On 10 February 2016, Luxembourg and Senegal reinforced their co-operation on an international level by signing a double tax treaty. Entering into force on 14 June 2018, and applicable from 1 January 2019, the treaty differs greatly to previous treaties between Luxembourg and African countries in that it is the first one to include specific guidance and provisions of the OECD/G20 Base Erosion and Profit Shifting project (BEPS) while combining influences from both the OECD and the UN models. The result is an economically balanced convention.
Will this brand-new format of treaty become a new standard of tax ethics in conventions between so-called developed and developing countries?
Ethics is increasingly important in tax, as this treaty shows. Rules everywhere are thus being adapted—or are in need of being adapted—to obtain balanced and fair taxation. When it was signed, the treaty with Senegal was the sixth double tax treaty (DTT) between Luxembourg and an African country, showing Luxembourg’s willingness to improve its economic relationship with Africa.
However, it remains to be seen whether this treaty will affect future policy with Africa, notably with regard to the recently signed treaty with Botswana.
A mixed tax treaty: the best of both pillars of the international tax field
The international tax framework has been built over the last few decades by the globalization of commercial and financial exchanges. In response to a fundamental need to avoid double taxation on a global scale, DTTs have been a core element of this international cooperation.
In pursuit of a coherent system and support for developing countries, various DTT models have emerged. Nowadays, most DTTs worldwide are based on either the OECD model or the UN model.
The tax influence of the 2014 OECD model and BEPS actions
Importantly, Senegal and Luxembourg are both members of the BEPS Inclusive Framework, a fact which without a doubt represents the cornerstone of the treaty and its being signed. The influence of the OECD—the body that initiated the BEPS project—on the Luxembourg–Senegal DTT is particularly noticeable in the preamble, its articles, and in the inclusion of a Principal Purpose Test (PPT).
Even though a preamble is often considered less important than the text itself, it is nevertheless an integral part of the treaty. It is legally binding and certainly a key factor in interpreting the text.
In the Luxembourg–Senegal treaty, both title and preamble emphasize the goal of preventing double taxation but also, more relevantly, the goal of preventing the creation of opportunities for double-non-taxation—one of the principal objectives of the BEPS project.
The inclusion of measures to prevent double-non-taxation is new, and appears all throughout the treaty. Indeed, a similar wording excluding the use of the treaty for tax evasion purposes is stipulated in Articles 10, 11, 12, and 22 (respectively, the tax treatment for dividends, interest, royalties, and other income).
These articles further evidence the BEPS influence on the treaty. The wording goes beyond a simple willingness to oppose tax abuses: rather, it instates a real PPT in the treaty. Directly inspired by BEPS Action 6 (“Preventing the Granting of Treaty Benefits in Inappropriate Circumstances”), this PPT aims to prevent treaty shopping and stipulates that the benefit of the treaty should be denied if one of the principal purposes of an arrangement or transaction is to obtain a tax advantage.
Additional clues of the OECD’s influence can be found in Article 30 of the treaty, which allows each contracting state to fight against tax evasion by applying their own domestic anti-abuse rules.
The tax influence of the UN model
Taking into accounts all these facts, the BEPS influence on the treaty is undeniable. But the reason why this treaty can be seen as a small revolution in the Luxembourg international tax framework is the fact that other significant tax characteristics of the treaty are clearly influenced by the UN model.
One of the main differences between the OECD and UN models is in the criteria for the allocation of the right to tax. In the OECD model, the right to tax is shared between the source country and the residence country. And while the OECD tends towards residence taxation criteria, the UN model is oriented more towards source taxation.
It is interesting to highlight that the Luxembourg–Senegal treaty demonstrates a reinforced orientation towards source-based taxation. In most of the articles, withholding tax is allowed, demonstrating a willingness to avoid depriving a State from its taxing rights. In fairness to taxpayers, this withholding tax maximum rate is, however, capped.
This influence by the UN model may not appear very significant, but it is: it should have sizeable consequences, and majorly transform the traditional double tax treaties signed with African countries. Why? Because all these tax influences tend towards fairer treaties.
Importantly, the idea of fair taxation brings an ethical side in a field more known nowadays for its controversy.
Beneficial co-operation: a fair share of taxing rights for both states
Assuming that this treaty does show Luxembourg’s willingness to meet the goal of fairer taxation, one could reasonably wonder why and how the different models were mixed.
One of the recurrent criticisms of the OECD model, and also of the BEPS project, is that the allocation of taxing rights and the proposed measures are efficient only if the flow of transaction between the contracting states is similar. In this case, if a treaty taxation is residence-based then no significant impact should be observed, as the contracting states should reciprocally receive an equal number of taxed transactions.
However, between a developed country and a developing one, the situation is different: the number of transactions could significantly differ. Most of the time, the investors are tax residents in the developed country, which is usually more internationally oriented, and the income is taken from the developing country and put in the other state. This means, from a practical point of view, that under the OECD model most of the income is taxed by the developed country. Furthermore, a double tax treaty, in most cases, offers lower rates than the domestic ones—this leads to an unfair situation where the developing country doesn’t benefit from its fair share of tax.
Senegal’s DTT with Mauritius could serve as an example of problematic residence-based taxation. Unlike its treaty with Luxembourg, Senegal’s DTT with Mauritius states that dividends, interests, and royalties should only be taxed in the country of residency of the beneficial owner. This results in an impossibility for Senegal to tax the revenue insofar as the beneficial owners are based in Mauritius, whereas through the Luxembourg treaty Senegal keeps the ability to tax, at source, the profits generated.
This is the reason why the UN’s influence on the treaty is so central, making it more than a show of willingness. Indeed, the treaty is a balanced and ethical one.
An opportunity for the AI funds industry
In an environment where public opinion is skeptical, and often negative, about tax—and thus where businesses are under growing reputational risk—this treaty should reduce uncertainty for investors considering doing business in Senegal. It will also help prevent reputational damages.
Most importantly, perhaps, it could also bring many opportunities to investors: trade, exchanges, knowledge, technology transfers, investments, growth… Senegal is a fast-growing market in Africa and a significant business location for Luxembourg investors, as shown by financial exchanges in 2017, which amounted to nearly 140 million euros.
From an alternative investment standpoint, the treaty provisions generally offer more favorable withholding tax rates than those of competing treaties with Senegal (5% for dividends, 10% for interest, and 10% for royalties). By signing the treaty, Luxembourg has positioned itself well for investors interested in a business relationship with Africa.
Should you want further information or advice regarding this topic, please contact KPMG Luxembourg.
Read more about this topic here.
Next up on the KPMG Blog: