partly transparent for tax purposes. The provision will apply in all cases in which all the parties to a CTA agree on its application.

Luxembourg decided to apply paragraph 1 of article 3, which clarifies that income derived by or through an entity or arrangement that one of the contracting states considers as wholly or partly fiscally transparent will be treated as income of a resident of a contracting state, to the extent it is treated as income of a resident of that contracting state for taxation purposes in that contracting state. Luxembourg-source dividends, for example, that are derived by a foreign partnership would be able to benefit from the withholding tax reduction under a tax treaty provided the partners of the partnership are subject to tax on the Luxembourg-source dividend in the other contracting state.

The inclusion of this paragraph in Luxembourg treaties may be welcomed as it clarifies that look-through treatment may also be applied for tax treaty purposes. Its application to a specific CTA will require the other contracting party to have made the same choice.

Luxembourg reserved its right not to apply paragraph 2 of article 3. That provision would result in CTAs not providing relief for double taxation where the other State’s tax is levied solely on the basis of residence (of the partners). There may be situations where this results in unrelieved double taxation which may explain Luxembourg’s reservation.

Dual resident entities (article 4)

This provision would replace the current tie-breaker rules applicable to dual-resident companies (which typically consider the country where the place of effective management is situated as the residence country) by a mutual agreement process. Luxembourg is one of 40 countries that have made a full reservation against this article, which means that existing tie-breakers would continue to apply.

Methods for Elimination of Double Taxation (article 5)

Article 5 allows signatories to choose between applying one of three different options, but also allows them to choose to apply none of the options. Where contracting states to a CTA choose different options, the option chosen by a contracting state would apply to its own residents only.

Luxembourg has chosen option A (together with four other jurisdictions). Under that option, Luxembourg would not grant an exemption otherwise foreseen in the CTA where the other contracting state applies the provisions of the CTA to exempt such income or capital from tax or to limit the rate at which such income or capital may be taxed. Instead, Luxembourg would grant a tax credit for the foreign tax on the income or capital (within the ordinary limits that apply to tax credits in Luxembourg). This amendment would apply to all the 81 agreements that are currently in force.

By choosing this option Luxembourg appears to address situations where income is subject to double non-taxation, such as income attributable to a “hybrid” permanent establishment (PE), i.e., an arrangement treated as giving rise to a PE in one country but not in the other (source) country, that is not subject to tax in the source country but derives interest income from the source country. However, it may also result in the dividend exemption under Luxembourg tax treaties being denied. A number of tax treaties concluded by Luxembourg specifically provide that dividends are exempt from Luxembourg tax provided certain minimum holding requirements are met. This exemption would no longer apply as a result of option A, if the other contracting state has applied the same tax treaty to reduce the withholding tax applicable to such dividends. This would result in a difference compared to the Luxembourg domestic participation exemption, which applies irrespective of whether or not the foreign jurisdiction has applied withholding tax on the dividend. The domestic participation exemption may therefore become more relevant.

Luxembourg has also chosen to reserve the right not to permit certain identified contracting states to apply option C to treaties with Luxembourg. Option C provides in relation to income or capital that may be taxed in a contracting state that the other contracting state applies the credit method to avoid double taxation, rather than the exemption method. The list consists of CTAs with 20 countries, including Belgium, France, Germany, the Netherlands and Switzerland.1

Treaty abuse

Part III of the MLI (articles 6 to 13) contains six provisions related to the prevention of treaty abuse, which correspond to changes proposed in the Report on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances). In particular, the Report contains provisions relating to the so-called “minimum standard” aimed at ensuring a minimum level of protection against treaty shopping (article 6 and article 7 of the MLI).

Purpose of a CTA (article 6)

All treaties concluded by Luxembourg (with the exception of the treaty with Senegal, which already has an equivalent provision) will be amended to include the following preamble text:

“Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions).”

This provision is a minimum standard and no reservations could be made against it. It is a significant change compared to current tax treaties, which apply (in the absence of specific exclusions) also to situations where a double taxation is merely possible, without the need for there to be actual double taxation. At the same time, to what extent this amendment will result in an actual change in a specific situation will have to be analyzed on a case-by-case basis.

In addition to the above change, Luxembourg also opted to include in all of its agreements specific language referring to a desire to develop an economic relationship or to enhance cooperation in tax matters.

Prevention of treaty abuse (article 7)

All treaties concluded by Luxembourg (with the exception of the treaty with Senegal, which already has an equivalent provision) will be amended to include a “principal purpose test” (PPT). It is not possible to make a complete reservation against this provision and countries could only choose between (i) the PPT, (ii) a detailed limitation on benefits (LOB) provision modeled on the one contained in the US Model Tax Treaty supplemented by specific rules targeting conduit financing arrangements, or (iii) or a combination of PPT and a simplified LOB provision. Where the other contracting state has not opted for the PPT, but for a detailed LOB provision, the MLI would not result in a direct change of the relevant tax treaty and the two states “shall endeavor to reach a mutually satisfactory solution” that meets the BEPS minimum standard. If the other contracting state has opted for a simplified LOB provision, but Luxembourg does not affirmatively agree to the simplified LOB application by the other contracting state, only the PPT can be applied.

The PPT is worded as follows:

“Notwithstanding any provisions of a CTA, a benefit under the CTA shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”

Luxembourg opted to include a competent authority relief provision, under which a person that is denied the benefits of a CTA may still be granted the benefits of the CTA as a result of a decision by the competent authority, “if such competent authority […] determines that such benefits would have been granted to that person in the absence of the transaction or arrangement.” Granting treaty access in these circumstances requires consultation with the competent authority of the other contracting state.

A PPT analysis will be very case-specific. It is not a substance-test, but refers to the purpose of an arrangement or transaction. Where treaty access is relevant, it will therefore be important to document the purpose and intention of a transaction.

Dividend transfer transactions (article 8)

This provision is intended to deal with abuse in relation to dividend withholding tax exemptions or reductions by among other things introducing a minimum holding period. Luxembourg has made a full reservation against this article. No explanation is given, but possibly it was felt that the amendment to the preamble together with existing safeguards were sufficient to deal with such transactions. The article requires approval by both contracting states, which means that no change to the dividend withholding tax provisions of Luxembourg tax treaties is expected as a result of the MLI.

Capital gains from alienation of shares in “real estate-rich companies” (article 9)

Luxembourg has made a reservation against the amendment of existing provisions of CTAs that allocate the right to tax capital gains from shares in “real estate-rich companies” to the country where the real estate is situated. Article 9 would allocate the right to tax such gains if a relevant value threshold is met at any time during the 365 days preceding the sale, and would require that the rule is expanded to apply to shares or comparable interests such as interests in a partnership or trust. Luxembourg is one of 36 countries that have made a full or partial reservation to this article.

As a result of the Luxembourg reservation, the existing provisions will remain in place and will not be amended to include reference to partnership interests or trusts. Luxembourg has also not opted to include a specific rule for real estate-rich companies in those CTAs that currently do not contain such clause. This would have been an “opt-in” provision, which Luxembourg decided not to pursue. The reason for this may be that the relevant existing tax treaties have already been amended or are in process of being amended to address land-rich companies.

Third-country PEs (article 10)

This provision deals with situations where an enterprise of one contracting state has a PE in a third country to which income from the other contracting state is allocated and exempt from tax in the first-mentioned state (triangulation situations). If the income is taxed at a low rate (less than 60% of the tax that would be imposed in the jurisdiction of the head office), the benefits of the treaty will not apply. Instead, the income remains fully taxable according to the domestic law of the other contracting state. The provision is modeled on the “triangulation clause” found in US treaties.

Luxembourg reserved its right not to apply this provision, as did 45 other jurisdictions.

Restrictions to taxing own residents (article 11)

Luxembourg (and 45 other countries) reserved its right not to apply a provision according to which a tax treaty would not restrict the rights of Luxembourg to tax its own residents, with certain exceptions.

Recognition of a PE (articles 12-14)

Part IV of the MLI (articles 12 to 15) describes the mechanism by which the PE definition in existing tax treaties may be amended pursuant to the BEPS Action 7 Final Report to prevent the artificial avoidance of PE status through: (i) commissionaire arrangements and similar strategies (article 12); (ii) the specific activity exemptions (article 13); and (iii) the splitting-up of contracts (article 14). Article 15 of the MLI provides the definition of the term “closely related to an enterprise,” which is used in articles 12 through 14.

Luxembourg made reservations on most of the changes dealt with in part IV (together with 38 or 44 other countries that made full reservations on article 12 or 14, respectively). Without these reservations, the threshold for the recognition of a PE would have been significantly lowered. As regards the provision dealing with specific activity exemptions, Luxembourg chose option B (as did six other countries). In essence, option B provides that a specific list of activities that was deemed not to constitute a PE in the CTA (prior to the MLI) will also not create a PE as a result of the MLI. This is irrespective of whether that activity is of a preparatory or auxiliary character (unless explicitly provided to the contrary in the relevant CTA). For any other activities carried on through a fixed place of business it does become important, under option B, whether the activity is preparatory or auxiliary in nature. Of those other activities, only those that are preparatory or auxiliary in character are deemed not to constitute a PE.

Mandatory binding arbitration

As part of the options contained in the MLI, jurisdictions can opt into mandatory binding arbitration, an element of BEPS Action 14 on dispute resolution. Of the 68 jurisdictions that signed the MLI, 25 opted in for mandatory binding arbitration. Luxembourg is among these 25.2 If the other contracting state also opted for mandatory arbitration, the Luxembourg tax treaty with that state would be amended to include mandatory arbitration, which would allow a person to request that a case on which the competent authorities are unable to find a mutual agreement under the mutual agreement procedure be submitted to arbitration. However, Luxembourg chose to not extend this possibility to those cases where a decision on the issue in question has been rendered by a court or tribunal of either contracting state before the arbitration decision. Luxembourg also chose to apply a provision that would allow the competent authorities to reach a different decision than the arbitration decision if such provision is reached within three months of the delivery of the arbitration decision.

The mandatory arbitration provisions of the MLI would not apply to those treaties that already contain an equivalent provision. In that case the existing arbitration provisions would continue to apply.3

Timing

The MLI will enter into force after five jurisdictions have deposited its instrument of ratification, acceptance or approval of the MLI. During the ratification process the choices made by jurisdictions may still change. With respect to a specific bilateral tax treaty, the measures will only enter into effect after both parties to the treaty have deposited its instrument of ratification, acceptance or approval of the MLI and a specified time has passed. The specified time differs for different provisions. For example, for provisions relating to withholding taxes, the entry into force date is the 1 January of the following year after the last party has notified of its ratification. It is possible that the changes made as a result of being a party to the MLI would be effective in 2019, though it is theoretically possible that some tax treaties may be affected as early as sometime in 2018.

Implications

The expectation that 1,100 tax treaties would be modified as a result of 68 jurisdictions signing the MLI constitutes an unprecedented moment in international taxation. It is also a key milestone in the implementation of the treaty-based BEPS recommendations. Even though Luxembourg has made a number of reservations, the introduction of a PPT and a number of other changes will still result in an unprecedented wave of amendments to Luxembourg tax treaties.

Endnotes

1. The other states being Austria, Bulgaria, Estonia, Hungary, Iceland, Liechtenstein, Monaco, Morocco, Panama, Poland, Romania, San Marino, Saudi Arabia, the Seychelles, and Slovakia.

2. The other 24 are Andorra, Australia, Austria, Belgium, Canada, Fiji, Finland, France, Germany, Greece, Ireland, Italy, Japan, Liechtenstein, Malta, the Netherlands, New Zealand, Portugal, Singapore, Slovenia, Spain, Sweden, Switzerland and the United Kingdom.

3. The countries are Estonia, Germany, Guernsey, Hong Kong, Isle of Man, Jersey, Liechtenstein, Mauritius, Mexico, San Marino, the Seychelles, Switzerland and Uruguay.

 

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