Germany and Luxembourg Sign Protocol of Amendment to the Double Tax Treaty
ADMIN / October 11th
On 6 July 2023, the Ministries of Finance of Germany and Luxembourg signed a Protocol of Amendment to the existing double tax treaty between Germany and Luxembourg dated 23 April 2012 ("DTT"). The reason for the amendment is likely to be the extension of the so-called "19-day rule" that has been in place until now, which regulates home office work for cross-border employees and is now to be simplified for tax purposes and integrated into the DTT itself for the first time. In addition, the Protocol contains clarifications regarding the treaty eligibility of investment fund structures and the taxation of salaries, pensions, and retirement benefits. Last but not least, anti-abuse provisions will also be included that meet the latest international standards.
The Protocol of Amendment will enter into force as soon as it has been ratified by both countries. Provided that ratification of the Protocol is completed in 2023, the provisions will apply for the first time as of 1 January 2024 in both contracting states.
Please find below an overview of the main changes.
I. New Home Office Regulation
The existing de minimis rule ("19-Day Rule") for cross-border workers will be included in the DTT for the first time through the introduction of a paragraph (1a) in Article 14 of the DTT and extended to 34 days per calendar year. This is intended to provide legal certainty for home office work, reduce bureaucracy in both contracting states and simplify taxation. A similar regulation is to be implemented for public service employees. This will enable cross-border employees to organize their work more flexibly in the future and to pursue their activities more frequently from their home office without having to fear that their income from employment will be subject to German taxation. In this context, work is deemed to have been performed on a working day in a state or territory as soon as it is carried out for a period of 30 minutes in said state or territory.
II. Prevention of Tax Structuring Opportunities
Measures of the BEPS1 project under the treaty are to be realized in the mutual relationship between the two contracting states. To this end, the preamble will be adapted on the basis of the template of Article 6 of the Multilateral Instrument ("MLI2") , clarifying that the purpose of the DTT is not only to prevent double taxation but also to prevent opportunities for non-taxation or low taxation through tax avoidance or evasion (including through abusive arrangements for the benefit of persons residing in third countries).
In addition, Article 27 of the DTT introduced the so-called Principal Purpose Test3 based on Article 7 of the MLI.
Article 1 of the DTT will be expanded to include a paragraph on the taxation of hybrid arrangements, along the lines of Article 3 no. 1 of the MLI. The objective is to ensure that, among others, partners of a partnership can benefit from the advantages of the DTT and, at the same time, to exclude non-resident partners from indirectly benefiting from the advantages of the treaty.
III. Taxation of Fund Structures
In the future, according to Article 13 of the Protocol of Amendment, undertakings for collective investments ("UCIs") established in one contracting state and receiving income from the other contracting state must be tax resident in the state in which they are established. In the case of Germany, the term UCI means an investment fund under the German Investment Tax Act. In the case of Luxembourg, UCI refers to investment funds within the meaning of the RAIF Law of 2016 ("Reserved Alternative Investment Fund"), the SIF Law of 2007 ("Specialised Investment Fund") and the UCI Law of 2010. Both in Germany and Luxembourg, this does not apply to undertakings established as partnerships. In the future, investment funds in the legal form of a Luxembourg "Fonds Commun de Placement" ("FCP"), which is considered tax transparent in Luxembourg but is not a partnership, will also fall under the term UCI. FCPs were previously only considered investment assets within the meaning of Article 10 of the DTT if the shares in the FCP were held by Luxembourg residents.
A UCI in one contracting state is also expressly referred to as the "beneficial owner" of the income it derives from the other contracting state.
IV. Changes within the Framework of Dividend Taxation
Article 10(2) and (3) of the DTT are amended, and the German Real Estate Investment Trust- Aktiengesellschaft ("REIT-AG") is included by name in the DTT. The maximum taxation of dividends at 15%, according to paragraph (2) letter (b), in the state of residence of the distributing company now only applies if it is a REIT-AG withing the meaning of the REIT Act or a Luxembourg real estate company and no longer, as before, a "real estate investment company". From a German perspective, letter (c) previously only referred to REITs anyway, which is why it makes sense to explicitly include the REIT-AG in the DTT.
Another new element in this context is that the maximum taxation of 15% in the paying company's state of residence applies to cases in which the dividends are distributed to a UCI.
If the dividend recipient is a transparent company, Article 10 of the DTT is to be applied in cases where the investors of the transparent company are resident in the state of said company as if the investors had received the dividends directly themselves.
V. Extension of the Scope of Application of Exit Taxation
The Protocol of Amendment rewrites Article 13(6) of the DTT. Among other things, "natural persons" are now referred to as "persons", and the so-called "minimum period of residence" of 5 years has been removed without replacement. This should expand the scope of application of the provision as the term "persons" now covers all persons within the meaning of Article 3(1) letter (d) of the DTT, which also includes companies within the meaning of Article 3(1) letter (e) of the DTT. The restriction according to which the provision only applies to natural persons who have been resident in the exit state for at least 5 years is thus no longer applicable.
The provision serves to ensure that hidden reserves of shares in a corporation in the exit state are taxed when the shareholder moves to another state as well as to prevent double taxation in the exit and the new residence state. The person is taxed in the exit state (previous state of residence) at the time of the change of residence as if he/she had sold shares corporation, which leads to the disclosure of hidden reserves. Hidden reserves that have arisen up to the termination of the unlimited tax liability are initially taxed in the exit state. If the shares are now actually sold in the new state of residence, there is a risk that the new state of residence will use the difference between the proceeds of the sale and the historical acquisition costs as the tax base, which may lead to double taxation of the hidden reserves that arose up to the time of the change of residence. This will be prevented by the provision by obliging the new state of residence to carry out a tax-neutral revaluation.
VI. Further Changes in a Nutshell
- Explicit inclusion of a provision in Article 14 of the DTT regarding the apportionment of compensation for persons who are employed in the field of transport of goods and passengers and whose employer or permanent establishment is resident or located in both contracting states.
- The 12-year period specified in Article 17(3) of the DTT regarding the taxation of pensions, similar compensations or annuities originating from Germany has been removed without replacement.
- Article 22 of the DTT has been amended and supplemented in many points, mainly involving adjustments to the wording of the Article itself, based on changes in the previous Articles of the DTT. Furthermore, there were some minor additions to the content. However, the basic framework of the exemption or credit method in the respective contracting state has remained unchanged.
- Repeal without replacement of Article 24(5) of the DTT "mutual agreement procedure" and thus repeal of the DTT internal arbitration procedure. The EU Arbitration Convention remains unaffected by these changes.
- General adjustments and additions to various terms and to the general wording of the respective amended provisions.
1 BEPS stands for "Base Erosion and Profit Shifting". The BEPS Project was initiated in 2013 with the purpose of combating harmful tax competition between states and aggressive tax planning by internationally active corporations. More than 140 states and jurisdictions have since joined the project. These include all states of the Organisation for Economic Cooperation and Development (OECD), the G20 group as well as other developing and emerging countries.
2 The so-called Multilateral Instrument is a multilateral treaty under international law that is intended to amend existing DTTs and contains recommendations and minimum standards to avoid double taxation and double non- taxation.
3 The PPT applies when obtaining a tax advantage is one of the main objectives of a transaction or company structure. If there is an alleged planned abuse, the treaty or the corresponding provision cannot be applied unless the taxpayer succeeds in proving the contrary.