On 21 May 2018, the Luxembourg-Cyprus double tax treaty (the Treaty) entered into force, with the application of its provisions starting 1 January 2019. This follows the vote for approval of the Treaty by the Luxembourg Parliament on 22 March 2018 and the publication of the ratification law of 17 April 2018 in the Official Gazette (Memorial). With this Treaty, Luxembourg now has double tax treaties in place with all the Member States of the European Union (EU). Luxembourg has hence further expanded its treaty network and has strengthened its position of key economical actor in the international arena.
This Treaty reflects the latest international standards in terms of avoidance of double non-taxation and exchange of information. It already fully takes into consideration the Base Erosion and Profit Shifting (BEPS) recommendations of the Organisation for Economic Co-operation and Development (OECD) and especially the Principal Purpose Test (PPT) clause that takes its origin in the OECD Multilateral Convention to Implement Tax Treaty Related Measures (MLI).
This Alert summarizes the main features of the Treaty.
Clarification that the Treaty is not intended to be used to generate double non-taxation
In line with the recommendations of the OECD in its final report on Action 6 of the BEPS project (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), the Preamble of the Treaty provides expressly that both States concluded the Treaty to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining relief provided in the Treaty for the indirect benefit of residents of third States).
Resident of a Contracting State
Article 4 defines the meaning of the term “resident of a Contracting State” and is intended to address cases of double residence (i.e., tie breaker rule). It should be noted that the Protocol explicitly confirms that a collective investment undertaking established in one Contracting State is considered as resident of such State and as beneficial owner of the income it receives. Consequently, collective investment vehicles are entitled to claim the benefits of the Treaty.
Article 5 of the Treaty defines the concept of permanent establishment, which determines the right of a Contracting State to tax the profits of an enterprise of the other Contracting State. The wording of this article corresponds to the wording of the OECD Model Tax Convention on Income and on Capital in its 2014 version (OECD Model Convention). It should however be noted that the Treaty deviates from the OECD Model Convention by extending the definition of a building site or construction or installation project, to any supervisory activities in connection with such site or project.
The Treaty provides for a 0% withholding tax on dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State if the beneficial owner is a company (other than a partnership) which holds directly at least 10% of the capital of the company paying the dividends. In all other cases, the withholding tax rate is 5% of the gross amount of the dividends paid.
The Treaty consequently provides for a withholding tax rate which is lower than the Luxembourg domestic rate (15% under current legislation). It should be noted that under domestic law, dividends distributed by Luxembourg resident companies to companies resident in an EU Member State, in a State which is member of the European Economic Area (EEA) or in a treaty jurisdiction are exempt from withholding tax under certain conditions.1
In principle, Cyprus does not levy withholding tax on dividends under its domestic law.
The Treaty provides that interest will not be subject to withholding tax and taxed only in the country of residence of the beneficiary, “subject to the legal acts of the European Union.” While the parliamentary documents do not provide for any explanation on this addition, it appears that the intention was to disallow the application of the provision if the interest payment was contrary to e.g., an anti-abuse measure as foreseen by a European Directive.
In principle however, neither Luxembourg nor Cyprus levy withholding tax on interest under their respective domestic law.2
The Treaty provides that royalties will not be subject to withholding tax. The definition of royalties is, compared to the wording of the OECD Model Convention, extended to payments received for the use, or the right to use, computer software.
In principle, Luxembourg does not levy withholding tax on royalties under domestic law.3
Cyprus does generally not levy withholding tax under domestic law on royalties earned on rights not used within Cyprus. A 10% withholding tax is levied on royalties earned on rights used within Cyprus; the rate is reduced to 5% for royalties relating to cinematographic films.
The Treaty provides for a “real estate-rich” clause according to which capital gains derived from the alienation of shares in a company deriving more than 50% of its value directly from immovable property shall be taxed in the State where the immovable property is situated.
As it is the case in several other recent double tax treaties signed by Cyprus, the Treaty provides for a separate article dealing with offshore activities.
A resident of a Contracting State who carries on activities offshore in the other Contracting State for more than 30 days in any period of 12 months, in connection with the exploration or exploitation of the seabed or subsoil or their natural resources, will be deemed, in relation to those activities, to be carrying on business in the other Contracting State through a permanent establishment situated therein. In addition, profits derived from the transportation of supplies or personnel to a location, or between locations, where any of the aforementioned activities are being carried on, will be taxable only in the Contracting State of which the enterprise is a resident.
The Treaty also provides for specific rules as regards the taxation of salaries, wages and similar remuneration derived in respect of employment connected with offshore activities.
Gains derived by a resident of a Contracting State from the alienation of exploration or exploitation rights or property situated in the other Contracting State and used in connection with the exploration or exploitation of the seabed or subsoil or their natural resources situated in that other State, may be taxed in that other Contracting State. The same applies for gains derived from the alienation of shares deriving their value or the greater part of their value directly or indirectly from such rights or such property or from such rights and such property taken together.
Elimination of double taxation
As a general rule, Luxembourg has opted for the exemption method to avoid double taxation. Consequently, where a Luxembourg resident derives income or owns capital that may be taxed in Cyprus, Luxembourg should exempt such income or capital, but may, in order to calculate the amount of tax on the remaining income or capital, apply the same rates of tax as if the income or capital had not been exempted (clause of progressiveness). The exemption shall however not apply to income derived or capital owned by a resident of Luxembourg where Cyprus applies the provisions of the Treaty to exempt such income or capital from tax or applies a withholding tax to such income. The aim of this provision is to avoid a double non-taxation resulting from disagreements between the two Contracting States on the facts and circumstances of a specific case or on the interpretation of the Treaty provisions.
With respect to dividends and income from artists and sportsmen that may be subject to withholding tax in Cyprus, Luxembourg grants a tax credit of an amount equal to the tax paid in Cyprus. The tax credit may however not exceed that part of the tax, as computed before the credit is given, which is attributable to such items of income derived from Cyprus.
Cyprus has opted for a tax credit method to eliminate double taxation. The credit shall not exceed the Cyprus tax which is appropriate to such income.
When, in accordance with any provision of the Treaty, income derived by a resident of Cyprus is exempt from tax in Cyprus, this income shall be taken into account in calculating the amount of tax on the remaining income of the taxpayer.
The Treaty contains non-discrimination provisions in line with article 24 of the OECD Model Convention.
Mutual agreement procedure
The Treaty provides for a mutual agreement procedure in line with article 25 of the OECD Model Convention, without however including the possibility to submit any unresolved issues arising from the case to arbitration.
Exchange of information
The Treaty contains an exchange of information provision in line with article 26 of the OECD Model Convention.
Entitlement to benefits
The treaty contains a PPT clause in accordance with Actions 6 and 15 of the BEPS project and in line with the latest 2017 OECD Model Convention and with the MLI. Treaty benefits shall be denied if “it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that beneﬁt was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that beneﬁt in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.” This provision hence allows the Contracting States to combat all cases involving an abusive use of the Treaty.
Entry into force
The provisions of the Treaty will be applicable:
- In respect of taxes withheld at source, to income derived on or after 1 January 2019
- In respect of other taxes on income, and taxes on capital, to taxes chargeable for any taxable year beginning on or after 1 January 2019
1. If the parent company is resident in an EU Member State, it has to be a collective undertaking within the meaning of Article 2 of the EU Parent-Subsidiary Directive (2011/96/EU) and has to hold, or commit to hold, at least 10% of the share capital or a participation with an acquisition cost of at least €1.2 million for at least 12 months in the paying company.
2. A 15% withholding tax is due in Luxembourg on certain types of bonds issued by a Luxembourg company.
3. A 10% withholding tax is due in Luxembourg on revenue derived by non-Luxembourg resident taxpayers from some literary, artistic and sportive activities carried out in Luxembourg.
EYG no. 03381-181Gbl
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