Tax Update - Luxembourg

Proposal for the limitation on deduction of payments made to non-cooperative jurisdictions.

On 25 March 2020, Luxembourg Government Council adopted a draft bill (Number 7547, the “Bill”) denying the tax deductibility of interest and royalties paid by Luxembourg companies to related entities established in non-cooperative jurisdictions and not supported by valid business reasons.

The Bill follows the ECOFIN guidelines issued at the Council of 5 December 2019 and provides for specific rules applicable to payments made to associated enterprises located in a country or territory deemed non-cooperative for tax purposes (i.e. listed in the so called EU “blacklist”).

The ECOFIN guidelines dated 5 December 2019 required all EU Member States to apply tax defensive measures as from 1 January 2021, for jurisdictions listed on the EU “blacklist”.

Currently, the following twelve jurisdictions are included in the EU “blacklist” - American Samoa, Cayman Islands, Fiji, Guam, Oman, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, US Virgin Islands and Vanuatu. Jurisdictions can be removed from this list provided that they amend or commit to amend their legislation to comply with the EU principles. The next review of the EU “blacklist” will be carried out in October 2020.

The Bill amends the Luxembourg income tax law (“LITL”), by adding a new paragraph 5 to the article 168 LITL. The new provisions deny the tax deductibility of interest and royalties as follows:

The entity paying the interest or royalty payments is a Luxembourg resident company
The recipient of the interest or royalty payments is an opaque entity (as defined by the article 159 LITL). If the latter is not the beneficial owner of such interest or royalties, the ultimate beneficial owner of such payments will have to be taken into account
The recipient opaque company is a related company (as defined in the article 56 LITL). This implies that it directly or indirectly participates in the management, control or share capital of the Luxembourg payer or that the same company participates directly or indirectly in the management, control or share capital of both entities (i.e. the recipient and the payer), and
The recipient opaque company is resident in a jurisdiction included in the EU “blacklist”.

The limitation of deductibility of interest and royalty payments mentioned above should anyhow not apply to the extent that Luxembourg taxpayer is in a position to prove that the payments of interest or royalties have sound business reasons reflecting the economic reality.

For interest and royalties paid to a related company not listed in the EU “blacklist” and payments made to a non-related entity, the situation should remain unchanged. Payments made by Luxembourg resident companies have to be in line with the arm’s length principle and supported by a business rationale. If such conditions are met, in principle, interest and royalties will remain deductible and not subject to Luxembourg withholding tax.

This new limitation of deductibility regime will enter into force as of 1 January 2021. The list of non-cooperative jurisdictions will be added to the article 168 (5) LITL further to a proposal from the Luxembourg government, with effect as from 1 January 2021 (based on the last published EU “blacklist” at the date of such proposal). For the following years, the list of non-cooperative jurisdictions will be updated on an annual basis by the Luxembourg Parliament according to the EU “blacklist” at that time. The new rule will apply to interest and royalty paid or due to a recipient company resident in a new jurisdiction included in the “blacklist” as of 1 January following its inclusion in the list by the Luxembourg government. However, in case of removal of a jurisdiction from the EU “blacklist”, the limitation of deduction will apply directly as from this date.

The draft law now needs to go through the Luxembourg legislative process and may be subject to amendments.

These new measures may have considerable implications for Luxembourg companies. In order to assess the impact and precise scope of these new rules (in particular regarding payments to tax-transparent entities established in the jurisdictions listed above), our tax team remains available to answer to any queries you may have in this respect.

For more information please contact Yacine Diallo, or Rafael Moll de Alba.