The Corporate Tax Planning Law Review: Luxembourg
During the past few decades, Luxembourg, located in the heart of Europe, has developed a vibrant financial centre. Originally active for the private banking sector, Luxembourg has since grown into a diversified hub for investment funds, banks, insurance and reinsurance companies, holding companies and family offices. The attractiveness of Luxembourg is due, among other things, to its flexible and practical corporate law; the broad range of legal forms available to companies, partnerships and associations under national law; the speed of company formation and the country's tax framework, such as an extensive double tax treaty network and a participation exemption regime.
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 the 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 needs of their shareholders, they 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 a Luxembourg resident under Luxembourg law. Luxembourg law considers a company to be a Luxembourg resident if its registered office (i.e., the company's statutory office as determined by its articles of incorporation) or its central administration (usually the place from which the company is effectively managed) 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, there are no additional economic substance requirements for the company to be considered as a Luxembourg resident.2 In an international context, however, a lack of sufficient economic substance in Luxembourg or maintaining close ties with another foreign jurisdiction may entitle foreign tax authorities to challenge the company's Luxembourg tax residency. Therefore, in an international context, Luxembourg companies should maintain at least a minimum level of economic substance in Luxembourg.
There are two main types of limited partnership under Luxembourg law: the CLP and the SLP. The particularity of CLPs and SLPs is that they are transparent for Luxembourg tax purposes. The main difference between them is that unlike a CLP, an SLP is not vested with legal personality. Both limited partnership regimes have proven to be widely accepted and used by persons wishing to have an onshore European-domiciled partnership with similar features to Anglo-Saxon types of partnership structures (such as a Cayman Island or a Delaware limited partnership).
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)3 or if it is tainted by business based on 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 SLP. 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 20134 are deemed not to be conducting a business activity.
Beyond that tax liability, where a CLP or SLP is subject to MBT, each of its non-resident limited partners will be considered to operate a permanent establishment (PE) in Luxembourg, as their interest in the CLP or SLP will generally be attributable to the PE in Luxembourg (unless different provisions in a double tax treaty would apply). 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 their tax transparency, CLPs and 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 is available to structure investments, including, inter alia:
- tailor-made investment funds (i.e., undertakings for collective investment (UCIs), special investment funds (SIFs) or reserved alternative investment funds (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 (UCITs);
- securitisation undertakings;
- pension funds; and
- family wealth management companies.
The investment vehicles mentioned in points (a), (c) and (e) may be established as entities that are treated as opaque or as transparent for direct tax purposes. Capital companies like the private limited liability company (société à responsabilité limitée), the public limited company (société anonyme) or the partnership limited by shares (société en commandite par actions) are treated as opaque for Luxembourg tax purposes. These investment vehicles are, however, income tax exempt. Merely a subscription tax varying from 0.01 per cent to 0.06 per cent computed on the net asset value applies. The most common tax-transparent entities are the Luxembourg partnership (société en nom collectif), the simple limited partnership (société en commandite simple) and the special limited partnership (société en commandite spéciale). Contractual types of funds as the fonds commun de placement are also treated as transparent from a Luxembourg tax standpoint. Subscription tax applies as for opaque vehicles.
Distributions to investors are WHT exempt.
The applicability of double tax treaties to these vehicles must be assessed on a case-by-case basis. Several double tax treaties with Luxembourg include explicit provisions allowing under certain conditions treaty benefits for Luxembourg collective investment vehicles (e.g., Germany,5 France6 and Singapore7) and with certain countries, agreements between the competent tax authorities are in place (e.g., Denmark, Spain and Ireland).8
SICARs, such as mentioned in point (b), are fully subject to income taxes, but the income arising from assets held in risk capital is exempt. As the purpose of a SICAR is limited to investments in risk capital, all of its income should theoretically be exempt from income taxes. If SICARs opt for an opaque entity form, double tax treaties should, in principle, be applicable to them.
The legal form of the investment vehicle should be chosen according to the tax treatment of the investors' jurisdiction and the jurisdiction(s) of the investments.9 Under certain circumstances, some European jurisdictions grant lower withholding taxes on dividends or interest payments if paid to a regulated entity.
The family wealth management company is an appropriated tool for private estate management; it can only be held by private persons or estate entities. This type of company is income tax exempt and is merely liable to a subscription tax of 0.25 per cent. No withholding tax is levied on dividend payments. Interest payments made to Luxembourg-resident individuals are subject to a final 20 per cent WHT; see the subsection on 'Withholding taxes'.
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 2021, CIT is levied at an effective maximum rate of 17per cent (18.19 per cent, including the 7 per cent surcharge for the employment fund) for net profits above €200,000. An intermediary rate of €26,250 plus 31 per cent of net income exceeding €175,000 is also available for corporate income between €175,000 and €200,000. Finally, a lower rate of 15 per cent for net profits below €175,000 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 2021). The aggregate CIT and MBT rate consequently amounts to 24.94 per cent in 2021 for companies located in Luxembourg City.
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. In that respect, liabilities in relation to exempt assets are not deductible when calculating the unitary value.
Furthermore, Luxembourg-resident companies are subject 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 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 ranging from €535 to €32,100 for a total balance sheet from €350,000 to at least €30,000,001, respectively.
Dividends paid by a Luxembourg company to its shareholders are, as a rule, subject to WHT at a rate of 15 per cent.
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 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 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 85 countries, and is in negotiation to sign a double tax treaty with 14 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 usually 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 may also apply to Luxembourg PEs of non-resident companies (e.g., US companies).
Pursuant to §171 of the Luxembourg General Tax Law, Luxembourg companies must be able to justify upon request of the Luxembourg tax authorities that their finances provided by related parties comply with the arm's-length principle. If the Luxembourg company is not able to demonstrate that the applied ratio and the interest rate on the debt comply with the arm's length principle, the Luxembourg tax authorities may requalify:
- the portion of the debt deemed in excess of an arm's length amount into equity, which would be non-deductible for net worth tax purposes, and
- the portion of interest deemed in excess of an arm's length amount into a hidden dividend distribution, which would be non-deductible for income tax purposes and potentially subject to withholding tax.
In accordance with the OECD's transfer pricing guidance on financial transactions,10 the transfer pricing documentation should cover the following:
- the qualification of the purported debt (economics of the debt, as well as the circumstances of the financing);
- the quantum thereof (i.e., debt/equity ratio); and
- the interest rate applied thereon.
Regarding more specifically companies that are engaged in intragroup financing activities, a circular letter11 issued by the head of the Luxembourg tax authorities (LTA) provides for the determination of the minimum equity at risk that a Luxembourg company must maintain in order to be able to assume the risks related to the financing activities.
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 can 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 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.
Horizontal fiscal unity is also allowed between qualifying companies that are held by a common qualifying parent company.12
Under the law of 19 December 2020, a group benefiting from 'vertical consolidation' is allowed to form a new group integrated through 'horizontal consolidation', without any negative tax consequences for the individual members of the tax consolidation group, subject to conditions and up to the 2022 fiscal year.
Participation exemption regime and other exemptions applicable to dividends, liquidation 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 Directive13 (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; 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 of at least 10 per cent or an acquisition price of at least €1.2 million for an uninterrupted period of at least 12 months. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in that 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.
Following the European Court of Justice (ECJ) ruling of 2 April 2020 in case C-458-18, the Luxembourg tax authorities issued a circular letter on 1 December 2020 regarding the non-application of Council Directive 2011/96/EU to companies established in Gibraltar. As from 1 January 2021, dividends paid by a company incorporated in Gibraltar to a Luxembourg company or qualifying PE may nevertheless be exempt from CIT and MBT where the Gibraltar company is a company limited by share capital and subject to a tax that is comparable to Luxembourg CIT – levied at an effective rate comparable to the Luxembourg CIT (at least 8.5 per cent) – on a mandatory basis and on a similar tax base, provided that the above other conditions of the participation exemption are fulfilled.
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, with a participation size 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.
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.
Outbound dividend distribution
Dividends paid by a Luxembourg company to its shareholders are, as a rule, subject to 15 per cent WHT, unless a reduced rate or an exemption applies under a 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 one of the following:
- a Luxembourg-resident fully taxable company;
- a company covered by Article 2 of the PSD or a Luxembourg PE thereof;
- Luxembourg, a municipality, or a syndicate of municipalities or local corporate bodies governed by public law;
- a company liable to a tax corresponding to Luxembourg CIT that is resident in 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 Luxembourg CIT, or a Luxembourg PE thereof; or
- a Swiss-resident company14 that is effectively subject to CIT in Switzerland without benefiting from an exemption; and
- 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 having 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 that 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 that the conditions of the Luxembourg participation exemption regime, as described above for dividends and liquidation proceeds, 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 the same 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 56bis of the ITL, the Luxembourg tax authorities issued a circular letter,15 dated 27 December 2016, which follows the OECD guidelines in transfer pricing matters.
On 11 February 2020, the OECD released a report16 containing transfer pricing guidance on financial transactions. The report is significant for Luxembourg transfer pricing considerations because it is the first time the OECD Transfer pricing guidelines include guidance on the transfer pricing aspects of financial transactions, which will contribute to consistency in the interpretation of the arm's-length principle with regard to financial transactions and help avoid transfer pricing disputes and double taxation.
Transfer pricing considerations, inter alia, apply to all companies engaged in intra-group financing transactions.
Determination of the arm's-length price
The comparability analysis is the main determinant in 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 existed had the parties been independent, and 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 thus be determined by an appropriate transfer pricing analysis on a case-by-case basis. While no specific methodology is provided for, equity at risk needs to be determined based on a credit risk analysis, including a market analysis, a balance sheet analysis and all other elements relevant to 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. The minimum economic substance in Luxembourg required is 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 on at least 50 per cent of their professional revenue. If a company is part of the management board, it must have its legal domicile and head office 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.
Interest payments to EU black-listed jurisdictions
Under the law of 10 February 2021, interest and royalties due to a related party established in a country or territory appearing on the EU list of non-cooperative jurisdictions (EU list) will be non-tax deductible. The new measure will apply to accruals made as of 1 March 2021, based on the version of the EU list published in the Official Journal of the European Union on that date. The current EU list, which was last revised on 22 February 2021, includes the following jurisdictions: American Samoa, Anguilla, Dominica (new), Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, the US Virgin Islands and Vanuatu. Barbados was removed from the list. The next revision is due to be performed in October 2021. Importantly, where the taxpayer provides evidence that a transaction was made for valid business reasons that reflect economic reality, the relevant accruals remain tax-deductible.
iii Indirect taxes
In 2021, 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.17 These appendices cover the specific scope of application of the reduced rates and must be strictly interpreted.
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 all 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.
The EU Directive 2018/1910 of 4 December 2018 and the Implementing Regulation 2018/1912 regarding harmonisation and simplification of certain rules in the value added tax system for the taxation of trade between EU member states, known as 'quick fixes', have been implemented into Luxembourg VAT law, in force as of 1 January 2020.
The quick fixes aim at tackling specific VAT issues concerning intra-community supplies of goods. In particular, the new measures relate to the conditions for the application of the VAT exemption to intracommunity supplies of goods, the evidence of intracommunity transport of goods, simplification measures for the call-off stock regime and the harmonisation of rules applicable to chain transactions.
On 1 January 2021, the United Kingdom officially became a third country with respect to the EU, implying that the EU VAT Directive ceased to apply to it. The main changes concern cross-border supply of goods and services as well as the VAT refund procedure.
Since 1 January 2021, any supply of goods between businesses (B2B) and transported from Luxembourg to the UK qualifies as an export of goods, instead of an intra-community supply of goods. Furthermore, the distance sales regime ceases to apply with regard to business-to-consumer (B2C) supplies of goods.
With regard to the supply of services, the general B2B place of supply rule remains unchanged, namely services remain taxable in the country of the recipient. In this respect, Brexit had a positive impact on the input VAT recovery right of Luxembourg companies rendering financial and insurance services to UK companies because the Luxembourg companies concerned are now entitled to deduct input VAT on related costs. In a B2C scenario, the place of taxation is still the country of the supplier; however, Luxembourg suppliers are not required post-Brexit to apply Luxembourg VAT to supplies of services such as advertising, IT, consultancy, banking, financial and insurance transactions.
Regarding the VAT refund procedure, UK-based taxable persons are required to use the VAT refund procedure under the 13th VAT Directive, whereas the Luxembourg companies concerned must contact the UK VAT authorities for VAT refund purposes.
iv Other tax measures
Advance tax confirmations
Since the end of the 2019 financial year, advance tax confirmations (ATCs) granted by the Luxembourg tax authorities before 1 January 2015 (i.e., under the administrative procedure in force until 31 December 2014) are no longer binding. Taxpayers that are concerned by this measure will be able to introduce a new request in compliance with the current administrative procedure. With respect to taxpayers that have a diverging financial year end (i.e., those taxpayers that have a financial year end diverging from the calendar year end), the tax authorities allow an ATC request to be filed before the closing date of their 2020 financial year end. However, a new request will only be successful if the transactions will not have produced their full effect at the time of expiry of the ATC.
Investment tax credits
Investment tax credits are available to Luxembourg companies and Luxembourg PEs of non-resident companies for their qualifying investments that are 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, as well as mineral and fossil deposits. As such, tax credits are available to Luxembourg companies to finance certain assets; for example, aeroplanes or software that has been acquired (as opposed to developed in-house), and can be extended, inter alia, to the shipping industry under specific rules.
Since 1 January 2018, a new intellectual property box regime (the IP Box Regime) following the modified nexus approach (as proposed under the Base Erosion and Profit Sharing (BEPS) Action 5) is in 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 use 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.
International developments and local responses
i OECD-G20 BEPS initiative
Implementation of the ATAD into Luxembourg law
- interest limitation rules;
- exit taxation rules;
- a general anti-abuse rule;
- controlled foreign company (CFC) rules; and
- hybrid mismatch rules. The hybrid mismatch rules have been modified by the law of 20 December 2019 implementing the provisions of ATAD II into domestic law.
Interest limitation rules
As a general principle, under interest limitation rules, a corporate taxpayer is no longer allowed to deduct net borrowing costs exceeding (1) 30 per cent of its EBITDA (earnings before interest, tax, depreciation and amortisation) or (2) €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.20
The purpose of the 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 if the following cumulative criteria are fulfilled:
- the level of participation – namely, direct or indirect holdings via related entities of more than 50 per cent of the 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 where 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 were it not controlled by a taxpayer containing the significant people and functions linked to those assets and risks that are instrumental in generating the CFC income.
On 4 March 2020, the Luxembourg tax authorities issued a Circular21 clarifying the administrative application of CFC rules in Luxembourg. Because Luxembourg follows a transfer pricing approach to determine the allocation of income for tax purposes, the Circular provides that taxpayers must have transfer pricing documentation, including a functional analysis available on an annual basis, and further specifies the content thereof.
Hybrid mismatch rules
New provisions have been introduced into domestic law with effect as from 1 January 2019 to transpose the provisions of the ATAD covering intra-EU hybrid mismatches involving hybrid instruments or entities that give rise to a double deduction or a deduction without inclusion of the same payment.
The rules apply either in the context of commercial or financial relationships between the taxpayer and an associated enterprise in another EU member state or, in the case of a structured arrangement, those concluded between a taxpayer and a party in another EU member state.
Associated enterprises imply a direct or indirect participation of 25 per cent or more of the voting rights or capital, or an entitlement to 25 per cent or more of the profits in the case of hybrid instruments. For hybrid entities, this percentage is increased to 50 per cent or more. The concept of a structured arrangement has not been defined.
If an arrangement falls within the scope of a rule, operating expenses are not tax-deductible in Luxembourg to the extent that they are already tax-deductible in the source member state, or to the extent that the corresponding income is not taxed in the other member state.
The law of 20 December 2019 implements the ATAD II provisions into domestic law. The new measures that have amended the initial (ATAD) anti-hybrid rules apply to financial years starting as from 1 January 2020, except for the rules on reverse hybrids, which will apply as from the 2022 financial year.
The new provisions extend the material scope of the ATAD measures to additional types of arrangements, introduce the 'acting together' concept and extend the territorial scope to transactions with third countries.
As a measure against diluting the thresholds that determine associated enterprises (25 per cent for hybrid instruments, 50 per cent for hybrid entities), persons acting together must be added together. For the sake of legal certainty, Luxembourg has implemented a simplification measure for investment funds. An investor that holds, directly or indirectly, less than 10 per cent of the interests in the Luxembourg investment fund and that is entitled to less than 10 per cent of the profits of that fund will not (unless it is proved otherwise) be considered as acting together with another investor in the fund.
According to the wording of the ATAD II and in line with the parliamentary documents, the deduction without inclusion must be caused by the hybrid mismatch; that is, the varying legal characterisation of the payment between the different tax jurisdictions must be the cause of the deduction in one jurisdiction and the non-inclusion in the other. If the entity in the recipient's jurisdiction is generally or specifically exempt from taxation or the recipient's jurisdiction applies a territorial exemption (like Hong Kong or Singapore), the cause of the non-inclusion does not lie in the hybrid mismatch.
In that context, payments that are deductible in the payer's jurisdiction and that are made to a Luxembourg investment company with variable capital in the form of a reserved alternative investment fund (RAIF) or a specialised investment fund (SIF) may fall outside the scope of the ATAD II provisions (irrespective of how these entities are treated for tax purposes in the jurisdictions of their investors). Similarly, payments to a Luxembourg investment company in risk capital may be out of scope.
The ATAD II provides that the reverse hybrid mismatch provisions shall not apply to a collective investment vehicle, so that a Luxembourg (special) limited partnership in the form of a RAIF or a SIF should, as a rule, be out of scope. The applicable explanations and examples in the OECD BEPS report on Action 2 can be used as a source of illustration or interpretation to the extent that they are consistent with the provisions of the ATAD II and with European Union law. However, there is no indication in Luxembourg law or in the parliamentary documents that the 'counterfactual test' foreseen by the OECD BEPS Final report22 should be applied in Luxembourg.
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, owing to the transfer, the member state of the head office no longer has the right to tax the transferred assets – triggers, as a rule, capital gains taxation on the assets (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.
The exit tax rules exclude asset transfers that relate to the financing of securities, to assets posted as collateral, to assets transferred in order to meet prudential capital requirements, or to those transferred for the purpose of liquidity management, provided that the assets are set to revert to the transferor within 12 months.
Exit tax rules under the ATAD, such as those implemented under the ATAD Law, have become applicable as of 1 January 2020.
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, an abuse of law exists if the legal route is not genuine (its main purpose, or one of its main purposes, having been to circumvent or reduce tax contrary to the object or purpose of the tax law) 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 is regarded as non-genuine to the extent that it has not been 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 EU proposals on taxation of the digital economy
Luxembourg has not taken any legislative action with regards to the European Commission's proposals on the taxation of the digital economy.
iii Tax treaties and the multilateral instrument
Currently, 68 of the 85 tax treaties with Luxembourg in force are covered by the multilateral instrument (MLI). Luxembourg has adopted a restrictive approach to the provisions under the MLI, 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.
In summary, the PPT clause aims at denying taxpayers the benefits of the double tax treaties covered where there is evidence to show that a given arrangement or transaction was set up for the principal purpose of obtaining those benefits (or for that principal purpose, among others).
The MLI provisions affecting withholding taxes apply to some of the relevant tax treaties with Luxembourg as from 1 January 2020. The entry into force in respect of each tax agreement covered needs to be analysed on a case-by-case basis because this depends on the entry into force of the MLI in the other contracting state. As from 1 February 2020, other taxes may also be concerned.
On 21 March 2020, the Luxembourg Parliament passed a law (the DAC6 Law) implementing Council Directive (EU) 2018/822 of 25 May 2018 amending Directive 2011/16/EU (DAC6) as regards mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements. In addition, the law of 24 July 2020 implements into domestic law Council Directive (EU) 2020/876 of 24 June 2020, which amends Directive 2011/16/EU to address the urgent need to defer certain time limits for the filing and exchange of information in the field of taxation because of the covid-19 pandemic (the Amendment).
Under the new rules, Luxembourg intermediaries and, in certain cases, taxpayers have had to disclose certain information on reportable cross-border arrangements to the Luxembourg tax authorities since 1 January 2021 within a specified period of time.
An arrangement will be reportable if it (1) concerns a covered tax, (2) is cross-border (i.e., involving another member state or a third country), and (3) includes a characteristic or feature that presents an indication of potential risk of tax avoidance (a 'hallmark'). The hallmarks are listed in the Appendix to the DAC6 Law. Some hallmarks will only trigger a reporting obligation if the arrangement in question meets the main benefit test. The main benefit test will be met when it can be established that the main benefit, or one of the main benefits, which a person may reasonably expect to derive from the arrangement, is the obtaining of a tax advantage in the EU or in a third state.
Pursuant to the Amendment, the reporting process started on 1 January 2021. Since that date, concerned intermediaries (not subject to legal professional privilege) or taxpayers, as the case may be, have been obliged to file reportable information with the Luxembourg tax authorities within a 30-day period beginning with the earliest of the following:
- the day after the reportable arrangement is made available for implementation;
- the day after the reportable arrangement is ready for implementation; or
- the day when the first step in the implementation of the reportable arrangement is made.
Furthermore, reports for reportable cross-border arrangements from the period 25 June 2018 to 30 June 2020 had to be filed by 28 February 2021.
The Luxembourg tax authorities will exchange the reported information automatically with other member atates through a centralised database. The Commission will have access only to the data necessary to monitor the implementation of the rules.
Late, incomplete or inaccurate reporting, non-reporting or non-compliance with the notification obligations are subject to a maximum fine of €250,000.
Certain case law from recent years is relevant for corporate tax planning regarding both new projects and existing structures.
i Perceived abuses
Buy-back of shares
In its decision of 23 November 2017,23 the Luxembourg Administrative Court confirmed that the buy-back by a company of all or part of the shares held by one of its shareholders – without a subsequent reduction of its share capital – will be considered as a disposal of shares (and not as a distribution of profits) and will not, therefore, be in scope for Luxembourg dividend withholding tax. With this decision, the court confirmed a position that the majority of practitioners already held. A withholding tax-free share buy-back is, however, subject to valid economic reasons. For a simulated transaction without an economic rationale for the repurchase and its price, the tax authorities may challenge the repurchase as being abusive.
Binding effect of ATCs
On 28 January 2020, the Luxembourg district court underlined that an ATC granted in line with the legal framework applicable at the time it was granted is binding.24 For 2013, the LTA had granted an ATC, which had been filed in line with the legal provisions applicable in 2013. The ATC confirmed for the tax year 2013 that mandatory redeemable preference shares (MRPS) in the underlying structure would be qualified as debt for Luxembourg tax purposes, and that payments due thereunder would be deductible and in line with the arm's-length principle. In 2015, the LTA demanded that the taxpayer is to demonstrate that the payments made in 2013 under the MRPS were in line with the arm's-length principle. The taxpayer refused, and referred to the confirmation in the 2013 ATC. In a subsequent letter, the LTA then challenged the MPRS for being abusive. The court ruled that because the ATC had been in line with the legal framework at the time and that there was no change to the facts for the relevant year, the LTA could not, ex-post, reverse its position on the MRPS treatment, and could not consider the same situation as abusive.
In its decision on 22 October 2018,25 the Luxembourg district court once again highlighted the need for taxpayers 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 to justify this rate, the LTA considered that it was excessive and that the rates should instead be 3.57 per cent for 2011 and 2.52 per cent for 2012, and that the excess interest should be requalified as a hidden dividend distribution that would be non-deductible and subject to 15 per cent withholding tax. 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 justify the 12 per cent rate (with arm's-length rates ranging from 3.21 per cent to 7.88 per cent). The second transfer pricing report, prepared during the litigation phase, did justify it (with an arm's-length rate range of 9.95 per cent to 19.61 per cent). While the district court concluded that the second transfer pricing documentation was admissible, it nevertheless confirmed the LTA's view because LuxCo was not able to explain the differences in outcomes and inconsistencies between the two transfer pricing reports.
A decision26 of the district court from 7 January 2019 focused on the application of the arm's-length principle to intercompany transactions. In the underlying case, 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 have done – especially as they could not be justified economically.
ii Recent successful tax-efficient transactions
Hidden dividend distributions – burden of proof
On 31 July 2019, the Luxembourg Administrative Court ruled in favour of the taxpayer in a case involving alleged hidden dividend distributions.27 The Luxembourg tax authorities had argued there was a lack of economic reasons for the transactions, but without sufficiently specifying further elements of the underlying case. The court underlined that the burden of proof for a hidden dividend distribution lies with the tax authorities, and that this burden does not shift to the taxpayer until the tax authorities have brought forward elements in the case that constitute evidence of a hidden dividend distribution.28
SICAR under Luxembourg domestic law
While the Danish Cases29 from the Court of Justice of the European Union had an EU-wide impact on the concept of beneficial ownership, as well as on the concept of abuse, the case involving a SICAR30 had particular implications for the Luxembourg context. The CJEU ruled that a SICAR could not benefit from the Interest and Royalties Directive, arguing that even if the SICAR were formally subject to corporate income tax in Luxembourg, the interest income would, in fact, be tax-exempt. However, this decision should not per se exclude that under Luxembourg domestic tax law, a withholding tax exemption could apply for dividends distributed by a Luxembourg capital company to a SICAR.
Outlook and conclusions
With further OECD guidelines, Luxembourg transfer pricing rules have been repeatedly subject to change in recent years. Transfer pricing compliance should, therefore, be closely monitored. The above case law illustrates the increased focus of the LTA on transfer pricing. Taxpayers should be able to provide proper transfer pricing documentation at the LTA's request to support the compliance of their intercompany transactions with the arm's-length principle, as well as the economic reality underlying those transactions.
DAC6 has introduced further compliance provisions. Irrespective of any impact on the tax considerations for a structuring, DAC6 may add an additional administrative burden on the taxpayer and the intermediary.
Most of the recently introduced provisions in Luxembourg that have an impact on corporate tax planning are those implementing EU Directives, which in turn are based on the OECD's anti-BEPS project. Keeping its commitment to OECD-compliance, Luxembourg has fully implemented those measures in a timely manner. Where the ATAD allowed options, Luxembourg sought investor-friendly implementations. With the implementation of the ATAD, Luxembourg further decreased its corporate income tax rate in 2019 to 17 per cent (18 per cent in 2018, down from 22 per cent in 2008). Some directives provided for the implementation of undefined terms into the Luxembourg tax law. Examples include the general anti-abuse rule (in addition to existing anti-abuse rules in the participation exemption provisions), the principle purpose test in the MLI and the main benefit test under DAC6. Certain provisions of the directives foresee concepts that are without precedent in Luxembourg tax law. The 10 per cent threshold for investment funds – a simplification measure for the interpretation of the acting together concept – and the recently issued circular for the CFC legislation and the interest limitation rules constitute initial measures taken to promote legal certainty. Further circulars, for example with regards to the anti-hybrid rules, may follow. So far Luxembourg has (as a reliable member of the OECD and a member state of the European Union) successfully managed to reconcile the international requirements for the implementation of these new international tax standards with its attractiveness as one of the world's major capital aggregator jurisdictions, by offering a variety of tax-neutral vehicles within an investor-friendly and politically, legally and financially stable environment. In its capacity as a first mover, it has often had occasion in the past to prove itself responsive and agile in a new environment. Thus, it has been an early anticipator of new needs, trends and opportunities in the business ecosystem – a status it ought to retain for the future ahead.
1 Eric Fort and Jan Neugebauer are partners and Philipp Jost and Henner Heßlau are senior associates at Arendt & Medernach.
2 It should, however, be noted that under administrative circular L.I.T.L. n° 56/1 – 56bis/1 of 27 December 2016, companies engaged in intra-group financing activities should comply with certain substance requirements.
3 The Income Tax Law dated 4 December 1967, as amended.
4 Implementing the Alternative Investment Fund Managers Directive 2011/61/EC.
5 No. 1 (1) and (2) of the Protocol to the treaty.
6 No. 2 of the Protocol to the 2019 tax treaty.
7 No. 1 of the Protocol to the tax treaty.
8 Circular Letter LIR No. 61, dated 8 December 2017 provides an overview of the treaty countries with regards to collective investment vehicles. Updates are regularly available on the website of the Luxembourg tax authorities at https://impotsdirects.public.lu/fr/conventions.html.
9 For potential hybrid mismatch scenarios, see Section III, Subsection 'Hybrid mismatch rules' below. http://www.oecd.org/tax/beps/transfer-pricing-guidance-on-financial-transactions-inclusive-
11 Circular Letter LIR No. 56/1 – 56bis/1, dated 27 December 2016 relating to the transfer pricing rules applicable to companies engaged in intra-group financing transactions.
12 A qualifying non-integrating company can be a fully taxable resident company, a Luxembourg permanent establishment of a non-resident company subject to a tax comparable to the corporate income tax applicable in Luxembourg, a company resident in an EEA country subject to a tax comparable to the corporate income tax applicable in Luxembourg, or a permanent establishment located in an EEA country, if both the permanent establishment and the head office (a corporation) are subject to a tax comparable to the corporate income tax applicable in Luxembourg.
13 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.
14 Namely a Swiss corporation organised under the form of a public limited company, a limited liability company or a corporate partnership limited by shares.
15 Circular Letter L.I.R. – No. 56/1 – 56bis/1.
16 Transfer Pricing Guidance on Financial Transactions: Inclusive Framework on BEPS: Actions 4, 8–10.
17 The Value Added Tax Law dated 12 February 1979, as amended.
18 Luxembourg law of 21 December 2018 implementing the ATAD.
19 Directive 2016/1164/EU of 12 July 2016 laying down rules against tax avoidance practices.
20 On 8 January 2021, the Luxembourg tax authorities issued administrative circular L.I.T.L. No. 168bis/1, providing some guidance on their interpretation of the ILR.
21 Circular letter L.I.R. No. 164ter/1 of 4 March 2020.
22 The OECD BEPS Final report (OECD/G20 Base Erosion and Profit Shifting Project Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2 - 2015 Final Report, paragraph 95 includes a 'counterfactual test', by contrasting the parties' actual tax treatment with what it would have been, if the instrument had been held directly and both the payer and payee were ordinary taxpayers that computed their income and expenditure in accordance with the ordinary rules applicable to taxpayers of the same type.
23 Decision No. 39193C.
24 Decision No. 41800.
25 Decision No. 40348.
26 Decision No. 40251.
27 Decision No. 42326C.
28 Regarding the question of hidden dividend distributions and the condition of new facts for the modification of a tax assessment, see Decision No. 42538C of 17 October 2019, Affaire Hellas.
29 On 26 February 2019, two decisions in joined cases; Regarding The Parent Subsidiary Directive joint cases C-116/16 and C-117/16 and regarding the Interest and Royalties Directive joint cases C-115/16, C-118/16, C-119/16, and C-299/16.
30 Case C -118/16.