On 14 February 2019, the Luxembourg Parliament adopted the law ratifying the OECD Multilateral Convention to implement tax treaty related measures to prevent BEPS, better known as the ‘multilateral instrument’ (MLI). The vote confirms the limited opt-ins indicated by Luxembourg last year when signing the MLI (see our overview here).
The MLI has been signed by over 80 jurisdictions and will effectively modify bilateral tax treaties between countries having ratified the MLI. It introduces a general anti-abuse provision – the principal purposes test (PPT) is a minimum standard – and the possibility to apply other specific measures when both countries have opted for them. For a general overview of the MLI mechanics, please refer to our newsletter of 25 November 2016.
Luxembourg has chosen to apply the PPT. The PPT provides that the benefit of a tax treaty may be denied if one of the principal purposes of an arrangement or transaction is to obtain tax treaty benefits unless granting these benefits is in line with the object and purpose of the applicable tax treaty. Clearly, it will be increasingly relevant in the future to demonstrate business purposes of an arrangement or transaction, and to ensure that there is adequate substance to achieve these purposes.
Luxembourg also wishes a series of provisions on mandatory binding arbitration to apply in case a dispute is not resolved by means of mutual agreement procedure within 2 years. Domestic judicial decisions would still prevail if rendered prior to an arbitration decision. Luxembourg thus signals its intention to provide legal certainty for taxpayers engaged in cross-border transactions and further mitigate exposure to double taxation.
In addition, Luxembourg has confirmed its opt-ins to the following provisions:
- granting treaty benefits when income is earned through a transparent entity subject to the condition that such income is also included in the tax base of the taxpayer claiming the treaty benefits;
- achieving a switch from the exemption to the credit method where the other country applies the tax treaty to reduce the tax levied on a given income, i.e., where there is a conflict of qualification;
- aiming to tackle the artificial avoidance of the permanent establishment status through the specific activities exemption by applying such exemption more restrictively.
The MLI should apply in respect of withholding taxes as from 1 January 2020 to the tax treaties concluded by Luxembourg with other jurisdictions that have completed the MLI ratification process or will do so prior to 1 October 2019. With respect to all other taxes, the MLI will have an impact in tax years starting at least nine months after Luxembourg or the other treaty state has deposited the ratification instrument at the OECD (whichever date is latest). Over time, more tax treaties will be covered as ratification progresses in other jurisdictions. A regularly updated overview of the signatories and ratifications is available here.