Remaining Simple And BEPS-Compliant: The 'Land-Rich Company' Clause

Many of Luxembourg's double tax treaties indicate that the right to tax capital gains arising from a disposal of shares in a company—specifically a company that, at the time of the sale, derives over 50% of its value (directly or indirectly) from real estate—is allocated to the country in which that real estate is located (in line with Art. 13.4 of the OECD Model Tax Convention, a so-called "land-rich company" clause). This means that, in these cases, notwithstanding the existence of other value-generating assets in the sold company, the taxing right over the entire gain from these share deals would be allocated to the country where the immovable property is located (so called "situs state").

Luxembourg recently decided to not add a further layer of complexity to this land-rich company clause in its treaty network—specifically, it opted not to modify those clauses in the way suggested in the Multilateral Instrument (MLI).1 It also opted not to insert a land-rich company clause into all of its covered tax agreements.

A positive choice

This is, in our view, a good choice since the modification proposed in the MLI may have led to practical difficulties, in particular when allocating the right to tax the above-mentioned gains among different jurisdictions.

Firstly, according to the rules proposed in the MLI, the situation at the time of the sale of a real-estate-rich company would no longer be relevant to the allocation of taxing rights. If, at any time during the 12 months preceding the sale of such shares, the company being sold derived more than 50% (or another defined percentage) of its value (directly or indirectly) from immovable property, the right to tax would be allocated to the country where the underlying real estate is located. As a consequence, the evolution of the real estate value (compared to all other valuable assets) would have to be retroactively tracked, which could cause difficulties and complexity in practice. In contrast, without the application of the MLI's proposed amendment, such complexity does not exist as only the situation at the share deal date would be of relevance.

Secondly, opting for the MLI's amendment could have led to detrimental situations in which taxing rights could be allocated to various jurisdictions resulting in double taxation (provided domestic tax laws picked up the taxing rights according to the corresponding DTT).

For example, imagine that ACo1 (tax resident of State A) is the sole shareholder...