During the past few decades, Luxembourg, located in the heart of Europe, has developed a financial centre, originally active for the private banking sector, growing into a truly diversified hub for investment funds, banks, insurance and reinsurance companies, holding companies and family offices. The attractiveness of Luxembourg is, among others, due to its flexible and practical corporate law, the broad range of various legal forms of companies, partnerships and associations available under national law, the rapidity of company formation and also to its tax framework, such as an extensive double tax treaty network and participation exemption.
II Local Developments
i Entity selection and business operations
Corporate law provides a wide range of legal forms of companies and partnerships. Historically, Luxembourg entrepreneurs have used commercial partnerships to carry out their activities. However, in the past decade this trend has shifted towards a more frequent use of corporate vehicles in this context. Inversely, in the funds area, the new common and special limited partnerships (CLPs and SLPs) have gained substantial recognition in the market.
Limited liability companies
Luxembourg-resident companies are fully subject to corporate income tax (CIT), municipal business tax (MBT) and net wealth tax (NWT). Depending on the need of the shareholders, they may generally adopt a corporate form such as a public limited company, a limited liability company or a corporate partnership limited by shares.
A limited liability company is subject to CIT, MBT and NWT if it is considered under Luxembourg law as a Luxembourg resident. Under Luxembourg law, a company is considered as a Luxembourg resident if its registered office (i.e., statutory office as determined by the articles of incorporation of the company) or its central administration (i.e., the place of effective management of the company) is located in Luxembourg. From a pure Luxembourg tax law standpoint, one of these two criteria is sufficient to consider a company as a Luxembourg resident and, generally, no additional mandatory substance requirements should be fulfilled for the company to be considered as a Luxembourg resident (except for companies engaged in intra-group financing activities). In an international context, however, the absence of sufficient economic substance in Luxembourg or maintaining closer links with another foreign jurisdiction may result in foreign tax authorities challenging the Luxembourg tax residence of the company. Therefore, in an international context, Luxembourg companies should have a minimum level of economic substance in Luxembourg.
There are mainly two types of limited partnerships under Luxembourg law: the CLP and the SLP. The specificity of CLPs and SLPs is that they are transparent for Luxembourg tax purposes. The main difference between them is that a SLP, unlike a CLP, is not vested with legal personality. Both limited partnerships regimes have proven to be widely accepted and used by all persons wishing to have an onshore European domiciled partnership with similar features to Anglo-Saxon types of partnership structures.
Owing to their tax transparency, they are not subject to CIT or NWT. However, a CLP or SLP may be subject to Luxembourg MBT if it carries out a genuine business activity in Luxembourg pursuant to Article 14(1) of the Luxembourg income tax law (ITL)2 or if it is tainted by business on the basis of the Geprägetheorie according to Article 14(4) of the ITL – namely where the general partner is a Luxembourg limited liability company that owns at least 5 per cent of the interests in the CLP or SPL. As regards this business activity, Circular letter L.I.R. No. 14/4, dated 9 January 2015, provides that CLPs and SLPs that qualify as alternative investment funds within the meaning of the Alternative Investment Fund Management law of 12 July 20133 are deemed not to be conducting a business activity.
The qualification of a CLP or SLP being subject to MBT would, besides tax liability, also result in the (material) consequence of non-resident limited partners being considered to each operate a permanent establishment (PE) in Luxembourg, as their interest in the CLP or SLP would generally be attributable to the PE in Luxembourg (unless under a double tax treaty where different provisions would apply). In principle, because of the non-MBT exposure of a properly structured CLP or SLP, independent professionals tend to structure their activity through such transparent entities. With regard to withholding tax (WHT), any 'distributions' by the partnership are, as a rule, made free of WHT in Luxembourg. Distributions are performed for corporate reasons only, but are disregarded from a tax perspective, as any income and loss derived at the level of the partnership is directly attributable to the partners.
Given its tax transparency, CLPs or SLPs may not benefit from double tax treaties but their partners may generally claim treaty benefits from the source state.
Under Luxembourg law, a full range of different vehicles are available to structure investments. As a general rule, those investment vehicles benefit from an advantageous tax regime. They consist of the following important investment vehicles:
- tailor-made investment funds, (i.e., undertakings for collective investment (UCIs), a special investment fund (SIFs) or a reserved alternative investment fund (RAIFs) opting for the SIF-like regime), which can take different corporate forms;
- companies investing in risk capital (SICARs), and RAIFs opting for the SICAR-like regime, which can take different corporate forms;
- common funds;
- securitisation undertakings;
- pension funds; and
- family wealth management companies (which are often structured together with a limited liability company and financed mainly with loans to benefit from the final 20 per cent WHT on interest distributions to Luxembourg-resident individuals; see the subsection on 'Withholding taxes').
The investment vehicles mentioned under points (a) and (e) and are thus only subject to a subscription tax without being subject to WHT on distributions to investors. It must be analysed on a case-by-case basis whether double tax treaties are applicable to these vehicles.
SICARs, such as mentioned in point (b), are fully subject to taxation but exempt from taxation on income arising from assets held in risk capital. As the purpose of a SICAR is limited to investments in risk capital, all of its income should thus be exempt from taxation. If SICARs opt for an opaque entity form, double tax treaties should, in principle, be applicable to them.
Domestic income tax
CIT and MBT
The taxable profit as determined for CIT purposes is applicable, with minor adjustments, for MBT purposes. MBT rates vary depending on the municipality in which the company's registered office or undertaking is located.
In 2019, CIT is levied at an effective maximum rate of 18 per cent (19.26 per cent, including the 7 per cent surcharge for the employment fund) for corporate income above €30,000. An intermediary rate of €3,750 plus 33 per cent of net income exceeding €25,000 is also available for corporate income between €25,000 and €30,000. Finally, a lower rate of 15 per cent for corporate income below €25,000 may also be applicable. MBT is levied at a variable rate according to the municipality in which the company is located (6.75 per cent for Luxembourg City in 2019). The maximum aggregate CIT and MBT rate consequently amounts to 26.01 per cent in 2019 for companies located in Luxembourg City.4
Luxembourg imposes NWT on Luxembourg-resident companies at the rate of 0.5 per cent (or 0.05 per cent for the upper tranche of net worth exceeding €500 million) applied on net assets as determined for NWT purposes. Net worth is referred to as the unitary value, as determined in principle on 1 January of each year. The unitary value is calculated as the difference between assets estimated at their fair market value and liabilities regarding third parties. In that respect, third-party liabilities in relation to exempt assets are not deductible when computing the unitary value.
Further, Luxembourg-resident companies are subject, as of 1 January 2016, to a minimum NWT. This is set at €4,815 for Luxembourg companies whose financial assets, receivable against related companies, transferable securities and cash deposits, cumulatively exceed 90 per cent of their total balance sheet and €350,000. All other companies that do not meet the aforementioned conditions are subject to a minimum NWT on the basis of their total balance sheet at year end, according to a progressive tax scale varying from €535 to €32,100 respectively for a total balance sheet from €350,000 to at least €30,000,001.
Dividends paid by a Luxembourg company to its shareholders are, as a rule, subject to WHT at a rate of 15 per cent.
An arm's-length interest paid by a Luxembourg company is generally not subject to WHT. However, a payment of interest or similar income made by a paying agent established in Luxembourg (or under certain circumstances in the European Union or the European Economic Area (EEA)) to or for the benefit of an individual owner who is a resident of Luxembourg, will be subject to a WHT of 20 per cent. This WHT will be in full discharge of income tax if the beneficial owner is an individual acting in the course of the management of his or her private wealth. Responsibility for WHT is assumed by the Luxembourg paying agent.
Liquidation proceeds (deriving from a complete or partial liquidation) paid by a Luxembourg company are not subject to WHT.
Royalties paid by a Luxembourg company are generally not subject to WHT.
Fees paid to directors or statutory auditors are subject to a WHT levied at the rate of 20 per cent on the gross amount paid (25 per cent if the withholding cost is borne by the payer). WHT is the final tax for non-resident beneficiaries if their Luxembourg-sourced professional income is limited to directors' fees not exceeding €100,000 per fiscal year.
International tax – double taxation elimination method
Luxembourg has an extensive double tax treaty network and has signed, as at the time of writing, double tax treaties with 83 countries, and is in negotiation to sign a double tax treaty with 15 more countries.
In the absence of a double tax treaty, resident taxpayers are generally subject to Luxembourg income tax on their worldwide income, but unilateral credit relief is generally available.
Under treaties concluded by Luxembourg, double taxation is generally avoided by way of an exemption method with a progressivity clause that permits the inclusion of foreign income into the Luxembourg tax base to determine the global tax rate. As an exception, Luxembourg generally relies on the credit method regarding dividends, interest and royalties. Some double tax treaties concluded by Luxembourg provide tax-sparing clauses, which should also apply to Luxembourg PEs of US-resident companies.
According to the general practice adopted by the Luxembourg tax authorities (LTA), the debt-to-equity ratio applicable to a fully taxable Luxembourg limited liability company is 15 for equity to 85 for all liabilities combined (shareholder and third-party debt, represented or not by an instrument). It is understood that these liabilities finance the acquisition of participations and bear a market interest rate.5 (See 'Transfer pricing consideration' subsection for the equity at risk requirements in relation to an intra-group financing transaction.)
ii Common ownership – group structures and intercompany transactions
Ownership structure of related parties – fiscal unity
Under certain conditions, Luxembourg-resident companies of the same group are allowed to consolidate their taxable profits and losses for CIT and MBT purposes.
The main conditions of the fiscal unity regime may be summarised as follows:
- the consolidating parent company must be either a fully taxable resident company or a Luxembourg PE of a non-resident company liable to a tax corresponding to Luxembourg CIT;
- the consolidated subsidiaries must be either fully taxable resident companies or Luxembourg PEs of non-resident companies liable to a tax corresponding to Luxembourg CIT;
- the consolidating parent company must hold, either directly or indirectly, a participation of at least 95 per cent in the share capital of the consolidated subsidiaries. Participation of at least 75 per cent may also qualify for fiscal unity, but is subject to the approval of the Ministry of Finance and of at least three-quarters of the minority shareholders. Indirect participation of at least 95 per cent may further be held through non-resident companies liable to a tax corresponding to the Luxembourg CIT. The participation condition must be uninterruptedly satisfied as of the beginning of the first accounting period for which the fiscal unity is requested; and
- the regime is granted upon written application filed jointly by the consolidating parent and the consolidated subsidiaries for at least five years. The application must be filed before the end of the first accounting period for which fiscal unity is requested.
Since 2016, horizontal fiscal unity has been permitted between qualifying companies that are held by a common parent company established in an EEA Member State and subject to a tax corresponding to CIT. This is fiscal unity between two or more Luxembourg-resident companies owned by the same non-resident parent, provided that the parent company is resident in a state of the European Economic Area.
Participation exemption regime and other exemptions applicable to dividends, liquidations proceeds and capital gains
Dividends and liquidation proceeds
To qualify for the participation exemption on dividends and liquidation proceeds, the following conditions must be met (Article 166 ITL):
- the parent company must be either:
- a Luxembourg-resident fully taxable company;
- a Luxembourg PE of a company covered by Article 2 of the amended EU Parent-Subsidiary Directive6 (PSD);
- a Luxembourg PE of a company resident in a country having a tax treaty with Luxembourg; or
- a Luxembourg PE of a company that is resident in a Member State of the European Economic Area, other than an EU Member State;
- the parent must hold a direct participation in the share capital of an eligible entity (the eligible entity), namely:
- a Luxembourg-resident fully taxable company;
- a company covered by Article 2 of the PSD; or
- a non-resident company liable to a tax corresponding to Luxembourg CIT;7 or
- at the time the income is made available, the parent company must have held or must commit itself to hold a participation in the eligible entity for an uninterrupted period of at least 12 months, a participation of at least 10 per cent or an acquisition price of at least €1.2 million. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
If the conditions for the participation exemption are not satisfied, dividends are as a rule taxable at the ordinary rate. As an exception, a 50 per cent exemption is available for dividends derived from a participation in one of the following entities:
- a Luxembourg-resident fully taxable company limited by share capital;
- a company limited by share capital resident in a state with which Luxembourg has concluded a double tax treaty and liable to a tax corresponding to Luxembourg CIT; or
- a company resident in an EU Member State and covered by Article 2 of the amended PSD.
Capital gains realised on the transfer of participations are exempt under the following conditions (Article 166(9)(1) ITL and Grand-Ducal Decree of 21 December 2001):
- the parent and the entity in which the participation is held must satisfy the same conditions as those applicable for the exemption of dividends (see the subsection on 'Dividends and liquidation proceeds'); and
- the parent must have held or commit itself to hold a direct participation in the share capital of the eligible entity for an uninterrupted period of at least 12 months, a participation of at least 10 per cent or an acquisition price of at least €6 million. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
If the above-mentioned conditions are not met, capital gains are as a rule taxable at the ordinary rate.
However, the participation exemption regime contains some rules intended to avoid a double benefit – namely the exemption of capital gains realised by a Luxembourg company upon disposal of its participation would not apply to the extent of the algebraic sum of related expenses and value adjustments that have decreased the tax result of the current or preceding years. Nevertheless, losses in relation to exempt income under the participation exemption remain deductible once they become final.
Outbound dividend distribution
Dividends paid by a Luxembourg company to its shareholders are as a rule subject to a 15 per cent WHT, unless a reduced rate or an exemption applies under an applicable double tax treaty, or because of the participation exemption regime.
Under Article 147 of the ITL, dividend payments made by a fully taxable Luxembourg company may be exempt from WHT provided that, at the time the income is made available:
- the distributing entity is a Luxembourg-resident fully taxable company;
- the recipient is either:
- a Luxembourg-resident fully taxable company;
- a company covered by Article 2 of PSD or a Luxembourg PE thereof;
- Luxembourg, a municipality, a syndicate of municipalities or local corporate bodies governed by public law;
- a company liable to a tax corresponding to Luxembourg CIT, and a resident of a country with which Luxembourg has a double tax treaty or a Luxembourg PE thereof;
- a company resident in an EEA Member State other than an EU Member State, and liable to a tax corresponding to the Luxembourg CIT or a Luxembourg PE thereof; or
- a Swiss-resident company8 that is effectively subject to CIT in Switzerland without benefiting from an exemption; or
- at the time the income is made available, the recipient holds or commits itself to hold directly for an uninterrupted period of at least 12 months a participation of at least 10 per cent or an acquisition price of at least €1.2 million in the share capital of the distributing entity. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
Such an application of the national participation exemption could be envisaged in the case of dividends distributed by a Luxembourg-resident company to its eligible shareholder in the form of a US real estate investment trust.
The participation of a Luxembourg company in another company will be considered as an exempt asset for NWT tax purposes to the extent the conditions of the Luxembourg participation exemption regime, as described above, are met (except that the Luxembourg company must merely hold the qualifying participation at the end of the previous accounting year).
Transfer pricing considerations
As a general rule, Luxembourg does not levy any WHT on arm's-length interest payments. However, companies engaged in intra-group financing activities need to evidence that their remuneration complies with the arm's-length principle. According to the OECD's arm's-length principle, activities that are carried out between affiliated companies must comply with market conditions, namely conditions that would apply between independent companies.
To provide practical guidance to companies engaged in intra-group financing activities and following the implementation of the new Article 56 bis of the ITL, the LTA issued a circular letter,9 dated 27 December 2016, which follows the OECD guidelines in transfer pricing matters.
Transfer pricing considerations, inter alia, apply to all companies that are engaged in intra-group financing transactions.
Determination of the arm's-length price
The comparability analysis is the main element for the application of the arm's-length principle: the arm's-length principle is based on a comparison of the conditions of a controlled transaction with the conditions that would have been made had the parties been independent had they undertaken a comparable transaction under comparable circumstances.
Equity at risk
Companies engaged in intra-group financing activities must have the financial capacity – or equity at risk – to assume the risks related thereto. The amount of equity at risk must hence be determined by an appropriate transfer pricing analysis on a case-per-case basis. No specific methodology is foreseen but equity at risk needs to be determined on the basis of a credit risk analysis, which includes a market analysis, a balance sheet analysis as well as all the other elements that are relevant for the determination of the risks linked to a financing activity.
To be able to control the aforementioned risks, an intra-group financing company must have a genuine presence in Luxembourg, which requires a minimum of economic substance in Luxembourg, as follows:
- the majority of the members of the board of managers, directors or managers having power to bind the company must be (1) Luxembourg residents or (2) non-residents who pursue a professional activity (i.e., a business or agricultural, forestry, independent or salaried activity) in Luxembourg and who are taxable in Luxembourg for at least 50 per cent of their professional revenue. If a company is part of the management board, it must have its statutory seat and central administration in Luxembourg;
- the company must have qualified personnel able to control the transactions performed. The company may, however, outsource functions that do not have a significant impact on the control of the risks;
- key decisions regarding the management of the company must be taken in Luxembourg. Companies that are required by corporate law to hold shareholder meetings must hold at least one annual meeting at the place indicated in the articles of incorporation; and
- the company must not be considered as a tax resident of another state.
iii Other tax incentives
On 1 January 2018, a new intellectual property box regime (the IP Box Regime) following the modified nexus approach (as proposed by the Base Erosion and Profit Sharing (BEPS)Action 5) entered into force. Eligible IP assets are mainly limited to patents, software protected by copyright under national or international provisions in force, and utility models. IP assets of a commercial nature are excluded. Taxpayers that carry out an economic activity in Luxembourg, including certain PEs, are entitled to the IP Box Regime (80 per cent exemption from CIT and MBT) according to a nexus approach on the net income from the eligible IP asset. Eligible IP assets are 100 per cent exempt from NWT.
Investment tax credits are available to Luxembourg companies and Luxembourg PEs of non-resident companies for their qualifying investments physically used in a country of the European Economic Area. As a general rule, qualifying investments include, among others, tangible depreciable assets other than buildings and livestock, and mineral and fossil deposits. As such, tax credits can be available to Luxembourg companies for certain assets financing, for example, planes or software that has been acquired (as opposed to self-developed), and can be extended inter alia to the shipping industry under specific rules.
iv Indirect taxes
In 2019, the standard value added tax (VAT) rate in Luxembourg is 17 per cent. Reduced rates of 3 per cent, 8 per cent and 14 per cent apply to supplies of goods and services that are specified in three appendices to the Luxembourg VAT Law.10 These appendices cover the specific scope of the application of the reduced rates and must be interpreted in a strict sense. The Finance Bill envisages the introduction of a reduced VAT rate of 3 per cent for e-books and e-press, as well as certain hygienic products, of 8 per cent for certain phytosanitary products and an increase in excise duties on petrol.
All supplies of goods and services carried out (or deemed to have been carried out) in Luxembourg for consideration, and by a person carrying out an economic activity, fall within the scope of the Luxembourg VAT Law. While located in Luxembourg, certain supplies of goods and services may benefit from a VAT exemption. The most frequently used VAT exemptions relate to: the supply and letting of real property, except where taxation is opted for; financial transactions; insurance and reinsurance, and connected services; and the management of regulated UCIs, SICARs, SIFs, alternative investment funds, pension funds and Luxembourg securitisation undertakings.
Persons that are closely bound by financial, economic and organisational links (cumulative conditions) can constitute a VAT group. A VAT group does not provide for any limitation as regards the status of the person (i.e., VAT taxable or not), or the nature or type of activity (e.g., VAT exempt or taxable supply of services or goods). However, persons may only be members of one VAT group and the members of a VAT group must be established within the same EU Member State (no cross-border VAT groups). Members of a VAT group are considered as a single entity for VAT purposes, with the result that supplies and services provided among members of a VAT group (i.e., internal transactions) are outside the scope of VAT.
III International Developments and Local Responses
i OECD-G20 BEPS initiative – the implementation of the ATAD in Luxembourg law
The EU Anti-Tax Avoidance Directive (ATAD)11 was adopted by the Council of the European Union to implement the OECD's recommendation in its BEPS project and aims to prevent aggressive tax planning, increase transparency and create a fairer environment for businesses in the European Union.
Accordingly, the ATAD sets measures to be adopted by all EU Member States in the following five specific areas:
- interest limitation rules;
- exit taxation rules;
- a general anti-abuse rule;
- controlled foreign companies (CFC) rules; and
- hybrid mismatch rules.
The ATAD lays down minimum rules that should be implemented into national law by EU Member States. It was implemented into Luxembourg law on 21 December 201812 (the ATAD Law).
Interest limitation rules
As a general principle, under interest limitation rules applicable as of tax year 2019, a corporate taxpayer is no longer allowed to deduct net borrowing costs exceeding 30 per cent of its EBITDA (earnings before interest, tax, depreciation and amortisation), or €3 million. The net borrowing costs correspond to the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest, revenues and other economically equivalent taxable revenues that the taxpayer receives in accordance with national law.
The purpose of CFC rules provided under the ATAD is to re-attribute the income of a low-taxed controlled subsidiary to its parent company, which will then become taxable on this income.
The CFC rules generally apply in Luxembourg as of tax year 2019, if the following cumulative criteria are fulfilled:
- the level of participation – namely direct or indirect holding via related entities of more than 50 per cent of voting rights or capital, or entitlement to more than 50 per cent of the profits of the entity;
- the amount of tax paid by the CFC – namely whether the actual CIT paid by the entity or PE on its profits is lower than the difference between the CIT that would have been charged in Luxembourg and the actual CIT paid by the entity (or PE); and
- non-genuine arrangements – namely the entity (or PE) neither owns the assets that generate its income nor would have undertaken the related risks that generate all, or part of, its income if it were not controlled by a taxpayer where the significant people functions linked to those assets and risks are carried out and are instrumental in generating the CFC income.
Hybrid mismatch rules
The ATAD implements rules to avoid mismatches in the legal characterisation of a financial instrument or entity in an arrangement structured between (1) a Luxembourg taxpayer and an associated enterprise in another EU Member State, or (2) when the commercial or financial relations between a Luxembourg taxpayer and an associated enterprise in another Member State give rise to a double deduction (DD) or to a deduction without inclusion (D/NI).
The thresholds to characterise an associated enterprise are 25 per cent or more of voting rights, capital or entitlement to 25 per cent or more of profits in the case of hybrid payments, and 50 per cent or more of voting rights, capital or entitlement to 50 per cent or more of profits in the case of a hybrid entity.
If a hybrid mismatch results in a DD, the deduction shall be given only in the EU Member State of the payer, whereas if a hybrid mismatch results in a D/NI, the EU Member State of the payer shall deny the deduction.
The ATAD Law implements the above-mentioned rules for hybrid mismatches between EU Member States as of 1 January 2019. On 25 October 2016, the European Commission presented an amended version of the ATAD (ATAD II), which was adopted on 29 May 2017 by the European Council. The ATAD II mainly contains anti-abuse rules in respect of hybrid mismatch arrangements involving third countries. Like the ATAD – which only applies to hybrid mismatch arrangements in EU Member States – the ATAD II provides that if a hybrid mismatch arrangement results in a DD (i.e., deduction from the tax base in the source state and no inclusion in the tax base in the state of residence), the deduction is granted only in the source state. The state of residence includes the amount in the tax base. If the state of residence does not include the amount in the tax base, the source state refuses the deduction. The ATAD II will be included in a separate bill of law (with an entry into force as of 1 January 2020, and 1 January 2022 for reverse hybrids at the latest).
Under the ATAD, a transfer of assets by the taxpayer from the head office to a PE in another Member State or in a third country – whereby the Member State of the head office no longer has the right to tax the transferred assets owing to the transfer – triggers, as a rule, capital gains taxation on the asset (i.e., taxation of the difference between the fair market value and the book value of the assets at the date of the transfer).
The same treatment applies to:
- a transfer of assets from a PE to its head office, or another PE in another Member State or in a third country;
- a transfer of the taxpayer's tax residence to another Member State or to a third country, except for those assets that remain effectively connected with a PE in the first Member State; and
- a transfer of the taxpayer's business carried on by a PE from a Member State to another Member State or to a third country.
For EU and EEA transfers, the taxpayer may be entitled to defer the payment of the exit tax over five annual instalments. Certain temporary transfers not exceeding 12 months are excluded.
Asset transfers related to the financing of securities, assets posted as collateral, or where the asset transfer takes place to meet prudential capital requirements or for the purpose of liquidity management, provided that the assets are set to revert to the transferor within 12 months, are excluded from the exit tax rules.
The exit tax rules under the ATAD, such as implemented under the ATAD Law, will become applicable as of 1 January 2020.
The current Luxembourg exit tax regime provides, under certain circumstances, for an optional deferral of the payment of tax on capital gains realised upon a migration, without any time limit. This rule has been grandfathered for such deferrals for exit tax related to financial years closed before 1 January 2020, whereas events that trigger exit tax thereafter will be governed exclusively by the new exit tax rules.
General anti-abuse rule
The ATAD Law has introduced certain amendments to align the existing abuse of law concept enshrined in Section 6 of the Tax Adaptation Law with the ATAD concept of artificial arrangements. Under the amended Section 6 of the Tax Adaptation Law, there is an abuse of law if the legal route – which, having been used for the main purpose or one of the main purposes of circumventing or reducing tax contrary to the object or purpose of the tax law – is not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part. An arrangement or a series of arrangements are regarded as non-genuine to the extent that they are not put in place for valid commercial reasons that reflect economic reality. The new general anti-abuse rule applies to all types of income, including dividends, capital gains and liquidation proceeds, as well as to assets taken into account for NWT purposes.
ii Multilateral instrument
On 7 June 2017, the official ceremony for the signing of the multilateral instrument (MLI) took place, bringing to a close a process initiated the previous year when a consensus was reached on the wording on 24 November 2016. The MLI has been negotiated by more than 100 jurisdictions and Luxembourg was one of them.
Luxembourg has adopted a restrictive approach to the provisions provided for under the MLO, and has sought to limit the scope and impact of this new layer of international legislation to the minimum standards required. Key features include the principal purpose test (PPT) clause and an improved dispute mechanism system. Luxembourg has declared that the related provisions will apply to all its double tax treaties that are in force.
In summary, the PPT clause aims at denying the benefits of the covered double tax treaties to taxpayers where there is evidence that a given arrangement or transaction was set up for the principal purpose of obtaining that benefit.
IV Recent cases
A recent decision13 of the district court has highlighted once again the necessity for the taxpayer to duly document compliance with the arm's-length principle of all intra-group transactions. In the case at hand, a Luxembourg company (LuxCo) financed the acquisition of a building in France through a shareholder loan bearing an interest rate of 12 per cent. In the absence of proper transfer pricing documentation justifying this rate, the LTA considered that it was excessive and should be 3.57 per cent for 2011 and 2.52 per cent for 2012, with the requalification of excessive interest into a hidden dividend distribution that is not deductible and subject to a 15 per cent withholding. Following this, two transfer pricing reports were prepared ex post for LuxCo: the first was submitted to the LTA during the tax assessment phase but was not able to support the 12 per cent rate (with arm's-length rates ranging from 3.21 per cent to 7.88 per cent), while the second transfer pricing report justifying it (with an arm's-length range of 9.95 per cent to 19.61 per cent) was prepared during the litigation phase. Even though the district court concluded that the second transfer pricing documentation was admissible, it confirmed LTA's view as LuxCo was not able to explain the differences in outcomes and inconsistencies between the two transfer pricing reports.
A second decision14 of the district court focuses on the arm's-length principle of intercompany transactions. In the case at hand, LuxCo waived loans granted to subsidiaries and depreciated participations in subsidiaries upon the acquisition of those participations. In LTA's view, LuxCo's decisions did not correspond to what independent parties would do – especially as they could not be justified economically.
The above case law shows the increased focus of the LTA on transfer pricing. Taxpayers should have proper transfer pricing documentation available at the LTA's request to support their compliance with the arm's-length principle of intercompany transaction as well as the economic reality of their transactions.
1 Eric Fort and Jan Neugebauer are partners and Philipp Jost is a senior associate, at Arendt & Medernach. The authors would like to thank Delphine Calmes, associate at Arendt & Medernach, for her valuable contribution.
2 The Income Tax Law dated 4 December 1967, as amended.
3 Implementing the Alternative Investment Fund Managers Directive 2011/61/EC.
4 On 5 March 2019, the Luxembourg government filed the new finance bill No. 7450 with the parliament (the Finance Bill), which envisages (1) increasing the amount of net profits subject to the minimum rate of 15 per cent from €25,000 to €175,000, (2) introducing an intermediary rate of €26,250 plus 31 per cent of net profits exceeding €175,000 if net profits range between €175,000 and €200,000, and (3) lowering the marginal rate from the current 18 per cent to 17 per cent, applicable if the net profits exceed €200,000. Accordingly, the maximum aggregate CIT and MBT rate would consequently amount to 24.94 per cent (instead of 26.01 per cent) in Luxembourg City. The Finance Bill should enter into force on 1 May 2019, the reduction of the CIT rate being, however, applicable to the tax year 2019.
5 In the case of non-compliance with this ratio, interest in relation to the excess of liabilities can be considered as hidden dividends for tax purposes. The consequence is that this excess interest is not deductible and is potentially subject to a 15 per cent WHT under the same conditions as distributed dividends.
6 EU Directive 2011/96/EU of 30 November 2011 as amended on the common system applicable in the case of parent companies and subsidiaries of different Member States.
7 See footnote 4.
8 Namely a Swiss corporation organised under the form of either a public limited company, a limited liability company or a corporate partnership limited by shares.
9 Circular Letter L.I.R. – No. 56/1 – 56bis/1.
10 The Value Added Tax Law dated 12 February 1979, as amended.
11 Directive 2016/1164/EU of 12 July 2016, laying down rules against tax avoidance practices.
12 Luxembourg law dated 21 December 2018 implementing the ATAD.
13 Decision No. 40348 dated 22 October 2018.
14 Decision No. 40251 dated 7 January 2019.