On 22 June 2016 the Luxembourg government submitted Bill n°7006 (hereafter “the Bill”) to Parliament. The Bill foresees the introduction of a specific provision into a protocol that would modify the existing US-Luxembourg treaty (hereafter “the Treaty”).
According to the commentaries on the Bill and to press releases issued by the US and the Luxembourg governments, both countries are indeed currently negotiating a protocol to amend the Treaty and have agreed, as part of the negotiations, to a specific change to prevent certain situations of non-taxation.
The concern relates to US-source income that is being paid to Luxembourg residents that, for purposes of Luxembourg tax law, treat the income as attributable to a permanent establishment in the US, and therefore as exempt from tax in Luxembourg, while at the same time treating the income as exempt from tax in the US. Therefore, the US-source income may be exempt from tax in both Luxembourg and the US.
The proposed provision would allow the US, as the source State of the income, to in certain cases deny the benefits of the Treaty, including reduced withholding tax rates, to income that is treated for the purposes of Luxembourg domestic law as profits attributable to a permanent establishment of another State. Firstly, the benefit of the Treaty would not apply to US-source income attributed to a permanent establishment that is taxed below a combined aggregate effective rate of 15%, or 60% of the general statutory rate of Luxembourg.
Secondly, the Treaty benefits would also be denied where the residence state (Luxembourg) treats the income as attributable to a permanent establishment that is located in a third country that does not have a comprehensive tax treaty with the contracting state where the benefits are being claimed, unless the residence state includes the income in its tax base. In practice, this may for example result in US withholding tax being levied (based on US domestic rates) on interest payments made by US borrowers to a Luxembourg head office (but attributed to its US permanent establishment).
The proposed provision further foresees a mutual agreement procedure whereby a resident of a contracting State that is denied the benefits of the Treaty based on the above provisions may nevertheless be granted the benefits of the Treaty (by the respective competent authority) if such a grant is justified in light of the reasons why such a resident did not satisfy the requirements of those provisions (e.g. existence of tax losses).
The Bill provides for a retroactive application of the new provision as it foresees that if the Treaty is amended by a protocol containing such a provision, and if the protocol so provides, upon entry into force of such a protocol, the provision will have effect for amounts paid or credited on or after the third day following the publication of the law enacting the Bill in the Official Gazette of Luxembourg.
Finally, it should be noted that other changes to the Treaty are to be expected as the negotiations between both countries continue.
The Bill will now follow the normal legislative process in front of the Luxembourg Parliament before being voted on (knowing that the Parliament will suspend its sessions for the summer break, after 15 July). Any future developments will now have to be closely monitored, and notably as to the expected timing of entry into force of the Bill.
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