The Corporate Tax Planning Law Review: Luxembourg
During the past few decades, Luxembourg, located in the heart of Europe, has developed a financial centre, originally active for the private banking sector, growing into a truly diversified hub for investment funds, banks, insurance and reinsurance companies, holding companies and family offices. The attractiveness of Luxembourg is, among other things, due to its flexible and practical corporate law, the broad range of various legal forms of companies, partnerships and associations available under national law, the rapidity of company formation and also to its tax framework, such as an extensive double tax treaty network and participation exemption.
i Entity selection and business operations
Corporate law provides a wide range of legal forms of companies and partnerships. Historically, Luxembourg entrepreneurs have used commercial partnerships to carry out their activities. However, in the past decade this trend has shifted towards a more frequent use of corporate vehicles in this context. Inversely, in the funds area, the new common and special limited partnerships (CLPs and SLPs) have gained substantial recognition in the market.
Limited liability companies
Luxembourg-resident companies are fully subject to corporate income tax (CIT), municipal business tax (MBT) and net wealth tax (NWT). Depending on the need of the shareholders, they may generally adopt a corporate form such as a public limited company, a limited liability company or a corporate partnership limited by shares.
A limited liability company is subject to CIT, MBT and NWT if it is considered under Luxembourg law as a Luxembourg resident. Under Luxembourg law, a company is considered as a Luxembourg resident if its registered office (i.e., statutory office as determined by the articles of incorporation of the company) or its central administration (i.e., corresponding in general to the place of effective management of the company) is located in Luxembourg. From a pure Luxembourg tax law standpoint, one of these two criteria is sufficient to consider a company as a Luxembourg resident and, generally, no additional mandatory substance requirements should be fulfilled for the company to be considered as a Luxembourg resident (except for companies engaged in intra-group financing activities). In an international context, however, the absence of sufficient economic substance in Luxembourg or maintaining closer links with another foreign jurisdiction may result in foreign tax authorities challenging the Luxembourg tax residence of the company. Therefore, in an international context, Luxembourg companies should have a minimum level of economic substance in Luxembourg.
There are mainly two types of limited partnerships under Luxembourg law: the CLP and the SLP. The specificity of CLPs and SLPs is that they are transparent for Luxembourg tax purposes. The main difference between them is that a SLP, unlike a CLP, is not vested with legal personality. Both limited partnerships regimes have proven to be widely accepted and used by all persons wishing to have an onshore European domiciled partnership with similar features to Anglo-Saxon types of partnership structures (like 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)2 or if it is tainted by business on the basis of the Geprägetheorie according to Article 14(4) of the ITL – namely where the general partner is a Luxembourg limited liability company that owns at least 5 per cent of the interests in the CLP or SPL. As regards this business activity, Circular letter L.I.R. No. 14/4, dated 9 January 2015, provides that CLPs and SLPs that qualify as alternative investment funds within the meaning of the Alternative Investment Fund Management law of 12 July 20133 are deemed not to be conducting a business activity.
The qualification of a CLP or SLP being subject to MBT would, besides tax liability, also result in the (material) consequence of non-resident limited partners being considered to each operate a permanent establishment (PE) in Luxembourg, as their interest in the CLP or SLP would generally be attributable to the PE in Luxembourg (unless under a double tax treaty where different provisions would apply). In principle, because of the non-MBT exposure of a properly structured CLP or SLP, independent professionals tend to structure their activity through such transparent entities. With regard to withholding tax (WHT), any 'distributions' by the partnership are, as a rule, made free of WHT in Luxembourg. Distributions are performed for corporate reasons only, but are disregarded from a tax perspective, as any income and loss derived at the level of the partnership is directly attributable to the partners.
Given their tax transparency, CLPs or SLPs may not benefit from double tax treaties but their partners may generally claim treaty benefits from the source state.
Under Luxembourg law, a full range of different vehicles are available to structure investments, including inter alia:
- tailor-made investment funds, (i.e., undertakings for collective investment (UCIs), a special investment fund (SIFs) or a reserved alternative investment fund (RAIFs) opting for the SIF-like regime), which can take different corporate forms;
- companies investing in risk capital (SICARs), and RAIFs opting for the SICAR-like regime, which can take different corporate forms;
- common funds;
- securitisation undertakings;
- pension funds; and
- family wealth management companies (interest payments made by those companies to Luxembourg-resident individuals are subject to a final 20 per cent WHT ; see the subsection on 'Withholding taxes').
The investment vehicles mentioned under points (a) and (e) and are subject to a subscription tax without being subject to WHT on distributions to investors. It must be analysed on a case-by-case basis whether double tax treaties are applicable to these vehicles.
SICARs, such as mentioned in point (b), are fully subject to income taxes but 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.
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 2020, CIT is levied at an effective maximum rate of 17 per 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 2020). The maximum aggregate CIT and MBT rate consequently amounts to 24.94 per cent in 2020 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 computing the unitary value.
Further, Luxembourg-resident companies are subject, as of 1 January 2016, to a minimum NWT. This is set at €4,815 for Luxembourg companies whose financial assets, receivable against related companies, transferable securities and cash deposits, cumulatively exceed 90 per cent of their total balance sheet and €350,000. All other companies that do not meet the aforementioned conditions are subject to a minimum NWT on the basis of their total balance sheet at year end, according to a progressive tax scale varying from €535 to €32,100 respectively for a total balance sheet from €350,000 to at least €30,000,001.
Dividends paid by a Luxembourg company to its shareholders are, as a rule, subject to WHT at a rate of 15 per cent.
An arm's-length interest paid by a Luxembourg company is generally not subject to WHT. However, a payment of interest or similar income made by a paying agent established in Luxembourg (or under certain circumstances in the European Union or the European Economic Area (EEA)) to or for the benefit of an individual owner who is a resident of Luxembourg, will be subject to a WHT of 20 per cent. This WHT will be in full discharge of income tax if the beneficial owner is an individual acting in the course of the management of his or her private wealth. Responsibility for WHT is assumed by the Luxembourg paying agent.
Liquidation proceeds (deriving from a complete or partial liquidation) paid by a Luxembourg company are not subject to WHT.
Royalties paid by a Luxembourg company are generally not subject to WHT.
Fees paid to directors or statutory auditors are subject to a WHT levied at the rate of 20 per cent on the gross amount paid (25 per cent if the withholding cost is borne by the payer). WHT is the final tax for non-resident beneficiaries if their Luxembourg-sourced professional income is limited to directors' fees not exceeding €100,000 per fiscal year.
International tax – double taxation elimination method
Luxembourg has an extensive double tax treaty network and has signed, as at the time of writing, double tax treaties with 84 countries, and is in negotiation to sign a double tax treaty with 18 more countries.
In the absence of a double tax treaty, resident taxpayers are generally subject to Luxembourg income tax on their worldwide income, but unilateral credit relief is generally available.
Under treaties concluded by Luxembourg, double taxation is generally avoided by way of an exemption method with a progressivity clause that permits the inclusion of foreign income into the Luxembourg tax base to determine the global tax rate. As an exception, Luxembourg generally relies on the credit method regarding dividends, interest and royalties. Some double tax treaties concluded by Luxembourg provide tax-sparing clauses, which may also apply to Luxembourg PEs of non-resident companies (e.g., US companies).
According to the general practice adopted by the Luxembourg tax authorities (LTA), the debt-to-equity ratio applicable to a fully taxable Luxembourg limited liability company is 15 for equity to 85 for all liabilities combined (shareholder and third-party debt, represented or not by an instrument). It is understood that these liabilities finance the acquisition of participations and bear a market interest rate.4 This practice may however have to be adapted following the issuance of new transfer pricing guidance on financial transactions by the OECD in February 2020, as a result of which the applicable debt to equity ratio may have to be determined through a financial analysis. (See the 'Transfer pricing considerations' subsection for the equity at risk requirements in relation to an intra-group financing transaction.)
ii Common ownership: group structures and intercompany transactions
Ownership structure of related parties – fiscal unity
Under certain conditions, Luxembourg-resident companies of the same group are allowed to consolidate their taxable profits and losses for CIT and MBT purposes.
The main conditions of the fiscal unity regime may be summarised as follows:
- the consolidating parent company must be either a fully taxable resident company or a Luxembourg PE of a non-resident company liable to a tax corresponding to Luxembourg CIT;
- the consolidated subsidiaries must be either fully taxable resident companies or Luxembourg PEs of non-resident companies liable to a tax corresponding to Luxembourg CIT;
- the consolidating parent company must hold, either directly or indirectly, a participation of at least 95 per cent in the share capital of the consolidated subsidiaries. Participation of at least 75 per cent may also qualify for fiscal unity, but is subject to the approval of the Ministry of Finance and of at least three-quarters of the minority shareholders. Indirect participation of at least 95 per cent may further be held through non-resident companies liable to a tax corresponding to the Luxembourg CIT. The participation condition must be uninterruptedly satisfied as of the beginning of the first accounting period for which the fiscal unity is requested; and
- the regime is granted upon written application filed jointly by the consolidating parent and the consolidated subsidiaries for at least five years. The application must be filed before the end of the first accounting period for which fiscal unity is requested.
Since 2016, horizontal fiscal unity has been permitted between qualifying companies that are held by a common parent company established in an EEA Member State and subject to a tax corresponding to CIT. This is fiscal unity between two or more Luxembourg-resident companies owned by the same non-resident parent, provided that the parent company is resident in a state of the European Economic Area.
Participation exemption regime and other exemptions applicable to dividends, liquidations proceeds and capital gains
Dividends and liquidation proceeds
To qualify for the participation exemption on dividends and liquidation proceeds, the following conditions must be met (Article 166 ITL):
- the parent company must be either:
- a Luxembourg-resident fully taxable company;
- a Luxembourg PE of a company covered by Article 2 of the amended EU Parent-Subsidiary Directive5 (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;6 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 this entity.
If the conditions for the participation exemption are not satisfied, dividends are as a rule taxable at the ordinary rate. As an exception, a 50 per cent exemption is available for dividends derived from a participation in one of the following entities:
- a Luxembourg-resident fully taxable company limited by share capital;
- a company limited by share capital resident in a state with which Luxembourg has concluded a double tax treaty and liable to a tax corresponding to Luxembourg CIT; or
- a company resident in an EU Member State and covered by Article 2 of the amended PSD.
Capital gains realised on the transfer of participations are exempt under the following conditions (Article 166(9)(1) ITL and Grand-Ducal Decree of 21 December 2001):
- the parent and the entity in which the participation is held must satisfy the same conditions as those applicable for the exemption of dividends (see the subsection on 'Dividends and liquidation proceeds'); and
- the parent must have held or commit itself to hold a direct participation in the share capital of the eligible entity for an uninterrupted period of at least 12 months, a participation of at least 10 per cent or an acquisition price of at least €6 million. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
If the above-mentioned conditions are not met, capital gains are as a rule taxable at the ordinary rate.
However, the participation exemption regime contains some rules intended to avoid a double benefit – namely the exemption of capital gains realised by a Luxembourg company upon disposal of its participation would not apply to the extent of the algebraic sum of related expenses and value adjustments that have decreased the tax result of the current or preceding years. Nevertheless, losses in relation to exempt income under the participation exemption remain deductible once they become final.
Outbound dividend distribution
Dividends paid by a Luxembourg company to its shareholders are as a rule subject to a 15 per cent WHT, unless a reduced rate or an exemption applies under an applicable double tax treaty, or because of the participation exemption regime.
Under Article 147 of the ITL, dividend payments made by a fully taxable Luxembourg company may be exempt from WHT provided that, at the time the income is made available:
- the distributing entity is a Luxembourg-resident fully taxable company;
the recipient is either:
- a Luxembourg-resident fully taxable company;
- a company covered by Article 2 of PSD or a Luxembourg PE thereof;
- Luxembourg, a municipality, a syndicate of municipalities or local corporate bodies governed by public law;
- a company liable to a tax corresponding to Luxembourg CIT, and a resident of a country with which Luxembourg has a double tax treaty or a Luxembourg PE thereof;
- a company resident in an EEA Member State other than an EU Member State, and liable to a tax corresponding to the Luxembourg CIT or a Luxembourg PE thereof; or
- a Swiss-resident company7 that is effectively subject to CIT in Switzerland without benefiting from an exemption; or
- at the time the income is made available, the recipient holds or commits itself to hold directly for an uninterrupted period of at least 12 months a participation of at least 10 per cent or an acquisition price of at least €1.2 million in the share capital of the distributing entity. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
Such an application of the national participation exemption could be envisaged in the case of dividends distributed by a Luxembourg-resident company to its eligible shareholder in the form of a US real estate investment trust.
The participation of a Luxembourg company in another company will be considered as an exempt asset for NWT tax purposes to the extent the conditions of the Luxembourg participation exemption regime, as described above, are met (except that the Luxembourg company must merely hold the qualifying participation at the end of the previous accounting year).
Transfer pricing considerations
As a general rule, Luxembourg does not levy any WHT on arm's-length interest payments. However, companies engaged in intra-group financing activities need to evidence that their remuneration complies with the arm's-length principle. According to the OECD's arm's-length principle, activities that are carried out between affiliated companies must comply with market conditions, namely conditions that would apply between independent companies.
To provide practical guidance to companies engaged in intra-group financing activities and following the implementation of the new Article 56 bis of the ITL, the LTA issued a circular letter,8 dated 27 December 2016, which follows the OECD guidelines in transfer pricing matters.
On 11 February 2020, the OECD released a report9 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 that are engaged in intra-group financing transactions.
Determination of the arm's-length price
The comparability analysis is the main element for the application of the arm's-length principle: the arm's-length principle is based on a comparison of the conditions of a controlled transaction with the conditions that would have been made had the parties been independent had they undertaken a comparable transaction under comparable circumstances.
Equity at risk
Companies engaged in intra-group financing activities must have the financial capacity – or equity at risk – to assume the risks related thereto. The amount of equity at risk must hence be determined by an appropriate transfer pricing analysis on a case-per-case basis. No specific methodology is foreseen but equity at risk needs to be determined on the basis of a credit risk analysis, which includes a market analysis, a balance sheet analysis as well as all the other elements that are relevant for the determination of the risks linked to a financing activity.
To be able to control the aforementioned risks, an intra-group financing company must have a genuine presence in Luxembourg, which requires a minimum of economic substance in Luxembourg, as follows:
- the majority of the members of the board of managers, directors or managers having power to bind the company must be (1) Luxembourg residents or (2) non-residents who pursue a professional activity (i.e., a business or agricultural, forestry, independent or salaried activity) in Luxembourg and who are taxable in Luxembourg for at least 50 per cent of their professional revenue. If a company is part of the management board, it must have its statutory seat and central administration in Luxembourg;
- the company must have qualified personnel able to control the transactions performed. The company may, however, outsource functions that do not have a significant impact on the control of the risks;
- key decisions regarding the management of the company must be taken in Luxembourg. Companies that are required by corporate law to hold shareholder meetings must hold at least one annual meeting at the place indicated in the articles of incorporation; and
- the company must not be considered as a tax resident of another state.
iii Indirect taxes
In 2020, the standard value added tax (VAT) rate in Luxembourg is 17 per cent. Reduced rates of 3 per cent, 8 per cent and 14 per cent apply to supplies of goods and services that are specified in three appendices to the Luxembourg VAT Law.10 These appendices cover the specific scope of the application of the reduced rates and must be interpreted in a strict sense.
All supplies of goods and services carried out (or deemed to have been carried out) in Luxembourg for consideration, and by a person carrying out an economic activity, fall within the scope of the Luxembourg VAT Law. While located in Luxembourg, certain supplies of goods and services may benefit from a VAT exemption. The most frequently used VAT exemptions relate to: the supply and letting of real property, except where taxation is opted for; financial transactions; insurance and reinsurance, and connected services; and the management of regulated UCIs, SICARs, SIFs, alternative investment funds, pension funds and Luxembourg securitisation undertakings.
Persons that are closely bound by financial, economic and organisational links (cumulative conditions) can constitute a VAT group. A VAT group does not provide for any limitation as regards the status of the person (i.e., VAT taxable or not), or the nature or type of activity (e.g., VAT exempt or taxable supply of services or goods). However, persons may only be members of one VAT group and the members of a VAT group must be established within the same EU Member State (no cross-border VAT groups). Members of a VAT group are considered as a single entity for VAT purposes, with the result that supplies and services provided among members of a VAT group (i.e., internal transactions) are outside the scope of VAT
The new measures foreseen by 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 call-off stock regime and harmonisation of rules applicable to chain transactions.
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 accepted that these taxpayers may file an ATC request before the closing date of their 2020 financial year end. However, a new request can only be successful as long as the transactions have not produced 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 physically used in a country of the European Economic Area. As a general rule, qualifying investments include, among others, tangible depreciable assets other than buildings and livestock, and mineral and fossil deposits. As such, tax credits can be available to Luxembourg companies for certain assets financing, for example, aeroplanes or software that has been acquired (as opposed to self-developed), 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 by 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 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
The implementation of the ATAD in Luxembourg law
- interest limitation rules;
- exit taxation rules;
- a general anti-abuse rule;
- controlled foreign companies (CFC) rules; and
- hybrid mismatch rules.
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.13
The purpose of CFC rules provided under the ATAD is to re-attribute the income of a low-taxed controlled subsidiary to its parent company, which will then become taxable on this income.
The CFC rules generally apply if the following cumulative criteria are fulfilled:
- the level of participation – namely direct or indirect holding via related entities of more than 50 per cent of voting rights or capital, or entitlement to more than 50 per cent of the profits of the entity;
- the amount of tax paid by the CFC – namely whether the actual CIT paid by the entity or PE on its profits is lower than the difference between the CIT that would have been charged in Luxembourg and the actual CIT paid by the entity (or PE); and
- non-genuine arrangements – namely the entity (or PE) neither owns the assets that generate its income nor would have undertaken the related risks that generate all, or part of, its income if it were not controlled by a taxpayer where the significant people functions linked to those assets and risks are carried out and are instrumental in generating the CFC income.
On 4 March 2020 the Luxembourg tax authorities issued a Circular14 specifying the administrative application of CFC rules in Luxembourg. With Luxembourg following a transfer pricing approach determining the allocation of income for tax purposes, the Circular provides that the taxpayer needs to have transfer pricing documentation with 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 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 applied 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 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 in the scope of the 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.
In December 2019, the Luxembourg Parliament passed the law implementing the ATAD II provisions into domestic law. The new measures which have amended the existing (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 1 January 2022.
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 determining 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 holding directly or indirectly less than 10 per cent in the interest of the Luxembourg investment fund and that is entitled to less than 10 per cent of the profits of this fund will not (unless proved otherwise) be considered as acting together with another investor in the fund.
According to the wording of the ATAD II provisions and line with the parliamentary documents, the deduction without inclusion must be caused by the hybrid mismatch, that is, the different legal characterisation of the payment in the 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 non-inclusion does not have its cause 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.
ATAD II provides that the reverse hybrid mismatch provisions shall not apply to a collective investment vehicle, so that a Luxembourg (special) limited partnership15 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 the Member State of the head office no longer has the right to tax the transferred assets owing to the transfer – triggers, as a rule, capital gains taxation on the asset (i.e., taxation of the difference between the fair market value and the book value of the assets at the date of the transfer).
The same treatment applies to:
- a transfer of assets from a PE to its head office, or another PE in another Member State or in a third country;
- a transfer of the taxpayer's tax residence to another Member State or to a third country, except for those assets that remain effectively connected with a PE in the first Member State; and
- a transfer of the taxpayer's business carried on by a PE from a Member State to another Member State or to a third country.
For EU and EEA transfers, the taxpayer may be entitled to defer the payment of the exit tax over five annual instalments. Certain temporary transfers not exceeding 12 months are excluded.
Asset transfers related to the financing of securities, assets posted as collateral, or where the asset transfer takes place to meet prudential capital requirements or for the purpose of liquidity management, provided that the assets are set to revert to the transferor within 12 months, are excluded from the exit tax rules.
The exit tax rules under the ATAD, such as implemented under the ATAD Law, 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, there is an abuse of law if the legal route – which, having been used for the main purpose or one of the main purposes of circumventing or reducing tax contrary to the object or purpose of the tax law – is not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part. An arrangement or a series of arrangements are regarded as non-genuine to the extent that they are not put in place for valid commercial reasons that reflect economic reality. The new general anti-abuse rule applies to all types of income, including dividends, capital gains and liquidation proceeds, as well as to assets taken into account for NWT purposes.
ii EU proposals on taxation of the digital economy
Luxembourg has not taken any legislative actions with regards to the European Commission's proposals on the taxation of the digital economy.
iii Tax treaties and the multilateral instrument
On 7 June 2017, the official ceremony for the signing of the multilateral instrument (MLI) took place, bringing to a close a process initiated the previous year when a consensus was reached on the wording on 24 November 2016. The MLI has been negotiated by more than 100 jurisdictions and Luxembourg was one of them. The MLI entered into force on 1 August 2019. Currently 66 of the 84 tax treaties in force with Luxembourg are covered by the MLI. Luxembourg has adopted a restrictive approach to the provisions provided for under the MLO, and has sought to limit the scope and impact of this new layer of international legislation to the minimum standards required. Key features include the principal purpose test (PPT) clause and an improved dispute mechanism system. Luxembourg has declared that the related provisions will apply to all its double tax treaties that are in force.
In summary, the PPT clause aims at denying the benefits of the covered double tax treaties to taxpayers where there is evidence that a given arrangement or transaction was set up for the principal purpose of obtaining that benefit.
The MLI provisions affecting withholding taxes apply to some of Luxembourg's covered tax treaties since 1 January 2020. The entry into effect will finally need to be analysed on a case-by-case basis, since it depends on the entry into force of the MLI in the other contracting state. As from 1 February 2020 other taxes may be concerned.
iii DAC 6
On 21 March 2020, the Luxembourg Parliament passed a law (the DAC 6 Law) implementing Council Directive (EU) 2018/822 of 25 May 2018 amending Directive 2011/16/EU (DAC 6) as regards mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements.
Under the new rules, Luxembourg intermediaries and, in certain cases, taxpayers will have to disclose certain information on reportable cross-border arrangements to the Luxembourg tax authorities as from 1 July 2020 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 DAC 6 Law. Some of the 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 DAC 6 Law, the reporting process will start as at 1 July 2020. As from that date, concerned intermediaries (not subject to legal professional privilege) or taxpayers, as the case may be, will have to file the reportable information with the Luxembourg tax authorities within a 30-day period from the first to occur of the following: (1) the day after the reportable arrangement is made available for implementation; (2) the day after the reportable arrangement is ready for implementation; or (3) the day when the first step in the implementation of the reportable arrangement has been made.
Furthermore, between 1 July 2020 and 31 August 2020, concerned intermediaries or taxpayers, as the case may be, will be required to report information on reportable cross-border arrangements whose first step was implemented between 25 June 2018 and 30 June 2020.
The Luxembourg tax authorities will exchange the reported information automatically with other Member States 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 shall be subject to a maximum fine of €250,000.
Certain case law from recent years is relevant for corporate tax planning regarding new projects as well as existing structures.
i Perceived abuses
Buy-back of shares
In its decision of 23 November 201716, the Luxembourg Administrative Court has 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, therefore, not be in scope of the Luxembourg dividend withholding tax. With its decision, the court has confirmed a position held by the majority of practitioners ever since. The withholding tax free buy-back of shares 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 relevant time is binding.17 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 the taxpayer to demonstrate that the payments made in 2013 under the MRPS were in line with the arm's-length principle, which the taxpayer refused, referring to the confirmation in the ATC. In another letter, the LTA then challenged the MPRS for being abusive. The court ruled, that since the ATC had been in line with the legal framework at the time and there was no change of 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 201818 the Luxembourg district court has highlighted once again the necessity for the taxpayer to duly document compliance with the arm's-length principle of all intra-group transactions. In the case at hand, a Luxembourg company (LuxCo) financed the acquisition of a building in France through a shareholder loan bearing an interest rate of 12 per cent. In the absence of proper transfer pricing documentation justifying this rate, the LTA considered that it was excessive and should be 3.57 per cent for 2011 and 2.52 per cent for 2012, with the requalification of excessive interest into a hidden dividend distribution that is not deductible and subject to a 15 per cent withholding. Following this, two transfer pricing reports were prepared ex post for LuxCo: the first was submitted to the LTA during the tax assessment phase but was not able to support the 12 per cent rate (with arm's-length rates ranging from 3.21 per cent to 7.88 per cent), while the second transfer pricing report justifying it (with an arm's-length range of 9.95 per cent to 19.61 per cent) was prepared during the litigation phase. Even though the district court concluded that the second transfer pricing documentation was admissible, it confirmed LTA's view as LuxCo was not able to explain the differences in outcomes and inconsistencies between the two transfer pricing reports.
A decision19 of the district court from 7 January 2019 focused on the arm's-length principle of 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 do – 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 where alleged hidden dividend distributions were in question.20 The Luxembourg tax authorities had argued there was a lack of economic reasons for the transactions, however without sufficiently specifying further elements of the underlying case. The court underlined that the burden of proof for a hidden dividend distribution is with the tax authorities and that the burden of proof does not shift to the taxpayer until the tax authorities have brought forward elements of the respective case at hand that constitute a hidden dividend distribution.21
SICAR under Luxembourg domestic law
While the so called Danish Cases22 from the Court of Justice of the European Union had an EU-wide impact on the beneficial ownership concept as well as on the notion of abuse, the case involving a SICAR23 had a particular meaning with regards to Luxembourg. The CJEU ruled that a SICAR could not benefit from the Interest and Royalties Directive, arguing that even if the SICAR is formally subject to corporate income tax in Luxembourg, the interest income is in fact tax-exempt. This decision should however 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 during 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 have proper transfer pricing documentation available at the LTA's request to support their compliance with the arm's-length principle of intercompany transaction as well as the economic reality of their transactions.
DAC 6 will introduce further compliance provisions. Irrespective of any impact on the tax considerations for a structuring, DAC 6 may add an additional administrative burden on the taxpayer and the intermediary.
Most of the recently introduced provisions in Luxembourg with an impact on corporate tax planning are implementations of EU Directives, which are in turn based on the OECD anti-BEPS project. Keeping its commitment to be OECD-compliant, Luxembourg has fully implemented those measures in a timely manner. Where the ATAD allowed options, Luxembourg sought investor-friendly implementations. With the implementation of ATAD, Luxembourg further decreased its corporate income tax rate in 2019 to 17 per cent (18 per cent in 2018; it was 22 per cent in 2008). Some directives provided for the implementation of undefined terms into the Luxembourg tax law. Examples are 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 DAC 6. Certain provisions of the directives foresee concepts 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 are first measures in order to promote legal certainty. Further circulars, for example with regards to the anti-hybrid rules, may follow. So far Luxembourg could successfully reconcile the international requirements for the implementation of the new international tax standards (as a reliable member of the OECD and a member state of the European Union) and its attractiveness as one of the most important capital aggregator jurisdictions in the world 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 proven in the past its reactivity and agility to a new environment and anticipated early new needs, trends and opportunities in the business environment, a capacity that it should keep in the upcoming future.
1 Eric Fort and Jan Neugebauer are partners and Philipp Jost and Henner Heßlau are senior associates at Arendt & Medernach.
2 The Income Tax Law dated 4 December 1967, as amended.
3 Implementing the Alternative Investment Fund Managers Directive 2011/61/EC.
4 In the case of non-compliance with this ratio, interest in relation to the excess of liabilities can be considered as hidden dividends for tax purposes. The consequence is that this excess interest is not deductible and is potentially subject to a 15 per cent WHT under the same conditions as distributed dividends.
5 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.
6 See footnote 4.
7 Namely a Swiss corporation organised under the form of either a public limited company, a limited liability company or a corporate partnership limited by shares.
8 Circular Letter L.I.R. – No. 56/1 – 56 bis/1.
9 Transfer Pricing Guidance on Financial Transactions: Inclusive Framework on BEPS: Actions 4, 8–10
10 The Value Added Tax Law dated 12 February 1979, as amended.
11 Luxembourg law dated 21 December 2018 implementing the ATAD.
12 Directive 2016/1164/EU of 12 July 2016, laying down rules against tax avoidance practices.
13 At the time of writing, the Luxembourg tax authorities have not yet provided any Circular specifying the application of these rules.
14 Circular letter L.I.R. No. 164ter/1 of 4 March 2020.
15 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.
16 Decision No. 39193C.
17 Decision No. 41800.
18 Decision No. 40348.
19 Decision No. 40251.
20 Decision No. 42326C.
21 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.
22 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.
23 Case C -118/16.