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The New – Czech Income and Capital Tax Treaty 1

Briefing note April 2013

The New Luxembourg – Income and Capital Tax Treaty On 5 March 2013, the Finance Ministers of Luxembourg and the Czech Republic signed an agreement on preventing double taxation which replaces the double tax treaty dated 18 March 1991. This new treaty and its concurrent protocol are in line with the OECD model and its standards, and especially include the international standard of an effective exchange of information upon request. However it does not only update existing provisions (e.g. withholding tax rates, permanent establishment definition, …) but also includes new provisions (such as a brand new anti-abuse clause or specific reference to investment funds). This briefing explains the key changes to be introduced.

months'' (Article 5-3a) whereas the 1991 version included any Tax Residency such site or construction or project existing for more than 6 Further to the abrogation of the Article 28 of the 1991 version months in the definition of permanent establishment. (excluding holding 1929 and similar entities), the protocol Concurrently, it encompasses the ''furnishing of services, dated March 2013 confirms that the term "resident" as including consultancy or managerial services (…) but only defined under Article 4 of the new treaty includes fiscally non where activities continue (…) for a period or periods transparent persons (including a collective investment exceeding in the aggregate 6 months within any 12 month vehicles) that are taxed at zero rate or even exempted from period.'' tax. In this respect, are of the view that Luxembourg should be considered as tax residents benefiting Dividends from the new treaty's provisions. This would be a significant change compared to the current practice. However, this point Dividend payments would be subject to a maximum 10% will have to be confirmed by the Czech authorities. withholding tax and potentially be withholding tax exempt if the beneficial owner is a corporation (i.e. not a partnership) Definition of Permanent holding at least 10 % of the capital of the distributing company for at least 12 months (instead of 15 % / 5% Establishment previously). On the corporate income tax side, the new version does not include a regime The new treaty amend the definition of Permanent applying on dividend received by Luxembourg companies Establishment. (see former Article 23-2c of the 1991 version). Consequently, Luxembourg companies holding Czech subsidiaries would The new version reduces its scope to ''building site, project or then have to rely on the domestic participation exemption activities where they continue for a period of more than 12 (article 166 Luxembourg Income Tax Law).

2 The New Luxembourg – Czech Republic Income and Capital Tax Treaty

Interests Capital gains

According to the Article 11 of the new treaty, no withholding Any capital gains arising from the alienation of real estate tax is levied on interest paid by Luxembourg or Czech property would be taxable in situ. Alternatively, the new treaty debtors. In this respect, the definition of interest is still does not include any real estate company provision and the covering income derived from debt-claims carrying a right to disposal of real estate company shares would only be taxable participate in the debtor's profit. However, the new treaty at the alienator level. now expressly excludes from the benefit of this article any item of income which is considered as dividend under the Concurrently, any gain arising from the disposal of ships, provision of Article 10-3, i.e. in other words any income boats, aircraft, road or railway vehicles operated an ''subject to the same taxation as income from shares by the enterprise active in international traffic business will only be law of the (paying/distributing) company''. This provision taxed where such enterprise has its place of effective should now be carefully monitored in case of specific management. instruments such as Stillegesellschaft or other participating bonds. Income from employment In addition, interest derived or born by a permanent establishment located in one of the contracting shall be Further to the OECD model, the right to tax employment deemed to arise in that state (the person paying the interest income is allocated based on several criteria among which being resident in Luxembourg, the Czech Republic or in a stands the ''famous 183 day'' period. The new treaty provides third country – see new Article 11-4). for clear rules on this period computation. In this respect, ''all days of physical presence including days of arrivals and departures, and days spent outside the State of activity such Royalties as Saturdays and Sundays, national holidays, holidays and business trip directly connected with the employment of the The maximum 10% withholding tax still applies to royalties recipient after which the activity was resumed'' shall be derived from ''patent, trade mark, design or model, plan, included (see Article 14-3a and b). These precise provisions secret formula or process, computer software or the use of echo the recent German Luxembourg treaty amendments equipment or commercial/industrial information or and their impacts on German commuters tax position. experience'' whereas no withholding tax would apply on copyright of literary, artistic or scientific work (including films, television or radio broadcasting). The new definition of Artistes and sportspersons royalties expressly excludes any copyrights for computer software from the withholding tax exemption (see Article 12- The new treaty abolishes the income exemption relating to 3a). cultural exchange activities (see former Article 17-3). More importantly, the protocol provides for a ''most favoured Elimination of double taxation clause'' according to which ''in the case that the Czech Republic signs with another EU Member Sate a convention The new version does not include a dividend exemption which limits the taxation of royalties arising in the Czech regime anymore (see former article 23-2c of the 1991 Republic to a rate lower, including exemption, than the rate version). Consequently, Luxembourg companies holding provided for in (this treaty), that lower rate or exemption will Czech subsidiaries would then have to rely on the domestic automatically be applicable (…) from the date of which the participation exemption (Article 166 Luxembourg Income Tax Convention between the Czech Republic and the EU Member Law). State concerned will have effect''.

The New Luxembourg – Czech Republic Income and Capital Tax Treaty 3

the law and why there is reason to believe that taxpayers Non-discrimination have not been compliant with that law supported by a factual basis). This paragraph is designed to end a particular form of discrimination resulting from the fact that in certain countries the deduction of interest, royalties and other disbursements Anti-abuse clause allowed without restriction when the recipient is resident, is restricted or even prohibited when he is a nonresident. The This new provision deals with a general anti-abuse clause. It same situation may also be found in the sphere of capital provides that treaty benefits may be denied to any person, if taxation, as regards debts contracted to a non-resident. It is after consultation between both contracting states tax however open to Contracting States to modify this provision authorities, it is decided that granting benefits would in bilateral conventions to avoid its use for constitute an abuse. purposes. Exchange of information Contacts

The provision has been completely reviewed and François-Xavier Dujardin corresponds to the latest version pursuant to the Model Partner convention. T: +352 48 50 50 254 E: François-Xavier.Dujardin It embodies the rules under which information may be @cliffordchance.com exchanged to the widest possible extent, with a view to laying the proper basis for the implementation of the domestic tax Vincent Marquis laws of the Contracting States and for the application of Counsel specific provisions of the Convention. The text of the Article T: +352 48 50 50 429 makes it clear that the exchange of information is not E: Vincent.Marquis restricted by Article 1 and 2, so that the information may @cliffordchance.com include particulars about non-residents and may relate to the David Kolacek administration or enforcement of taxes not referred to in Partner Article 2. T: +420 222 555 222 In addition, the information must be "foreseeably relevant" for E: David.Kolacek the administration of the taxes of the requesting party, @cliffordchance.com regardless of bank secrecy and a domestic tax interest. The Petr Sebesta standard of "foreseeable relevance" is evolving in order to Senior associate provide for exchange of information in tax matters to the widest possible extent and at the same time to prohibit fishing T: +420 222 555 222 expeditions. The main evolution is that even though "fishing E: Petr.Sebesta expeditions" (i.e. speculative requests of information that @cliffordchance.com have no apparent nexus to an open inquiry or investigation) remain clearly not authorized, the commentary now allows for group requests to the extent that the standard of "foreseeable relevance" is met (i.e. the requesting state has to provide a detailed description of the group and the specific facts and circumstances that have led to the request, an explanation of

4 The New Luxembourg – Czech Republic Income and Capital Tax Treaty

This publication does not necessarily deal with every important topic or cover , 2-4 Place de , B.P. 1147, L-1011 Luxembourg, Grand- every aspect of the topics with which it deals. It is not designed to provide Duché de Luxembourg legal or other advice. © Clifford Chance 2013 www.cliffordchance.com If you do not wish to receive further information from Clifford Chance about events or legal developments which we believe may be of interest to you, please either send an email to [email protected] or by post at Clifford Chance LLP, 10 Upper Bank Street, Canary Wharf, London E14 5JJ Abu Dhabi ■ ■ Bangkok ■ Barcelona ■ ■ ■ ■ Casablanca ■ Doha ■ Dubai ■ Düsseldorf ■ ■ Hong Kong ■ Istanbul ■ Kyiv ■ London ■ Luxembourg ■ ■ Milan ■ Moscow ■ Munich ■ New York ■ Paris ■ Perth ■ ■ Riyadh* ■ ■ São Paulo ■ Seoul ■ ■ Singapore ■ Sydney ■ Tokyo ■ ■ Washington, D.C.

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