Luxembourg Tax Alert 2024-03

On 6 July 2023 Luxembourg and Germany signed an amending Protocol (hereafter ‘the Amending Protocol’) to the Germany-Luxembourg tax treaty (hereafter ‘the DTT’), which has been recently commented by a circular issued by the Luxembourg tax authorities¹ (hereafter ‘the Circular’). 

The Amending Protocol incorporates certain provisions implementing the BEPS Multilateral Instrument (hereafter ‘MLI’) and modifies several significant provisions affecting employees, employers, corporate taxpayers and investment funds.

The key changes are the following:

• Extension of the tolerance threshold for cross-border workers to 34 days; 

• Introduction of a new ‘effectively taxed’ clause (hereafter ‘the Clause’) to avoid double non-taxation;

• Amendment of the provisions related to treaty benefits granted to investment funds; 

• Revision of the provisions on exit tax in the case of a change of tax residence; and

• Insertion of the anti-abuse provision of the MLI (preamble and principal purpose test).  

Given that these provisions already apply since 1 January 2024, we generally recommend that a careful impact assessment of current situations or structures is performed.

Whilst the following tax alert is focusing on individuals and cross-border workers, please refer to our separate tax alert for an overview of the impacts for corporate taxpayers and investment funds.

The maximum tax threshold is now the same for residents of Germany, Belgium, and France working for a Luxembourg employer.
 

b. Accounting for tolerance workdays, fractions of a workday, and “on-call” duty: 

All workdays, or portions of workdays, performed during a calendar year in which the employee effectively carries out their salaried activity for which they receive a remuneration, are considered as effective workdays for the computation of the 34-day tolerance.

According to the DTT, a salaried activity is only considered exercised during a working day in a specific State, provided that the activity is performed in that State for at least 30 minutes. Therefore, any such activity below 30 minutes during a non-Luxembourg workday, would not be counted for the 34-day tolerance.

“On call” duty premiums are taxable in Germany if the 34-day tolerance threshold is exceeded. When a worker resident in Germany would be required to be available to their Luxembourg-based employer from home, the remuneration resulting from the “on call” duty (i.e. a permanence premium) would be taxable in Germany (even if the taxpayer would not intervene), if the 34-day tolerance threshold is exceeded.  
 

c. Notice period with work exemption: 

Employment remunerations paid during a notice period, while the employee is exempt from performing their salaried activity, are considered taxable in the State from which the employee would have worked in the absence of any work exemption during the notice period. 
 

d. Indemnities received in case of employment termination, collective dismissal, or back pay salaries: 

The Amending Protocol regulates the attribution of the right to tax the indemnities which an employee receives, by virtue of an agreement between the employer and the staff representation in the event of collective dismissal in Luxembourg or Germany. Before making collective dismissals, the employer must enter into negotiations with staff representatives in order to draw up a social plan for the staff concerned. Dismissal or severance indemnity payments also form part of this agreement, when such an agreement is reached by the social partners.

In addition, the Amending Protocol defines the term "collective dismissal", referring to job cuts for reasons that are not inherent to the individual employee, which must involve at least 7 employees over a period of 30 days, or 15 employees over a period of 90 days. The Amending Protocol specifies that these indemnities are taxable only in the State in which the agreement was concluded, in accordance with its domestic law.

The Amending Protocol stipulates that indemnities paid under an employment contract consisting of wages, back pay salary or other employment remunerations are taxable in the State where the salaried activity was performed for past services. The same applies to indemnities paid in case of termination of the employment contract of the worker.

For cases where the employee has exercised their activity before the termination of the contract partly in their State of residence (Germany) and/or in a third State or territory and partly in the other State (Luxembourg), the Amending Protocol provides that the compensation may only be taxed in the other State (Luxembourg) up to the percentage obtained by taking into account the total salaries received during the 5 years preceding the termination of the employment contract, and the portion in relation to the salaries taxable in the other State (Luxembourg) during these 5 years.
 

e. Indemnities with a welfare character: 

Indemnities which have the nature of pension/welfare provisions would fall under paragraph (1) of article 17 of the DTT and be only taxable in the State of residence of the beneficiary. 

Some DTT changes have been made relating to the taxation of pensions governed by German legislation falling within article 17.

Also, the agreement signed by Luxembourg and Germany on 11 January 2024 (hereafter ‘Mutual Agreement’)² lists in point V. certain allowances and remuneration falling within the scope of paragraph (2) of Article 17 concerning sums paid to a resident of a Contracting State in application of the social legislation of the other Contracting State, and which are taxable only in that other State.
 

f. Transport sector: 

The Amending Protocol provides for a lump sum allocation of the right of taxation for remunerations received by employees engaged in the transport of goods or passengers (e.g., professional road or bus drivers, locomotive drivers, and accompanying personnel).

This applies to employees engaged in the international cross-border transport of goods or passengers by transport companies, that are residents of Luxembourg or Germany, or have a permanent establishment in one of these States, that bear the remuneration of employees. This allocation applies to individuals, who perform their salaried activity in this specific field.

The right of taxation of the remunerations is split according to the lump sum allocation rate established between Luxembourg (for the percentage of activities performed there) and the State of residence of the worker (Germany) for non-Luxembourg workdays.
 

g. Public services: 

The 34-day tolerance threshold is extended to remunerations falling within the scope of the public services (governmental administration) of the DTT.  

This provision would allow civil servants to carry out their salaried activity for 34 workdays out of Luxembourg, either in their State of residence (e.g., teleworking in Germany) and/or third-States, while remaining taxable in Luxembourg. If the threshold is exceeded, all the non-Luxembourg workdays would be taxable in Germany as the State of residence of the worker.
 

h. Overtime: 

Please refer to section III below for the impact on overtime as a result of the “effectively taxed” Clause.

Article 6 of the Amending Protocol provides a new paragraph replacing paragraph 6 of Article 13 of the DTT. This provision covers the disposal of shares by a person (an individual or company) resident of one Contracting State but previously resident in the other State. 

If the other State has taxed the latent capital gain on the shares upon exit, the new State of tax residence would then have to compute the taxable gain on the basis of the value used upon exit in the other State, provided that such a basis does not exceed the fair market value. In other words, the new State of tax residence would only tax a potential incremental gain.

In addition to the specific income (for example, capital gains on the shares of land-rich companies) to which Germany applies the credit method (as opposed to the exemption method), point f) of paragraph (1) of article 22 of the DTT provides that Germany also applies the credit method to items of income or elements of capital whose taxation right is allocated to Luxembourg under the DTT, but which are not effectively taxed in Luxembourg. This type of clause has been inserted in several double tax treaties concluded by Germany³.

This Clause is further specified in point 2 of paragraph (2) of article 13 of the Amending Protocol (amending the Protocol of 2012 attached to the DTT), in point VII. of the Mutual Agreement and in the Circular issued by the Luxembourg tax authorities. 

Income, or items of income, are deemed to be effectively taxed when such income or capital form part of the total amount of income or capital on the basis of which the tax is calculated in the other State. 

The Mutual Agreement specifies that income or items of income are considered to be effectively taxed even if they are partially taxed or not taxed following the deduction of an allowance, obtaining costs or carry-forward loss. 

On the one hand, the wage supplements remunerating work performed at night, Sundays and public holidays are considered to be effectively taxed, since only the supplements are exempt from Luxembourg income tax, whereas the basic wages paid for such work are fully subject to Luxembourg income tax.

On the other hand, the following income items are not considered to be income effectively taxed: income not in scope of the Luxembourg Income Tax Law (such as lottery gains) and wages and supplements paid for overtime worked by the employee, which are completely exempt from income tax. In such a case, Germany would hold the right to tax this income, and would mitigate double taxation, if any, based on the tax credit method.

While the Mutual Agreement contains useful clarifications and examples with respect to employment income, there are other types of income subject to tax relief under Luxembourg domestic law (such as capital gains on shares realized by individual taxpayers), for which it is unclear whether Germany would recover its right to tax under the Clause. As a result, it would be key to properly assess those scenarios according to the German interpretation of the DTT. The recovery of the taxation right by Germany under the Clause should however have a tax impact only if the relevant item is not exempt under German domestic law.

As the Clause refers to exemption under Luxembourg domestic law, it must therefore be distinguished from the provisions under point e) of paragraph (1) of article 22 allowing Germany to apply the credit method to income or capital that is exempt in Luxembourg by virtue of the DTT (as opposed to domestic law). 

The Clause deserves a recommended case-by-case tax check considering the variety of situations that can occur for individuals. 

The end result in terms of German personal taxation for the cross-border worker would depend, among other elements, on the variety/level of the worker’s income taxable in Germany, but also of the tax deductions and class applicable to the worker. 

For the workers, it is the right time to think about the Clause’s tax effect considering that the upfront tax reporting of the overtime will have to be managed by them upon filing of their German personal tax return for CY 2024 income.

For Luxembourg-based employers, it is recommended they monitor this overtime application, and inform the potentially exposed workers to this new reality, and of course consult in case of doubt or questions. 

The Mutual Agreement is also intended to have retroactive effect in certain areas for cases that are still open or subject to a mutual agreement. Some German tax authorities want to apply the reversion of the right of taxation for overtime remuneration exempt from tax in Luxembourg in the past as well. It should therefore be carefully examined to what extent it is actually possible to apply the ‘effectively taxed’ Clause before 1 January 2024.