New Germany-Luxembourg Tax Treaty
On April 23, 2012, Germany and Luxembourg signed a new Double Tax Treaty (“DTT”). The aim of the new DTT is to replace the one signed in 1958, and follow the structure and, for the most part, the content of the OECD Model Tax Convention. You will find below an overview of the main provisions of the new DTT, which will particularly bring along important changes regarding real estate investments through German investment vehicles and hybrid funding into Germany, as Peter Kleingarn and Samantha Nonnenkamp explain hereafter.
Under the new DTT, dividends will be subject to a withholding tax (“WHT”) of maximum:
• 5% in case the beneficial owner holds at least 10% of the capital of the subsidiary.
• 15% in the other cases.
These provisions are more beneficial than the ones outlined in the old DTT, which provided a WHT of 10% in case of a shareholding of 25%, and 15% in the other cases.
However, a specific provision has been included for real estate investment companies. Dividends arising from those companies will be subject to a WHT of 15% (so that the 5% and 15% max rates mentioned above will not apply), to the extent the real estate investment Company is fully or partly exempt from tax or can deduct its distributions when computing its profit.
The aim of this provision is to make sure that distributions made by German REITs are still, as in the past, subject to a WHT of 15% on their distributions. It may however affect a prospective REIT regime to be introduced in Luxembourg in the future, if Luxembourg also decides to subject these vehicles to a WHT on their distributions.
Interest payments will only be taxable in the country of the recipient, thus cannot be subject to WHT. This was already the case under the old DTT. There are however specific provisions for certain debt instruments listed in the protocol (please refer to our comments below).
Royalties will be subject to a WHT of max 5%, which is also the rate applicable under the old DTT.
Capital gains & real estate companies
The new DTT includes a specific provision, according to which capital gains derived by a resident of a Contracting State from the alienation of shares and similar rights in a Company, deriving directly or indirectly more than 50 % of its value from immovable property situated in the other Contracting State, may be taxed in that other State.
• For real estate investment structures with German real estate Companies investing in German real estate, the tax treatment under the new DTT will be as follows: capital gains realised by Luxembourg residents on the sale of shares (and similar rights) in German real estate companies, will now be taxed at source, i.e. in Germany. Nevertheless these gains should, under certain conditions, benefit from an exemption of 95% and lead to a taxation of approximately 1,5%. So far, these gains were exempt from taxation in Germany and potentially also exempt in Luxembourg based on the participation exemption regime under certain conditions.
• For real estate investment structures with Luxembourg real estate Companies investing in German real estate, the tax treatment under the new DTT will be as follows: capital gains realised by Luxembourg residents on the sale of shares (and similar rights) in Luxembourg real estate companies could, in theory, be taxed in Germany. Since the German tax legislation does currently not entail any specific provision dealing with foreign real estate companies, i.e. a provision which would allow Germany to tax the capital gains in such case, no taxation will occur in Germany.
In any case, German real estate investment structures will have to be carefully reviewed.
A new provision has been introduced dealing with the sale of participations in capital companies. Individuals who have been resident for more than five years in a contracting state and who have shifted residence to the other contracting state could be taxed by their former state of residence on the increase in value of participations held in capital companies situated in that state.
As far as income arising from Germany on profit participating loans (partiarische Darlehen), silent partnerships (stille Gesellschaft) and participations bonds (Gewinnobligationen) are concerned, sec. 2(1) of the protocol to the new DTT attributes the taxation right to Germany, under German internal rules, regardless of their nature, where the said income have been deducted from the profits of the payer. This may lead to a German taxation at source of up to 25%.
As far as income arising from Luxembourg on profit participating bonds and silent partnerships are concerned, sec 2(2) of the protocol qualifies this income as dividend. This dividend may then be subject to WHT at a maximum rate of 15% (DTT rate).
Income from employment
As far as income of employment is concerned, even though the rule has been redrafted to follow the OECD Model Tax Convention wording, the rule remains that the income derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State, unless the employment is exercised in the other Contracting State.
Here, it is worth mentioning that the situation of German cross-border workers will not change under the new DTT, as the mutual agreement reached last year by the German and Luxembourg authorities will remain applicable (this is expressly indicated in the mutual agreement). For a presentation of the provisions of the mutual agreement, please refer to an article published in the ATOZ newsletter of June 2011.
As far as pensions are concerned, pensions paid out of a compulsory social security system will generally be taxed in the source country. However, some other provisions have been introduced, which deal with specific situations.
Application of some DTT provisions to Collective Investment Vehicles (“CIVs”)
The new DTT is the first Luxembourg DTT, which provides expressly (in its Protocol) that it will apply to CIVs. This follows the OECD report “The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles”.
As far as Luxembourg FCPs and German “Sondervermögen” are concerned, they may claim the benefits of articles 10 (dividends) and 11 (interest) in order to benefit from the reduced WHT rates on dividends and the exemption of WHT on interest, to the extent their units are held by persons, who are resident in the country, in which the FCPs/Sondervermögen are established (so, Luxembourg resident investors in the case of FCPs)
Luxembourg SICAVs, SICAFs and SICARs will be able to claim the provisions of articles 10 (dividends) and 11 (interest) in order to benefit either from the reduced WHT rates on dividends or from the exemption of WHT on interest.
Methods to avoid the double taxation
Germany in principle applies an exemption system to avoid double taxation. However, it may change to credit system for instance in case of non-taxation in Luxembourg to avoid “white income”.
As far as dividends are concerned, the exemption system applies only to the extent the German parent Company is a corporation, which holds directly at least 10% of the shares of the Luxembourg Company and the Luxembourg Company has not deducted the amount paid to the German parent Company. In the other cases of dividend distributions, the credit method will apply.
Luxembourg generally applies the exemption method. The credit method may however apply to the extent income from dividends, royalties and income of artists and sportsmen are subject to tax in Germany.
Exchange of information
The new DTT has implemented what Luxembourg and Germany had already agreed back on 11 December 2009 in the protocol to the 1958 DTT, which will no longer be applicable as soon as the new DTT will enter into force. The protocol to the new DTT confirms that there will be no automatic exchange of information and that the so-called “fishing expeditions” are still not allowed under the new DTT.
Entry into force
The new DTT will enter into force on the day when Germany and Luxembourg will exchange the instruments of ratification, following the ratification in their respective country. The new DTT will apply to taxes in relation with the calendar year, which will follow the entry into force, i.e. to taxes in relation to the tax year 2013 at the earliest.
The new DTT is welcomed, as it will ensure that Germany and Luxembourg will now have a DTT which generally follows the OECD Model Tax Convention. The latter is good news as it generally simplifies questions of treaty interpretation and provides, in most cases, more legal certainty to tax payers. Positive developments introduced by the new DTT are the new maximum WHT rate on dividends and the granting of DTT benefits (which becomes much clearer now) to CIVs. The new DTT, however, will have an impact for German real estate investment structures, investments in German financial instruments and taxation of capital gains derived on participations in capital companies by individuals moving their residency from one state to the other. We recommend that tax payers either carefully review the investment structures they have already in place with their tax advisers or reconsider any structuring of German real estate investments and financial instruments for the near future.
For more information, please contact Peter Kleingarn at email@example.com or Samantha Nonnenkamp at firstname.lastname@example.org .