On 14 December 2023, the Luxembourg Parliament approved the amendments to the double tax treaty between Germany and Luxembourg. The main changes introduced by the protocol of July 2023 include the introduction of the BEPS minimum standards in the DTT, access to tax treaty protection for certain investment funds, as well as simplification measures for cross-border employees working from home.
Overview of key changes
The protocol includes amongst others:
- Clarifications to the provisions relating to dividends applicable to certain collective investment vehicles;
- Treaty entitlement and beneficial ownership for certain collective investment vehicles;
- A new step-up in basis for capital gains realized on shares;
- The adoption of the so-called BEPS minimum standards, including amongst others the introduction of a principal purpose test in the text of the DTT itself;
- An increase in the tolerance threshold from 19 to 34 days for cross-border employees working from home.
Impact of the protocol for certain collective investment vehicles
In line with the existing DTT, withholding tax on dividend distributions can be reduced to 5% if the beneficial owner is a company which directly owns at least 10% of the share capital of the company paying the dividends. In all other cases, a rate of 15% applies. Investors which are resident in either Germany or Luxembourg and which invest through a tax transparent entity can benefit from the DTT on a look-through basis.
In addition, the protocol provides that the maximum amount of withholding tax levied on (i) dividends paid by a real estate investment trust (REIT) established under the German REIT law or Luxembourg real estate investment companies that can be assimilated for tax purposes to a German REIT as well as (ii) dividends paid to collective investment vehicles is 15%.
The term collective investment vehicle refers to:
- In Germany: an investment fund within the meaning of the German investment fund law, to the exclusion of tax transparent entities; and
- In Luxembourg: an investment fund within the meaning of the Luxembourg law on undertakings for collective investments (UCITs), specialized investment funds (SIFs), reserved alternative investment funds (RAIFs), to the exclusion of tax transparent entities.
Germany or Luxembourg can add additional vehicles to this definition, provided that these vehicles are (i) widely held, (ii) directly or indirectly own a diversified portfolio of securities or, alternatively, invest into real estate with the main view to securing regular rental income, (iii) are subject to investor protection rules in its jurisdiction of establishment and (iv) are either established in Germany or Luxembourg.
The DTT explicitly deems collective investment vehicles which are established in one contracting state, but which derive income from the other contracting state, to be resident for purposes of the DTT in that first contracting state and to be the beneficial owner of the income so derived. Collective investment vehicles which are not established in the form of tax transparent entities are therefore entitled to treaty benefits under the DTT.
This provision may encourage certain managers to set up regulated funds with a corporate form – especially as a master fund in master/feeder structures – as the typical special limited partnership (SCSp) fund vehicle will still not qualify for treaty benefits itself.
The parliamentary documents to the DTT clarify that Luxembourg mutual funds (fonds communs de placement) fall within the scope of these new provisions on collective investment vehicles.
Step-up in basis for capital gains realized on shares
Whereas the article on capital gains remained largely unchanged, the protocol introduces a step-up in basis provision.
If a person resident in one contracting state disposes of shares which have been subject to exit taxation in the other contracting state, the first-mentioned state calculates the capital gain on the basis of the value that the other state used as the basis for taxation at the time of the change of residence, provided this value does not exceed the market value.
Whereas Luxembourg domestically already provides for a step-up in basis for taxpayers becoming Luxembourg residents, the step-up in basis under the DTT is larger in scope, as it does not restrict (for individual taxpayers acting in the context of management of their private wealth) its application to so-called 'substantial participations' (i.e., participations in companies exceeding 10% of the respective share capital) and seems to apply to all shares held by eligible taxpayers.
Introduction of a principal purpose test in the DTT
In addition to other minimum standards under the OECD multilateral instrument (i.e., an update to the preamble of the DTT as well as a clause disallowing treaty access to certain hybrid entities), the protocol more importantly introduces a so-called principal purpose test in the DTT.
The principal purpose test is a subjective anti-avoidance clause, which denies tax treaty benefits to taxpayers in situations where it is reasonable to conclude, having regard to all facts and circumstances, that obtaining the treaty benefit is one of the principal purposes of that taxpayer. There is a carve out where granting treaty benefits is nonetheless, irrespective of the principal purpose of the taxpayer, in accordance with the object and purpose of the relevant double tax treaty. In this particular case, the principal purpose test only applies to clauses that provide for rate reductions, without affecting the application of the other clauses of the DTT.
Access to the DTT will therefore only be given to taxpayers that are established in either Luxembourg or Germany for valid economic reasons and not with the main purpose of having access to the DTT.
Introduction of a 34-day tolerance threshold for cross-border employees
The protocol introduces a tolerance threshold of 34 days for cross-border employees working from home. By introducing this tolerance threshold, the state of residence waives the right to tax remuneration that is linked to an activity carried out in its territory or in the territory of a third country. An employee resident in Germany who habitually carries out his salaried activity in Luxembourg for a Luxembourg employer will remain taxable in Luxembourg even if this employee is required to carry out his employment from time to time in Germany or in a third country without exceeding the 34-day threshold. If the 34-day threshold is exceeded, the country of residence of the employee will regain the sole tax rights.
Entry into force
The protocol shall apply in both Contracting States, in respect of taxes withheld at source, to income attributed on or after 1 January of the calendar year immediately following the year in which the protocol enters into force (which could be 2024 at the earliest), and in respect of other taxes to taxes due for any taxable year beginning on or after 1 January of the calendar year immediately following the year in which the protocol of amendment enters into force.
Whereas Luxembourg has voted the protocol of amendment into law on 14 December, Germany has not yet done so to the best of our knowledge.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
