Tax News - Luxembourg

Transposition of EU Directive 2016/1164 on anti-tax avoidance

On June 19, 2018, the bill of Law 7318 (the Bill) transposing the EU Anti-Tax Avoidance Directive (ATAD) was submitted to the Luxembourg Parliament. 

The ATAD was adopted by the Council of the European Union on June 28, 2016 in order to implement part of the OECD’s recommendations on Base Erosion and Profit Shifting (BEPS).

The ATAD imposes certain tax measures to be implemented by Member States in the following five areas:

• Rules limiting the interest deduction
• Controlled foreign corporations rules
• Hybrid mismatch rules
• General anti-abuse rule and
• Exit taxation rules.

The ATAD gives options to Members States in order to transpose the tax measures. In light of the Bill Luxembourg has opted for flexible and business friendly options.

The Bill is now under the process of parliamentary approval and it is expected that the law will be approved in the coming months. The new rules introduced by the Bill will be applicable as from January 1, 2019 (except for the rules on exit taxation that will be applicable as from January 1, 2020).

Deductibility of interest payments

The purpose of this provision is to discourage Luxembourg corporate taxpayers to reduce their taxable basis with debt financing, which creates tax deductible interest expense. According to the current tax rules applicable in Luxembourg, interest expense is fully deductible provided that the terms of the debt respect the arm’s length principle.

As from January 1, 2019, the deductibility of exceeding borrowing costs will be limited to the higher of (a) 30% of EBITDA (the taxpayer’s taxable earnings before interest, tax, depreciation and amortization) or (b) EUR 3 million. Exceeding borrowing costs is defined as the negative difference between interest income realised by the taxpayer and its interest expenses. This interest deduction limitation will apply for financing granted by related and unrelated parties.

Loans issued before June 17, 2016 will be subject to a grand-fathering clause and be excluded from the scope of the ATAD arrangements. Modifications that may be made to the loan after this date will not impact the applicability of the ATAD.
Controlled foreign companies (CFCs)

Controlled foreign companies (CFCs)

Luxembourg currently does not have any CFC rules. The Bill introduces CFC rules for non-genuine arrangements whose essential purpose is obtaining a tax advantage. In this regard, a Luxembourg corporate taxpayer will have to include in its taxable basis certain income realised by its low-taxed direct or indirect subsidiaries or permanent establishments, even if this income has not been distributed by the CFCs.

A CFC will be considered to be low-taxed, if the tax paid by the CFC on its income is less than half of the Luxembourg corporate income tax that would have been paid in Luxembourg.

The inclusion of the income of the CFC in the taxable basis of the Luxembourg taxpayer is limited to the income deriving from the functions performed by the Luxembourg taxpayer in relation to the activities of the CFC. In this respect, to the extent that the Luxembourg taxpayer does not intervene in the activities of the CFC, Luxembourg corporate taxpayers should not be impacted by CFC rules.

CFC rules will only be applicable for Luxembourg corporate income tax purposes (Luxembourg municipal business tax will not affected by these new rules).

Hybrid mismatches

The Bill foresees anti-hybrid rules in order to eliminate the non-taxation created by the use of specific hybrid instruments or entities between EU Member States. A hybrid mismatch structure is a structure where (i) a financial instrument or an entity is characterized differently for tax purposes in two different Member States and (ii), as a consequence, such mismatch leads to a double deduction of expenses in the two Members State or to a deduction of expenses in one Member State without the corresponding inclusion of income in the other Member State (deduction without inclusion).

As from January 1, 2019, Luxembourg corporate tax payers will not be entitled to deduct an expense deriving from a hybrid mismatch structure if:

• The expense has its source and is also deductible in another EU Member State or,
• The expense does not create taxable income in another Member State. 

The Bill transposing ATAD only addresses the hybrid mismatches within EU as described above. Broader rules against hybrid arrangements (including, among others, hybrid arrangements with third countries) will be addressed in a separate law, when the Directive 2017/952 of 29 May 2017 (the so-called ATAD 2) will be transposed into Luxembourg law. It is expected that the bill transposing ATAD 2 will become available in the course of 2019 given that most of the anti-hybrid rules imposed by the ATAD 2 should be transposed into Luxembourg law by the end of 2019.

General Anti-Abuse Rule (GAAR)

The ATAD introduces a GAAR aiming at tackling non-genuine arrangements implemented for the main purpose, or one of the main purposes, of obtaining a tax advantage that defeats the purpose of the applicable tax law. In this context, these arrangements should be disregarded for the purpose of calculating the corporate tax liability. If an arrangement is ignored, the tax liability should be calculated in accordance with domestic law. Arrangements are considered as non-genuine if they are implemented without valid commercial reasons reflecting economic reality.

Luxembourg currently has a GAAR in its tax legislation (in article 6 of the Tax Adaptation Law -Steueranpassungsgesetz -). The Bill adapts the wording of the existing GAAR contained in Luxembourg tax law in order to bring it in line with the GAAR of the ATAD and with the Luxembourg jurisprudence of the past years.

Exit taxation rules

The Bill includes the relevant article of the Luxembourg tax code, stipulating taxation at fair market value for capital gains realised upon certain outbound transfers of assets. The Bill furthermore includes all the situations mentioned by the ATAD. These rules will be applicable as from January 1, 2020. For EU / EEA transfers, Luxembourg taxpayers may be entitled to defer the payment of the exit tax in five annual instalments.

Additional tax measures contained in the Bill

In addition, the Bill brings two new tax measures applicable as from January 1, 2019.

• The existing tax neutral regime for capital gains realised upon the conversion of debt will no longer be available
• The definition of permanent establishment will be modified in order to avoid mismatches. Pursuant to this new provision, the sole criteria to apply in order to determine whether a Luxembourg taxpayer has a permanent establishment will be the ones stipulated in the applicable double tax treaty.

Conclusion

The transposition of the ATAD and the additional measures may have a significant impact on many Luxembourg taxpayers. In order to smoothly monitor the potential impact of these significant changes in Luxembourg income tax law, it is recommended for Luxembourg entities to have their compliance status reviewed.

Tax partners and their team at Charles Russell Speechlys are available for your questions, to help you navigate through the upcoming changes in the law. For more information please contact Rafael Moll de Alba on +352 26 48 68 95 or at Rafael.MolldeAlba@crsblaw.com; or Yacine Diallo on +352 26 48 68 94 or at Yacine.Diallo@crsblaw.com.