2019 Tax Protocol with Luxembourg
On September 20, 2019, the US Treasury Department announced the ratification of a new tax protocol (“Additional Protocol”) between the United States and the Grand Duchy of Luxembourg. The new agreement will replace Article 28 of the 2009 tax treaty, which currently regulates the exchange of information between the two countries’ tax administrations.
Under the new version of Article 28, information exchanged must be “foreseeably relevant.” The standard of “foreseeable relevance” is intended to provide for the exchange of information (for tax purposes) to the widest possible extent and, at the same time, to clarify that contracting states are not at liberty to request information that is unlikely to be relevant to the tax affairs of a given taxpayer (source: Commentary of Article 26 of the OECD Tax Convention approved by OECD Council, available at this link: https://www.oecd.org/ctp/exchange-of-tax-information/120718_Article%2026ENG_no%20cover%20.pdf). It includes information that would otherwise be protected by domestic bank secrecy laws and covers persons of any nationality if the individual maintains a financial connection to the applicable jurisdiction (e.g., a bank account).
In practice, the new tax rules mean that the US is entitled to receive all bank account, income, and asset information held by a bank in Luxembourg in order to determine whether the signatory of the account holds unreported income. Reciprocity applies, so Luxembourg will enjoy the same rights.
Tax Arbitration Agreement with Switzerland
The US also improved tax transparency with Switzerland earlier this year by signing the 2019 Amending Tax Protocol. The Amending Tax Protocol introduces the same mechanisms described in the 2019 Tax Protocol with Luxembourg and includes a “Mutual Agreement Procedure” in Article 26, which is intended to help the two countries resolve tax disputes.
Under the Mutual Agreement Procedure (MAP), if the tax authorities in the two countries are not able to resolve a tax dispute, the taxpayer is authorized to submit the dispute to an arbitration panel. The panel’s decision would then only be binding if the petitioner accepts the result.
The Amending Tax Protocol also modifies certain tax exemption rules. Under the new version of Article 10 of the agreement, “dividends, pensions or other retirement arrangements” may not be taxed in one of the contracting countries if they are owned by a resident of the other contracting state. Additionally, the exemption requires that the Swiss and US authorities agree that the assets in question generally corresponds to a pension, retirement arrangement, or individual retirement account.
Tax heavens in general
“Tax havens” are jurisdictions that impose little or no taxation on foreign individuals and businesses, maintain pervasive bank secrecy laws, or offer little collaboration when it comes to the exchange of tax information. Countries traditionally considered to be tax havens include Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Channel Islands, the Cook Islands, The Island of Jersey, Hong Kong, The Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, St. Kitts, and Nevis, only to name a few. In recent years, many countries have tried to gather financial information from tax heavens by putting political and economic pressure on the most successful of them (e.g. Luxembourg and Switzerland) in order to improve financial transparency. International organizations, like the OECD and the IMF, have also suggested legislative and executive measures to limit the effects of bank secrecy.
After 9/11, US authorities grew increasingly concerned about foreign investments in the US as well as US taxpayer offshore financial reach. Following various important pieces of legislation enacted since 2001, in March 2010, the US Government adopted the Foreign Tax Compliance Act (FATCA), which allows the automatic exchange of information between foreign financial entities and the US Government.
Between 2013 and 2015, the OECD developed its own program to facilitate the exchange of information between member states. On July 15th, 2014, the OECD Council approved the Common Reporting Standard (CRS), which instructs member states to obtain information from their financial institutions and exchange that information with other jurisdictions. The CRS also sets out requirements for the type of financial information to be exchanged, the financial institutions that must comply, which accounts and taxpayers covered, and the common due diligence procedures to be followed by financial institutions (source: https://www.oecd.org/tax/automatic-exchange/common-reporting-standard/).
Luxembourg was the first jurisdiction to commit to the OECD’s global standards and one of 113 jurisdictions that have signed on to the US FATCA program.
Despite their recent regulatory modifications to improve transparency on tax and bank secrecy, Luxemburg and Switzerland remain important financial players in the international market. In 2018 alone, managed funds in Luxembourg reached over EUR 4,000 billion (source: Association of the Luxembourg Fund Industry, https://www.alfi.lu/, data available at this link https://www.alfi.lu/Alfi/media/Statistics/Luxembourg/ouverture_section_statistique_chiffres_du_mois.pdf). Meanwhile, in 2018, Swiss banks held $6.5 trillion in assets, according to the Swiss Bankers Association, of which 48 percent originated from abroad (source: Swiss Bankers Association https://www.swissbanking.org/en/topics/tax/the-automatic-exchange-of-information ).