Protocol to the United States-Luxembourg tax treaty

Protocol to the United States-Luxembourg tax treaty

The Luxembourg government on 22 June 2016 submitted Bill n°7006 to the Parliament, with respect to a Protocol that would modify the existing income tax treaty between Luxembourg and the United States.

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According to the commentaries and press releases, the countries are currently negotiating a Protocol to amend the existing income tax treaty and have agreed, as part of the negotiations, to a specific change to prevent certain situations of non-taxation. The change relates to U.S.-source income that is being paid to Luxembourg residents that, for purposes of Luxembourg tax law, treats the income as attributable to a permanent establishment in the United States, and therefore is exempt from tax in Luxembourg, while at the same time, treats the income as exempt from tax in the United States. Therefore, the U.S.-source income may be exempt from tax in both Luxembourg and the United States.

The proposed provision would allow the United States, as the source country of the income, in certain cases to 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 country. 

  • First, the benefit of the treaty would not apply to U.S.-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. 
  • Second, the treaty benefits would also be denied when 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 U.S. withholding tax being levied (based on U.S. domestic rates) on interest payments made by U.S. borrowers to a Luxembourg head office (but attributed to its U.S. permanent establishment). 

The proposed provision further foresees a mutual agreement procedure (MAP) whereby a resident of a contracting state that is denied the benefits of the treaty based on the new provisions may nevertheless be granted the benefits of the treaty (by the respective competent authority) if 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 Luxembourg 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 would 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. 

What’s next?

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 of the Luxembourg Parliament before there is a final vote. Note the Parliament will suspend its sessions for the summer break, after 15 July 2016. 


Read a June 2016 report prepared by the KPMG member firm in Luxembourg

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