On the 23 April 2012, Germany and Luxembourg signed a new Double Tax Treaty ("the Treaty") which is to replace the previous treaty dating back to 1958. And according to Dechert, the new Treaty may impact on many US, UK and other non-German investors as Luxembourg is often used as a tax efficient jurisdiction for German inbound investments (particularly used by funds, private equity and real estate investors).
The main changes include:
Explicit Treaty access for funds – Luxembourg investment funds in the legal form of a SICAV, SIVAF or SICAR are to be able to claim Treaty benefits in their own name (leading to a reduction of German withholding tax from 26.375% to 15 % on (portfolio) dividends and to 0 % for interest payments). Investment funds of a contractual type (i.e. FCP) qualify for a limited Treaty benefit, i.e. subject to the (German) tax residency of its investor base.
Investment into real estate companies – The Treaty provides for a new provision which covers capital gains from shares in companies which derive more than 50 % of their value directly or indirectly from real estate assets. Hence, investments in German real estate holding companies, held through a Luxembourg holding company, may be subject to German tax under the new Treaty.
Hybrid debt instruments (often used by private equity and real estate funds) – Investments in German target companies (e.g. by private equity and real estate funds) are often capitalised through hybrid debt instruments (e.g. profit participating loans, "PPL") by which a certain portion of German derived profits is repatriated. Under the current Treaty, such financial instruments were (subject to the individual terms) not subject to any German withholding tax. Under the new Treaty, however, Germany is entitled to apply its German withholding tax rate (of 26.375 %) to payments under such financial instruments, if they qualify as so-called "profit participating instruments" (i.e. if the respective "interest" payment under such financial instrument is linked to the profit of the German "borrower").
Application of new rules – It is expected that the new Treaty will be ratified by the Luxembourg and German parliaments in due course and, in principle, will apply as of 1st January 2013. Thus any restructuring of existing investment structures would need to be implemented during the course of 2012.
As the above-mentioned changes under the new Treaty may affect US, UK and other non-German fund, private equity and real estate investors holding (indirect) investments in Germany, this may lead to a heightened interest in exploring alternative structuring solutions.