I INTRODUCTION

Situated in the heart of Europe, Luxembourg has built its role as a major European financial centre on its political stability, good communications and powerful service sector. At the same time, its limited dimensions have allowed it to maintain a certain degree of flexibility in its legal system and to cope easily with an ever-increasing volume of foreign investments.

II COMMON FORMS OF BUSINESS ORGANISATION AND THEIR TAX TREATMENT

There are several forms of entity with separate legal personality through which business can be carried out in Luxembourg:

    • a corporate entities:

• public limited company (SA);

• private limited company (SARL); and

• public company with both limited and unlimited liability shareholders (SCA); and

  • b non-corporate entities:

• general partnership (SNC);

• limited partnership (SCS); and

• special limited partnership (SLP).

The above-mentioned corporate entities are fully subject to corporate income tax, municipal business tax and net wealth tax, and can therefore be considered opaque for tax purposes.

The SARL is the most frequently used corporate form owing to the favourable combination of its limited liability, the flexibility of its statute and corporate rules, and the limited minimum capitalisation requirements.

Even if the partnerships listed above have legal personality (with the exception of the SLP), from a corporate income tax perspective they are not separate from their partners, and are therefore transparent. The partnership is considered as a mere collection of the partners’ individual businesses: even though the taxable commercial income is determined at the level of the partnership, it is attributed and taxed pro quota directly to the partners. Municipal business tax is instead levied directly from the partnerships that carry on commercial activity or that are deemed to carry on commercial activity by virtue of the commercial nature of the majority of their partners (SNC) or of some partners holding a minimum interest in the partnerships (SCS and SLP). An SNC in which the majority of interests are held by a capital company and an SCS or SLP having a capital company as general partner holding at least a 5 per cent interest are deemed to derive commercial income irrespective of their actual activity, and as such are fully subject to municipal business tax. For the purpose of determining the nature of the activity carried out by a partnership whose interests are (fully or partially) held by another partnership, the latter is considered as a capital company when it carries out a commercial activity or is deemed to do so.

In 2013 the SLP, a special limited partnership without legal personality that otherwise shares most legal features with the SCS, was introduced. The same law introducing the SLP modernised the rules concerning the establishment and the management of the SCS.

The purpose of the modernisation of the SCS and the introduction of the SLP is to ease the establishment of vehicles suitable for the structuring of unregulated funds. The tax treatment of the modernised SCS and of the SLP should not differ from the current tax treatment of the SCS briefly outlined above.

III DIRECT TAXATION OF BUSINESSES

i Tax on profits

Business income is subject to corporate income tax and to municipal business tax. Since the taxable basis of these taxes is to a large extent the same, the rules for its determination are examined together, and the main differences are highlighted where relevant.

Determination of taxable profit

Resident taxpayers are taxed on their worldwide income on a yearly basis, whereas non-resident taxpayers are taxed in Luxembourg only on income sourced therein. In principle, income is determined and taxed separately for each category of income, but corporate entities and deemed commercial partnerships are considered to derive only business income. In general, the commercial profit of an entity is defined as the increase in value of its net assets over the fiscal year, adjusted for capital contributions, capital repayments and profits distributed. The determination of the net assets’ value is based on the accounts of the company. Therefore, the taxable profit in principle coincides with the financial result and is determined on an accrual basis, unless specific tax rules expressly deviate from the accounting rules or a special tax regime is in place. For this purpose, a ‘fiscal balance sheet’ is prepared, where the accounting values of the assets and liabilities are replaced by the values of the same that should be used for tax purposes where different. In broad terms, all the expenses that are related to the business are deductible unless they refer to exempt income. Some expenses are explicitly classified as deductible (e.g., non-creditable foreign taxes and VAT, real estate tax and capital duty, depreciation and amortisation), whereas some expenses are explicitly classified as non-deductible (e.g., corporate income tax, municipal business tax, net wealth tax, directors’ fees referred to supervisory services, fines, non-qualifying gifts, profits distributions).2

For municipal business tax purposes, profits and losses derived through a foreign permanent establishment (PE) are not taken into account; nor are profits and losses already taxed at the level of a commercial partnership of which the taxpayer is a member.

Capital and income

Capital gains are included in the taxable basis for corporate income tax and municipal business tax, and taxed at the ordinary rates.3

Losses

Losses can be carried forward and offset against the taxable income of the same taxpayer that generated them on the condition that they result from acceptable accounts for 17 consecutive years. The losses generated before 2017 can be carried forward indefinitely. When a corporate reorganisation takes place (e.g., merger), the losses generated by an entity that disappears as a consequence of the reorganisation (e.g., the merged company) cannot be carried forward by the company resulting from it (e.g., the merging company). According to recent case law, a change in the ‘economic owner’ of the losses (e.g., change in the ownership of the loss-making company) is of no prejudice to the carry-forward of losses unless the abusive intent of the reorganisation that led to a major change in the ownership of the company is demonstrated. Trading of loss-making companies for tax-saving purposes when no other economic reasons can be demonstrated is still not possible. No carry-back of losses is allowed.

Rates
Corporate income tax

The fiscal reform of 2017 introduced new tax rates. For the fiscal year 2017, the rate is 15 per cent for income not exceeding €25,000, 39 per cent for income between €25,001 and €30,000 and 19 per cent for income exceeding €30,001. For 2018, those rates would respectively change to 15, 33 and 18 per cent.

A 7 per cent solidarity surcharge applies to the aforementioned rates, leading to mainstream rates of 20.33 per cent (2017) and 19.26 per cent (2018).

Municipal business tax

The tax rate is determined every year by each municipality. For Luxembourg City, the current rate is equal to 6.75 per cent.4

Administration

As a general rule, the fiscal year coincides with the calendar year. In such a case, companies have to file electronically with the competent office of the Luxembourg Inland Revenue the annual corporate income tax, municipal business tax and net wealth tax returns, along with the commercial and fiscal balance sheets, by 31 May of the next year. Under certain conditions, this deadline can be postponed at the request of the taxpayer. After a preliminary review of the returns, the tax authorities can request further documents and information, or invite the taxpayer to discuss potential adjustments of the returns submitted. A final assessment is then issued: the amounts due, net of the quarterly advance payments made, have to be paid within one month. Alternatively, and at the option of the tax authorities, a self-assessment procedure can apply, whereby an assessment is issued based on the tax returns submitted by the taxpayer requesting the immediate payment of the corporate taxes computed on such basis. The assessment can be reviewed later by the tax administration before the ordinary statute of limitation expires, potentially giving rise to a higher corporate tax liability. The taxpayer can file an appeal against the final assessment within three months of its receipt, provided that such assessment leads to an actual claim from the tax administration (i.e., following the assessment, the taxpayer is not in a loss position). The decision of the head of the tax authority can be appealed before the Administrative Tribunal within three months, whereas the decision of the Administrative Tribunal can be appealed before the Administrative Court. The risk of a litigation procedure can be limited by asking for clarification by the tax authorities where there is uncertainty as to a correct interpretation of the tax law applied to specific circumstances (see Section IX.iv). The statute of limitation for the assessment and the collection of income tax is generally five years following the end of the calendar year in which the tax liability arose.

Tax grouping

If an option thereto is made before the end of the respective calendar year, a fiscal unity regime is available for corporate income tax and municipal business tax purposes to a Luxembourg parent company or to a Luxembourg PE of a foreign company fully subject to a tax comparable to the domestic corporate tax (group parent), as well as to qualified subsidiaries (group subsidiaries, together with the group parent, the group). As of 2016, the fiscal unity regime is also available to the Luxembourg subsidiaries of an EEA country fully subject to a tax comparable to the domestic corporate tax, or to a PE of such corporation in the EEA. Subsidiaries can be included that are controlled, directly or indirectly, by the group parent for at least 95 per cent of their capital since the beginning of the fiscal year for which the option is exercised; and have a fiscal year coinciding with the fiscal year of the group parent. The tax unity regime lasts for at least five years.

Taxable income and losses of each company pertaining to the group are determined on a stand-alone basis and then aggregated at the level of the group parent, and adjusted to eliminate double taxation and double deduction of the same items of income. As the requirements for the application of the participation exemption regime are less strict than the requirements for the application of the tax unity, inter-corporate dividends paid under a tax unity regime are already fully exempt and do not need to be adjusted when determining the profit of the group. Losses generated prior to the tax unity can be used to offset the income of the group up to the taxable income of the group subsidiary that generated them. Once the regime ends, losses generated during the tax unity have to be left at the level of the group parent.

If the fiscal unity regime is terminated within five years, or the requirements for its application are no longer met, the benefits obtained during the tax unity are recaptured and the tax liability of each company participating in the consolidation is retrospectively assessed on a stand-alone basis.

ii Other relevant taxes
Net wealth tax

Net wealth tax is levied at a 0.5 per cent rate on the estimated net realisable value (unitary value) of the assets of businesses as of the beginning of the fiscal year. As of 2016, the rate is reduced to 0.05 per cent for taxable net wealth in excess of €500 million. The profit of the previous year and carried over profits are included in the unitary value until their distribution is resolved. An independent expert’s appraisal is not required for the determination of the unitary value, which is generally determined using the accounting book values, adjusted where necessary. The unitary value of real estate assets is determined on the basis of cadastral values assessed in 1941, or ‘normalised’ to estimated 1941 values if assessed later, and hence is usually much lower than the market value. Assets giving rise to exempt or partially exempt income (i.e., exempt participations and qualifying intellectual property rights) are generally also exempt for net wealth tax purposes, and assets allocated to a foreign PE and foreign real estate are generally exempt by virtue of tax treaties signed by Luxembourg. Liabilities are generally deductible if they do not relate to exempt assets. Provisions for liabilities, the existence of which is not certain (e.g., provisions for risks), are not deductible. Net wealth tax is not deductible for income tax purposes and is generally not creditable in foreign jurisdictions. Net wealth tax is not due for the first year of existence of the company (as the assets as of 1 January are deemed to be nil). As from 2016, the minimum corporate income tax was replaced with a minimum net wealth tax. The minimum net wealth tax can be fixed (€4,815) if the financial assets of the resident corporate taxpayer in a given year exceed 90 per cent of its total balance sheet and such assets exceed €350,000, which is the case for most holding and financing companies. In all other cases, the minimum tax is contingent on the balance sheet total of the resident corporate taxpayer, and varies from €535 to €21,400 (for a balance sheet total exceeding €20 million).

Capital duty or registration tax

The proportional capital duty, previously levied on contributions to newly incorporated companies, or upon transfer of the legal seat or of the effective management of a foreign company to Luxembourg or upon the set up of a local branch of a foreign company, was abolished as of 1 January 2009 and replaced by a €75 fixed duty.

Other ad valorem or fixed registration duties may apply depending on the assets or documents registered.

Real estate taxation

A real estate tax is levied annually on the unitary value of real estate properties located in Luxembourg at a rate that depends on the classification and on the location of the property. The unitary value, determined by the tax administration in accordance with the Valuation Law, generally does not exceed 10 per cent of the market value of the property.

Value added tax (VAT)

Being an EU Member State, Luxembourg applies EU VAT Directive 2006/112/EC. Luxembourg’s standard VAT rate is the lowest in the EU (17 per cent). Luxembourg also applies reduced rates (3, 8 and 14 per cent) to various goods and services. The VAT rate of 3 per cent notably applies for radio, television and broadcasting services. This is a favourable element for media and e-commerce companies. Contrary to other Member States, Luxembourg has not implemented the ‘use and enjoyment’ rule that obliges non-registered holding companies to pay the VAT on services received from non-EU suppliers without being allowed to recover it. Following the recent case-law of the European Court of Justice, Luxembourg is expected to strictly limit – if not simply to disallow – the use of ‘independent group of persons’ (cost sharing). As a counterpart, many expect Luxembourg to implement VAT grouping in the near future. Luxembourg has also an extensive definition of regulated funds qualifying for the VAT exemption on the management of regulated funds.

IV TAX RESIDENCE AND FISCAL DOMICILE

i Corporate residence

Collective entities are considered resident in Luxembourg for tax purposes if they have their legal seat or their central administration therein. Therefore, for domestic tax law purposes, both collective entities incorporated in Luxembourg, and collective entities incorporated abroad but having their central administration in Luxembourg or having their registered office in Luxembourg, are considered resident therein for tax purposes. The central administration of an entity is deemed to be located in Luxembourg if the direction of the entity’s affairs is therein concentrated. The central administration should be determined on the basis of facts through a substance-over-form analysis; in this respect, the place where the central accounting and archives of an entity, as well as the place where the shareholders’ meetings are held, are generally considered relevant.

ii Branch or permanent establishment

A definition of PE is provided by domestic law to determine the minimum threshold of business activity a foreign taxpayer must reach in Luxembourg in order to be taxed therein on the income ‘directly or indirectly realised’ by it. The domestic definition of PE is broader than the Organisation for Economic Co-operation and Development (OECD) Model Convention definition, as it generally includes a ‘place which serves for the operation of an established business’, and therefore does not require that the business is realised ‘through it’. Further, the definition includes places of purchase and sale of goods.

In the absence of specific guidelines provided by the tax law, it is accepted that for the purposes of determining the profit derived by it, a PE should be considered as an entity separate from the foreign head office. As for domestic companies, the income of a local PE is determined on the basis of the commercial accounts, which should be adjusted to take into account the differences in the determination of the commercial profit and in that of the taxable income. The deduction of expenses is allowed to the extent that they are in a direct economic relation to the business income realised by the PE, whereas domestic companies may deduct expenses that are generically incurred ‘for the purpose of the business’. The tax authorities may – but are not obliged to – follow different criteria for the determination of the income of the PE (e.g., formulary apportionment). If the commercial accounts of the PE are considered unreliable, or if they are not supported by adequate documentation, the tax authorities may re-determine the taxable income of the PE.

Tax treaties signed by Luxembourg are mainly drafted according to the OECD Model Convention and limit the Luxembourg taxing rights of business income derived in Luxembourg by foreign taxpayers to income derived through a local PE. The income taxable in Luxembourg is only the income that is attributable to the PE (i.e., no force of attraction applies) net of the expenses that are thereto allocable. The majority of tax treaties signed by Luxembourg provide for the prohibition of discrimination in the tax treatment of local PEs of foreign taxpayers as compared with domestic companies.

V TAX INCENTIVES, SPECIAL REGIMES AND RELIEF THAT MAY ENCOURAGE INWARD INVESTMENT

i Holding company regimes

There is no specific holding company regime in Luxembourg. The participation exemption regime is available to both Luxembourg SOPARFIs and to other resident companies, or PEs of non-resident companies holding qualifying participations.

Dividends (including constructive dividends and interest on profit-sharing bonds), liquidation proceeds and capital gains are fully exempt when the participation they refer to:

  • a is held, directly or through a domestic transparent entity, in a fully taxable resident company, in a European company meeting the requirements listed in Article 2 of the Parent–Subsidiary Directive or in a non-resident company subject to a tax that is comparable (in terms of rate and taxable basis) to the Luxembourg corporate income tax5 (subsidiary);
  • b is held by a fully taxable resident company or by a domestic PE of a EU company meeting the requirements listed in Article 2 of the Parent–Subsidiary Directive, or by a domestic PE of a company resident in a treaty country or in an EEA country (parent); and
  • c represents at least 10 per cent of the capital of the subsidiary (or alternatively, has a purchase price of at least €1.2 million – for the exemption of dividends and liquidation proceeds – or €6 million – for the exemption of capital gains) and was held without interruption over the previous 12 months (or alternatively, the parent commits to hold such participation for at least 12 months).

Pursuant to the amendment of the Parent–Subsidiary Directive, with the introduction of an anti-hybrid provision (EU Directive 2014/86/EU) and a minimum common general anti-abuse rule (EU Directive 2015/121/EU), as of 1 January 2016 profit distributions covered by the Parent–Subsidiary Directive received by a Luxembourg company do not benefit from the participation exemption regime to the extent that the same payments were deductible in the country of the payor, or were paid in the framework of an arrangement or a series of arrangements that, having been put in place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purposes of the Parent–Subsidiary Directive, are not genuine.

If the above-mentioned minimum holding requirement under (c) is not met, an exemption of 50 per cent is available for dividends (including constructive dividends and interest on profit-sharing bonds, and excluding liquidation proceeds) distributed by a resident fully taxable capital company, a company covered by Article 2 of the Parent–Subsidiary Directive, or a capital company resident in a state with which Luxembourg has concluded a tax treaty and that is subject in its country of residence to income tax comparable with that of Luxembourg. The exemption applies to the net dividend income (i.e., the dividend income minus directly related costs and write-offs on the participation in connection with a dividend distribution of the same year).

Capital losses are deductible.

Costs (typically, financing costs) and write-offs relating to exempt participations are deductible as long as they exceed the exempt dividends received in the same year. If they exceed the overall positive income of the parent, the resulting loss can be carried forward indefinitely. However, such ‘exceeding deductions’ are recaptured when a capital gain is realised on the disposal of the same participation. The capital gain is exempt only to the extent it exceeds the amount of costs and write-offs recaptured.

ii IP regimes

Under the Luxembourg IP regime, now repealed, the net income derived by resident taxpayers and by PEs of non-resident taxpayers from the use of qualifying intangible property, as well as the capital gains derived on the disposal of the same, was 80 per cent-exempt from corporate income tax and municipal business tax; qualifying intangible properties are further fully exempt from net wealth tax. Qualifying intangible properties include software copyrights, patents, trademarks, designs, models, and domain names acquired or created after 31 December 2007, provided that they were not acquired from an associated company (i.e., 10 per cent or more direct participation between the receiving and the transferring company, or 10 per cent or more direct participation of one company in both the receiving and the transferring company; the contribution of the property upon incorporation of a new company is not regarded by the tax authorities as a related party acquisition). Following up on the base erosion and profit shifting action plan 5 of the OECD, which sets out the modified nexus approach to be applied for IP regimes, the Luxembourg IP regime was abolished as per 1 July 2016. A five-year grandfathering period exists for qualifying IP that was created or acquired before 1 July 2016. This grandfathering period started as per 1 July 2016 and ends on 30 June 2021. As an anti-anticipation rule, the grandfathering is reduced for qualifying IP that is acquired from a related entity after 31 December 2015, unless the qualifying IP was already eligible for the Luxembourg IP regime or a corresponding foreign IP regime prior to such acquisition. The reduced grandfathering for the 80 per cent corporate income tax exemption ended on 31 December 2016, and for the net wealth tax exemption as from 1 January 2018. A bill of law currently under review provides for the introduction of a new IP regime respecting the ‘OECD Nexus approach’ and to be implemented for fiscal year 2018.

iii Tax subsidies

The main subsidies and incentives are mentioned in this chapter. Business investments, professional development and employment are, however, further supported through specific tax credits granted for new investments in qualifying business assets located in Luxembourg and put to use in Luxembourg or in the EEA (with the exception of ships, which benefit from the credit even if operated abroad);6 sustained employees’ training expenses; and hiring employees previously registered as unemployed.

The above-mentioned subsidies are available to all businesses and do not refer to any specific sector of activity.

VI WITHHOLDING AND TAXATION OF NON-LOCAL SOURCE INCOME STREAMS

i Withholding on outward-bound payments (domestic law)

Dividends paid by a resident company to non-resident shareholders are generally subject to a 15 per cent withholding tax.

As a general rule, there is no withholding tax on outbound royalties and interest; however, outbound payments to related parties exceeding the arm’s-length measure can be requalified as hidden dividend distributions and be subject to a 15 per cent withholding tax. Furthermore, profit-sharing interest received by a ‘money provider’ as payments on loans represented by securities that, in addition to a fixed coupon, are entitled to a variable coupon that depends on the company’s profit distributions, are subject to a 15 per cent withholding tax.

ii Domestic law exclusions or exemptions from withholding on outward-bound payments

A dividend withholding tax exemption is granted provided that a participation of at least 10 per cent (or alternatively a participation whose purchase price is at least equal to €1.2 million) was held for an uninterrupted period of at least 12 months for dividends paid to:

  • a a European company meeting the requirements listed in Article 2 of the Parent–Subsidiary Directive or a Luxembourg PE thereof; pursuant to the amendment of the Parent–Subsidiary Directive with the introduction of a minimum common general anti-abuse rule (EU Directive 2015/121/EU), as of 1 January 2016 profit distributions covered by the Parent–Subsidiary Directive paid by a Luxembourg company do not benefit from the participation exemption regime to the extent they were paid in the framework of an arrangement or a series of arrangements that, having been put in place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purposes of the Parent–Subsidiary Directive, are not genuine;
  • b a non-resident company subject to a tax that is comparable (in terms of rate and taxable basis)7 with Luxembourg corporate income tax and resident in a treaty country;
  • c a company resident and fully taxable in Switzerland not benefiting from any exemption; or
  • d a fully taxable company resident in an EEA country, or a Luxembourg PE thereof.
iii Double tax treaties

Luxembourg has more than 80 tax treaties currently in force, which are mainly drafted in accordance with the OECD Model Convention, and further treaties are being negotiated. The table in Appendix 1 shows the highest withholding tax rate applicable on dividends, interest and royalties according to such treaties.

iv Taxation on receipt

Economic and juridical double taxation of foreign profits are generally avoided through a full or partial exemption system. The general conditions for the participation exemption regime are described in Section V.i. When a certain participation threshold is reached in a foreign company, tax treaties signed by Luxembourg generally provide for the exemption of foreign profits as a system to relieve double taxation. When foreign dividends are not exempt, taxes levied by the foreign authority to the Luxembourg recipient can be at least partially recovered, if certain conditions are met, through the domestic foreign tax credit system. Domestic law does not provide for an indirect tax credit system of taxes levied by the foreign authority at the level of the foreign entity.

VII TAXATION OF FUNDING STRUCTURES

Entities are commonly funded with a mix of equity and debt. Hybrid instruments are also very common, especially when investors are established in jurisdictions that adopt a formal approach in classifying financing tools as debt or as equity, whereas in Luxembourg, a substance-over-form criterion is commonly used. The equity investment can be represented by different classes of shares that track different income or investments of the same company (or both). Several financing tools can be created that combine features of debt and equity according to the projected profitability of the investments, and are tailored to the needs of the investors (base reduction in Luxembourg, withholding tax planning, repatriation of profits, flexibility upon exit).

i Thin capitalisation

There are no specific thin capitalisation rules under Luxembourg law. However, when a loan is granted or guaranteed by related parties, and such loan finances assets are different from financing assets (e.g., participations, real estate, intellectual property rights), a (normal interest bearing) debt-to-equity ratio of at least 85:15 is generally required in practice. A higher debt ratio is accepted in practice in the presence of debt instruments that track 85 per cent or less of the income of the issuing company. The interest payments related to the debt exceeding this ratio may be treated, for tax purposes, as dividends, and, therefore, considered non-deductible for corporate income tax purposes and subject to the 15 per cent dividend withholding tax.

ii Deduction of finance costs

As a general rule, any arm’s-length costs incurred for the purposes of the business activity are deductible to the extent they are not related to exempt income. See also Section V.i.

iii Restrictions on payments

Distributions can be made up to the amount of freely distributable reserves as shown in approved financial statements after the accruals to the legal reserve required by the law are thereto allocated. Under certain conditions, interim dividends can be distributed.

iv Return of capital

In principle, share capital contributions can be repaid to the shareholders without triggering any taxation to the extent that the share capital repaid was not formed by allocations of profit reserves to the share capital, which are deemed to be distributed first; and the share capital reduction is supported by valid economic reasons. Repayments that correspond to profit reserves allocations to the share capital or that are not supported by valid economic reasons are considered, from the perspective of the shareholders, as income from capital. The formal repayment of capital is, however, subject to limits and procedures set by corporate law: the share capital resulting from the repayment cannot be lower than the minimum share capital required by the law, and creditors must have been paid in full or, alternatively, the competent tribunal must have approved the share capital reduction before any share capital repayment (for SAs only). A higher degree of flexibility can be obtained through the provision of a share premium reserve or through a shareholders’ interest-free debt financing. From a tax perspective, the concepts of hidden capital contribution and of hidden capital repayment are applied, under certain conditions. Both hidden capital contributions and hidden capital repayments benefit from the tax treatment of formal contributions and repayments irrespective of their different accounting treatment. As a typical example, a shareholders’ debt waiver could be considered exempt from corporate income taxes if certain features, typical of hidden capital contributions, are present.

VIII ACQUISITION STRUCTURES, RESTRUCTURING AND EXIT CHARGES

i Acquisition

See Section VII for a general comment on funding structures.

ii Reorganisation

As a general rule, the assets of a resident company merged into (or demerged in favour of) another resident company or into a foreign company are deemed realised at market value, and are, therefore, fully taxable in Luxembourg.

Domestic and European reorganisations can be performed tax-neutrally to the extent that, broadly speaking, Luxembourg’s future taxing right on latent gains is not lost because of the reorganisation (e.g., a PE is maintained in Luxembourg to which part or all of the assets incorporating a latent gain are allocated). The taxation can, therefore, be deferred to the future actual realisation of latent gains.

For domestic mergers, tax neutrality is granted if the cash payment does not exceed 10 per cent of the face value of the share capital of the absorbed company; and the merger allows the future taxation in Luxembourg of latent capital gains.

For domestic demergers, tax neutrality is granted if, in addition to the conditions set out above for mergers, the shareholders of the divided company receive, in exchange for their participation, a proportional participation in each beneficiary company (i.e., ‘proportional demerger’); and the assets transferred include at least an autonomous business unit.

If the beneficiary of the merger or of the demerger maintains the book values of the assets and liabilities acquired, the historical acquisition dates can be maintained. Such rule is relevant for the application of the participation exemption regime (e.g., the date of acquisition of the participation can be maintained by the company acquiring it by way of a merger or demerger).

The same neutrality regimes apply to mergers whereby a fully taxable resident company is absorbed by a company resident in a Member State, and to demergers whereby a fully taxable resident company is demerged into companies resident in other Member States.

iii Exit

As a general rule, when a domestic business (in an incorporated or unincorporated form) leaves the Luxembourg tax jurisdiction, exit taxation applies (a deferral applies upon demand in the case of migration to an EEA country and to a tax treaty country).

When a resident company transfers its legal seat and its central administration abroad, the company is deemed liquidated, and capital gains accrued on its assets and liabilities are subject to tax. The migration can, however, be performed at book values, thereby deferring the capital gain taxation, when the assets of the migrating company are attributed to a domestic PE.

When a non-resident company disposes of or transfers abroad a domestic PE, the capital gains accrued on its assets and liabilities are subject to tax. A tax deferral can be obtained if the PE is transferred to a company resident in a Member State by way of a going concern contribution, merger or demerger; and the book values of the PE transferred are maintained by the acquiring company.

When the foreign PE of a domestic company is disposed of, the accrued capital gains on the assets and liabilities of such PE are subject to tax unless a tax treaty providing for the exemption of foreign PEs is in force with the country where the PE is located.

When an asset is attributed to a foreign (exempt) PE, it is debatable whether the Luxembourg head office is taxable on the deemed capital gain realised. The main position of the doctrine is that, even if the attribution of the asset should be booked at fair market value according to the ‘separate entity approach’, the resulting capital gain is taxable only once the asset is actually disposed of by the PE and to the extent a capital gain is actually realised.

IX ANTI-AVOIDANCE AND OTHER RELEVANT LEGISLATION

i General anti-avoidance

The taxpayer is free to choose the structure or the transaction that allows the most tax-efficient results. Nonetheless, the law provides that the tax benefits deriving from the use of forms and constructions that, even though formally permitted, are aimed at mitigating or evading taxes and lack further economic reasons, cannot be recognised. In such cases, taxes will be levied that correspond to the form or to the construction that would be reasonable and appropriate in consideration of the economic reality.

The civil law concept of simulation can also be used by the tax authorities to deny the tax benefits deriving from a certain transaction if it can be proved that the intention of the parties is to put in place a different, hidden transaction. In such a case, the tax effects of the latter will be applicable.

In an international setting, the applicability of some tax regimes (e.g., participation exemption) is conditional to the proof of a minimum level of effective taxation of the foreign entity involved.

ii Controlled foreign corporations (CFCs)

There are no controlled foreign corporations rules under Luxembourg law.

iii Transfer pricing

Luxembourg did not have detailed transfer pricing legislation until 2015, when the arm’s-length principle, already applied in practice, was codified,8 and in 2016, when a new article dealing with the main principles on which a transfer pricing functional analysis should be based (i.e., the commercial and financial relations between affiliated companies and the economically significant circumstances of these relations) was introduced.9

A circular letter issued on 28 January 2011 by the Luxembourg tax authorities, recently replaced by the circular issued on 27 December 2016 (the Circular) officially clarifies the criteria to be followed for the determination of arm’s-length remuneration on intragroup financing transactions. The Circular applies to group companies whose principal activity other than holding activities consists of intragroup financing transactions, which are defined as the granting of loans or advances to associated companies refinanced by any financial means. While the Circular does not address other intragroup situations, such as borrowing from an affiliate to acquire receivables in the market, the principles set out in it should also be largely relevant to those transactions.

Inter alia, the Circular highlights the main substantive requirements that a group financing company established in Luxembourg is required to meet to be able to enter into an advance pricing agreement (APA) with the tax authorities. In this respect, and among other substance requirements, the financing company should be adequately capitalised to face the functions performed and the risks assumed in connection to its financing activity. The amount of equity that a financing company needs should be benchmarked.

Pursuant to the Circular, it is specified that the APA procedure will only be available for intragroup financing companies that have sufficient substance in Luxembourg and bear the risks linked to the financing activities.

A Luxembourg company will be considered as having sufficient substance if, broadly summarised:

  • a the majority of its directors or managers are Luxembourg residents and have the capacity to take binding decisions for the company;
  • b personnel should have the understanding of risk management in relation to the transactions carried out;
  • c the key decisions regarding its management are taken in Luxembourg, and at least one shareholders’ meeting a year takes place there;
  • d it has a bank account in Luxembourg;
  • e it is not considered as tax-resident in another country;
  • f its equity should be sufficient for the functions it performs, the assets used and the risks it assumes ; and
  • g the financing company should have fulfilled its obligations regarding the filing of tax returns at the time when it requests an APA.
iv Tax clearances and rulings

On the basis of a written and motivated request by any taxpayer, the competent tax office will issue an advance decision regarding the application of the Luxembourg tax laws to certain operations described by the taxpayer (ATA). Such decision would bind the tax office, albeit only with respect to the requesting taxpayer and limited to the concrete case described by the latter. The decision of the tax office will be taken on the basis of a uniform interpretation of the tax laws and the principle of equality. An administrative fee applies, ranging between €3,000 and €10,000, determined by the Luxembourg tax authorities on the basis of the complexity of the case concerned.

On 13 July 2016, a law on the mandatory automatic exchange of information in the field of taxation, implementing EU Council Directive 2015/2376 extending the scope of mandatory exchange of information on cross-border ATA and APA, was approved. As a consequence, the Luxembourg tax authorities will, as from 1 January 2017, exchange information on ATA and APA with other Member States of the EU with retroactive effect (the exchange applies to ATA and APA amended or renewed as from 1 January 2012, provided they were still valid on 1 January 2014). ATAs and APAs that involve only individuals or taxpayers with a low turnover (i.e., less than €40 million in the year preceding the issuance of the ATA or APA) are excluded.

X YEAR IN REVIEW

2017 was a year of limited changes in Luxembourg corporate tax law. However, in the broader framework of very important international tax changes, several amendments are in the process of being introduced in 2018, such as, for instance:

  • a a reduction of the main corporate income tax rate to 18 per cent from 2018 onwards;
  • b the expected implementation of a new intellectual property tax regime, which should enter into force in January 2018 (if the currently pending bill of law is approved). Such regime should provide for an exemption of profits related to IP assets (excluding domain names, trademarks, designs and models) taking into account the company’s research and development costs and expenses; and
  • c the implementation of the EU Council Directive 2016/1164 of 12 July 2016 (ATAD I).

XI OUTLOOK AND CONCLUSIONS

Luxembourg is committed to continuing and extending its role as a major European financial centre, ensuring at the same time the transparency and, in general, the compatibility with EU laws and principles of its own tax law. Outside the taxation arena, major initiatives are being undertaken in other fields, notably that of investment funds, one of the other main drivers in the financial area.

Appendix I: Domestic and treaty rates for dividend, interest and royalty payments

Dividends

Interest

Royalties

Individuals, companies

Qualifying companies

Domestic rates %

Companies

15

0

0/15

0

Individuals

15

N/A

0/15/35

0

Treaty country %

Andorra

15

5

0

0

Armenia

15

5

0/10

5

Austria

15

5

0

10

Azerbaijan

10

5

10

5/10

Bahrain

10

0

0

0

Barbados

15

0

0

0

Belgium

15

10

0/15

0

Brazil

25

15

0 /10/15

15/25

Brunei

10

0

0/10

10

Bulgaria

15

5

0/10

5

Canada

15

0/5/10

0/10

0/10

China

10

5

0 / 10

6/10

Croatia

15

5

10

5

Czech Republic

15

0

0

10

Denmark

15

5

0

0

Estonia

15

5

0/10

5/10

Finland

15

5

0

0/5

France

15

5

10

0

Georgia

10

0/5

0

0

Germany

15

5

0

5

Greece

7.5

7.5

8

5/7

Guernsey

15

5

0

0

Hong Kong

10

0

0

3

Hungary

10

0

0

0

Iceland

15

5

0

0

India

10

10

10

10

Indonesia

15

10

10

10/12.5

Ireland

15

5

0

0

Isle of Man

15

5

0

0

Israel

15

5

0/5/10

5

Italy

15

15

10

10

Japan

15

5

10

10

Jersey

15

5

0

0

Kazakhstan

15

5

0 / 10

10

Korea

15

10

5 /10

0/5/15

Laos

15

0/5

0 / 10

5

Latvia

10

5

10

5/10

Liechtenstein

15

0/5

0

0

Lithuania

15

5

10

5/10

Macedonia

15

5

0

5

Malaysia

10

0/5

10

8

Malta

15

5

0

10

Mauritius

10

5

0

0

Mexico

15

5

0/10

10

Moldova

10

5

0/5

5

Monaco

15

5

0

0

Morocco

15

10

10

10

Netherlands

15

2.5

0

0

Norway

15

5

0

0

Panama

15

5

5

5

Poland

15

0

5

5

Portugal

15

15

10/15

10

Qatar

5/10

0

0

5

Romania

15

5

0/10

10

Russia

15

5

0

0

San Marino

15

0

0

0

Saudi Arabia

5

5

0

5/7

Serbia

10

5

10

5/10

Seychelles

10

0

5

5

Singapore

10

0/5

10

10

Slovak Republic

15

5

0

10

Slovenia

15

5

5

5

South Africa

15

5

0

0

Spain

15

5

10

10

Sri Lanka

10

7.5

10

10

Sweden

15

0

0

0

Switzerland

15

0/5

0/10

0

Taiwan

15

10

0/10/15

10

Tajikistan

15

0

0/12

10

Thailand

15

5

10/15

15

Trinidad and Tobago

10

5

0/7.5/10

10

Tunisia

10

10

7.5/10

12

Turkey

20

5/10/20

10/15

10

Ukraine

15

5

5/10

5/10

United Arab Emirates

10

0/5

0

0

United Kingdom

15

5

0

5

United States

15

0/5

0

0

Uruguay

15

5

0/10

5/10

Uzbekistan

15

5

0/10

5

Vietnam

15

5/10

10

10

Source: IBFD, Amsterdam, based on information available on 21 November 2017

It is not uncommon for a tax treaty to establish more than one highest withholding tax rate applicable to the same item of income (e.g., dividends, interest or royalties). For instance, dividend withholding rates generally decrease when certain participation thresholds are reached. At the same time, interest paid by or to the government of one contracting state is frequently exempt from withholding tax. However, since each treaty is the result of the negotiation between Luxembourg and the relevant contracting state, it is not possible to define a common rule on the application of treaty rates. For more information, reference should be made to the specific tax treaty.10

On 7 June 2017, Luxembourg (together with 67 other jurisdictions) signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI). The purpose of the MLI is to introduce the BEPS principles in double tax treaties. Luxembourg declared that all the signed tax treaties currently in force will be seen as covered tax treaties for the purpose of the MLI. However a large number of treaty partners have not signed yet the MLI (including the United States). Even though Luxembourg has made several reservations about the application of the MLI, which in most instances will be applied only as far as the ‘minimum standards’ are concerned, certain MLI provisions (for example, the principal purpose test) will impact the application of the current double tax treaties.

1 Pieter Stalman is a partner and Chiara Bardini is a counsel at Loyens & Loeff.

2 See Section V for a more detailed discussion of the deductibility of expenses related to exempt participations and to partially exempt income from intellectual property rights.

3 See Section V for a description of the exemption regime applicable to capital gains on qualifying participations and intellectual property rights.

4 Giving rise to a combined profit tax rate of 26.01 per cent (19.26 per cent plus 6.75 per cent) for 2018.

5 The Luxembourg tax authorities generally consider that a foreign tax is comparable with the Luxembourg corporate income tax if the rate of the foreign tax is at least 9 per cent (i.e., half of the current corporate income tax rate) and the taxable base is computed on the basis of criteria that are comparable to the Luxembourg criteria.

6 Following the Tankreederei I SA decision by the European Court of Justice (C-287/10 of 22 December 2010), which ruled that the scope of application of the incentive is contrary to the freedom of movement of capital, a circular issued by the tax authorities (Circular 152-bis/3 of 31 March 2011) and an update of the law now clarify that the tax credit is also applicable to new investments in qualifying business assets located in Luxembourg put to use in a state that forms part of the European Economic Area.

7 The Luxembourg tax authorities generally consider that a foreign tax is comparable with the Luxembourg corporate income tax if the rate of the foreign tax is at least 9 per cent (i.e., half of the current corporate income tax rate) and the taxable base is computed on the basis of criteria that are comparable to the Luxembourg criteria.

8 Article 56 LIR.

9 Article 56 bis LIR.