The Multilateral Instrument (MLI) effectively entered into force for the Luxembourg-Singapore tax treaty (Treaty) on 1 August 2019. The MLI will broadly modify the application of the Treaty as from January/February 2020 depending on the taxes concerned. The Singapore Ministry of Finance has adopted an order reflecting how the MLI will modify the Treaty. Singapore also intends to incorporate the MLI-based changes directly in the Treaty, subject to Luxembourg’s agreement.
Based on the final options chosen by both Luxembourg and Singapore, the following MLI provisions will have the following impact on the Treaty:
- The existing preamble language of the Treaty will be replaced by a statement that both countries do not intend to create opportunities for tax evasion or avoidance and desire to further develop their economic relationship and enhance their co-operation in tax matters.
- The principal purpose test (PPT) will apply. 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 Treaty benefits unless granting these benefits is in line with the object and purpose of the Treaty. The PPT applies to all forms of income (including dividends, interest, royalties and capital gains) and all taxes covered by the Treaty. The PPT is a subjective test and will make it 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. However, both countries will be able to grant discretionary relief under the PPT following a request from the taxpayer resulting in Treaty benefits being available. This rule is provided for in article 27A of Annex A to the Treaty.
- Article 9(2) of the Treaty will be replaced with a new paragraph provided for in Annex A providing that both countries are required to make a downward adjustment to the profits of a taxpayer in its jurisdiction if the other contracting jurisdiction makes an upward adjustment based on the arm’s length principle to the profits of a taxpayer in that other contracting jurisdiction. Any increase in Luxembourg could thus be mirrored by a corresponding downward adjustment to the profits of the taxpayer in Singapore or vice versa (subject to the local law requirements).
- New articles dealing with mandatory binding arbitration, articles 25A-G of Annex A, introduce an alternative dispute resolution mechanism for disputes that are not solved within a period of two years under the mutual agreement procedure provided for in article 25 of the Treaty. The standard type of arbitration, baseball arbitration (i.e. the arbiters are only allowed to pick one of the solutions proposed by the Treaty partners), will apply. Arbitration proceedings will not be allowed or will be terminated in case a decision on the issue has been or is rendered by a court or administrative tribunal of either country. The confidentiality provision has also been adopted. For Singapore, cases involving the application of its domestic general anti-avoidance rules contained in Section 33 of the Income Tax Act, case law or juridical doctrines are excluded from arbitration.
The abovementioned MLI provisions will have effect with respect to withholding taxes on taxable events occurring on or after 1 January 2020. For all other taxes covered by the Treaty, including corporate income tax, the MLI provisions will have effect on taxable periods that begin on or after 1 February 2020. Articles 25A-G of Annex A will already have effect with respect to any tax payable on or after 1 August 2019.
The provision that is expected to have the biggest impact is without a doubt the PPT. Investors carrying out cross-border transactions and claiming benefits provided for in the Treaty are urged to verify whether their set-up meets the requirements of the post-MLI era. Singapore or Luxembourg based holding and financing companies are especially recommended to assess the potential impact of the PPT. Singapore based multinationals availing of a European hub based in Luxembourg are further recommended to review their European set-up with respect to their various European source countries and the impact of the MLI thereon.