The Luxembourg fiscal unity regime: Practical aspects

The Luxembourg fiscal unity regime has been increasingly used over the last few years, both by Luxembourg based entities and international groups. The principle of a Luxembourg fiscal unity regime between Luxembourg resident capital entities has been in force for many years and thanks to the amendments to the conditions for applying the regime made in 2002 and the enlargement of the scope of fiscal unity in 2004, the fiscal unity regime has sparked new interest.

However, Luxembourg taxpayers still face some practical issues when entering into tax unity. This article analyses the features of the Luxembourg tax unity regime and examines its main practical pitfalls and areas for attention.

I. Introduction to the Luxembourg tax unity regime

The fiscal unity regime prescribed in Article 164bis of the Luxembourg Income Tax Law (“LITL”) allows fully taxable capital companies that are resident in Luxembourg, or Luxembourg branch¹, to form with one or several Luxembourg subsidiaries (capital companies) in which it holds, directly or indirectly, at least 95 percent of the share capital, a single pool of profit and loss for corporate income tax purposes.

The possibility of forming a tax unity for corporate income tax purposes was first implemented in 1981, whereas the fiscal unity regime for municipal business tax purposes was established by the Municipal Business Tax Law dated December 1, 1936. This regime, mainly inspired by the German Organschaft rules, was amended following the Law of December 21, 2001 to ensure consistency between the corporate income tax unity regime and the regime established in the municipal business tax legislation. Since this date, entities benefiting from the fiscal unity regime provided by Article 164bis LITL are also automatically benefiting from a fiscal unity for municipal business tax purposes.

Conversely, no fiscal unity regime is stipulated for net wealth tax, nor for VAT². Please note that the Chamber of Commerce fee³ is based on the individual results of the entity’s part of a tax unity.

II. Application of the fiscal unity

A. Notion of group

The fiscal unity regime was introduced in the Luxembourg tax law by the Law of July 1, 1981. The conditions for applying the regime were later amended and are the following:

• The head of the tax unity should be a Luxembourg capital company fully subject to tax⁴ or, since 2002, a Luxembourg permanent establishment of a foreign company which is subject to a tax similar to the Luxembourg income tax in its resident State⁵.
• The consolidated subsidiaries have to be fully taxable resident capital companies⁶.
• The threshold of direct or indirect participation was lowered from 99 percent to 95 percent⁷. This threshold must be maintained, without any interruptions, from the beginning of the first accounting year for which the fiscal unity regime is requested.
• The indirect participation of 95 percent of a fully taxable resident company can be held through foreign capital companies provided that they are subject to a tax corresponding to Luxembourg Corporate Income Tax⁸.
• The conditions of economic⁹ and organisationa^l0 integration were removed by the Law of December 21, 2001. Thus, since 2002 the fiscal unity is possible even if:
  • Companies belong to different sectors of activity;
  • Companies do not have any commercial or industrial activity and are limited to the holding of participations or financing activities
• The fiscal unity regime applies for a period of at least five accounting periods.
• The integrated companies have to open and close their accounting periods on the same date¹¹.
• The condition of ministerial approval was abolished in 2004. Nevertheless, the regime is not automatic and a joint written request from the parent company (or the Luxembourgish permanent establishment) and the respective subsidiaries is required. The request should be filed with the Luxembourg tax authorities before the end of the first accounting period for which the fiscal unity regime is demanded.

As mentioned above, since the entry into force of the Law of December 21, 2001, the requirements for the fiscal unity for municipal business tax are in line with the ones required for corporate income tax and no separate request is required for the entities to benefit from s tax unity for municipal business tax purposes.

B. Taxation of the overall result of the group

The Luxembourg tax unity regime works as a partial tax consolidation, where each member of the tax unity is required to compute its own results on a stand-alone basis. Subsequently, the profits or losses of each member company are added up and allocated to the parent entity, which will be the head of the tax unity and will pay taxes on the aggregate result of the group¹². Accordingly, each group entity must determine its own taxable result and file an individual tax return as if it did not take part in the group. The parent entity is, however, liable to file an additional consolidated tax return, aggregating the results of each member company after some adjustments for the neutralisation of double deductions or double taxation¹³. The group, though, does not have a separate fiscal personality¹⁴.

From a compliance/administrative perspective, the head of the tax unity is held responsible for paying the corporate income tax and the municipal business tax for the members of the group, as well as for settling the tax advances due by the unity. Hence, all tax assessments from the Luxembourg tax authorities will only be issued to the head of the tax unity, since this is the entity responsible for reporting the results of the group.

III. Practical aspects

A. Determination of the consolidated result

The determination of the consolidated result of the group entities for corporate income tax purposes at the level of the head of the tax unity follows two main principles:

• consolidation or compensation of the profits and tax losses made by each entity part of the tax unity¹⁵; and
• neutralisation of potential double deductions and/or double taxations arising from the application of the fiscal unity regime.

A.(i) Impacts of the fiscal unity regime on the computation of individual results

Losses prior to the fiscal unity regime

According to Article 114, paragraph 3, of the Luxembourg Income Tax Law, only the taxpayer that suffered losses can deduct them from its taxable base¹⁶. Under this principle, losses realised by a group entity (parent or subsidiary) prior to its entry in the tax unity cannot be offset against profits of other group companies.

However, these losses may offset profits of the group but only to the extent of the profits realised by the company that has suffered those losses. Accordingly, they will only be taken into account when computing the stand-alone results of this company.

Hence, a company having pre-unity losses in the amount of ten, and a taxable profit of four in the first year of the tax unity would only be able to use part of its losses (four) on year one. Therefore, its taxable basis for year one would be nil, and the remainder of the losses (six) would be carried-forward for the next year, for the use of that company only, without the possibility of being transferred to other group companies in a profitable position.

Lately, it has been debated whether pre-unity losses belonging to the head of the tax unity would also fall under the same rule. Indeed, since the corporate income tax and the municipal business tax are assessed only at the level of the head of the tax unity, and considering that the results of the other companies are ultimately integrated into the results of the head of the unity to form a single taxable basis, it has been argued that the head of the tax unity should be allowed to use pre-unity losses against profits obtained by the unity. This argument, however, has been systematically rejected by the Luxembourg tax authorities.

Losses realised during the fiscal unity regime

Given that only the parent company is considered as liable to tax during the fiscal unity regime, this entity itself is deemed to have suffered all the losses realised during the said regime, whether such losses were incurred by the parent entity or by one of the subsidiaries. Accordingly, losses suffered by a subsidiary during the fiscal unity regime, are, in principle, transmitted to the parent entity that will deduct them from the group’s results.

Upon termination of the fiscal unity regime, only the head entity of the tax unity keeps the right to carry forward, on its individual results, losses realised during the fiscal unity regime (including losses suffered by its subsidiaries during that period). This constitutes certainly a major drawback of the system as a new company could become the head of the tax unity. Indeed, losses previously available at the tax unity level would not be accessible in the new tax unity due to the change of the head entity.

The law and its execution provisions do not foresee whether a loss-making entity should be compensated by the parent company due to the losses transferred. If it is expected that the parent company compensates the company for the transferred losses, we need to know when this compensation is due: at the end of the accounting period during which the losses were realised and transferred to the parent company? On the exact day when the losses of the subsidiary are used to reduce the profits of the group? Or, when the company which realised the losses would have been able to use them if it had not been under the fiscal unity regime?

Neutralisation of certain operations - Adjustment of the overall result

In the computation of the overall result of the group, double deduction, as well as any double taxation, have to be neutralised.

The law provides for only one practical example of neutralisation adjustment when ascertaining the results of the unity, i.e. where the parent company books a write-down on the shares of its subsidiary part of the tax unity. In fact, such a write-down, if not corrected, would lead to a double deduction since the parent company adds the loss of its subsidiary to its own taxable result. In a similar way, the Circular LITL n° 86 of February 17, 1982, specifies that the parent company should reinstate the write-down made on shares of any integrated subsidiary.

Although there is no formal guidance from the Luxembourg tax authorities in this regard, there are other cases where neutralisation adjustments could be necessary, especially when the recognition and reversal of provisions come into play. These are situations where receivables are held on a group company and liability is partly or fully irrecoverable, provision for contingencies related to the activity of a group company in the case (for example) where the parent entity provided a subsidiary with a guarantee to secure debt and where the subsidiary is not able to fulfil its obligations. This may also be applicable in case of waiver of receivables towards group companies where the waiver is deductible in the hands of the grantor company and only partially taxable in the hands of the beneficiary¹⁷.

B. Horizontal/vertical integration

Under the current legislation, Luxembourg subsidiaries party to the tax integration have to be held directly or indirectly, at least 95 percent, by a Luxembourg company or a Luxembourg permanent establishment.

Luxembourg sister companies held by a foreign parent company without a permanent establishment in Luxembourg are not allowed to enter into a tax unity among themselves. Therefore, the scope of the regime can be considered narrow since a “vertical integration” (i.e., between parent and subsidiary) of tax results is necessary under the Luxembourg legislation.

This restriction has been challenged at the Luxembourg Administrative Court¹⁸ in the past, on the basis of a non-discrimination provision contained in the treaty to avoid double taxation between Luxembourg and Belgium (the “Luxembourg–Belgium Treaty”). The case is known as “Assurisk” and concerns a tax unity request made by six Luxembourg sister companies held by a Belgian company without a permanent establishment in Luxembourg. The Luxembourg entities intended to form a tax unity only between themselves (i.e. without the involvement of the Belgian parent), having one of the sister companies as the “head” of the unity. The Luxembourg tax authorities have denied their request, since the companies did not meet one of the requirements for the application of the regime, i.e. their parent company was a foreign entity without a permanent establishment in Luxembourg.

One of the companies of the group, hence, brought the case to the Luxembourg Administrative Court, alleging that the decision of the tax authorities was not in line with the non-discrimination clause in Article 24(6) of the Luxembourg–Belgium Treaty. The Luxembourg Administrative Court held that the denial of the unity was appropriate, and did not imply discrimination under the Luxembourg–Belgium Treaty, to the extent that Luxembourg sister companies held by a Luxembourg parent are equally restricted from entering into a horizontal tax unity only among themselves (i.e. without the participation of the parent company). The Luxembourg Administrative Court did not examine further whether the provisions of the Luxembourg legislation were compatible with EU Law. According to the court, the basis of the reasoning developed according to which the law would allow a horizontal integration between sister companies held by a resident entity and not by a foreign entity was not correct.

Many authors consider, however, that the Luxembourg legislation could be seen as a restriction to the freedom of establishment since a horizontal integration between Luxembourg companies could be achieved through a vertical integration; where the Luxembourg head of the integration has a nil result and holds two subsidiaries, one with loss, the other one with profit which could be consolidated at the level of the head of the tax unity¹⁹.

C. Corporate reorganisations

Entities party to a tax unity should monitor any projects concerning corporate reorganisations to avoid incurring events that can lead to its exclusion from the tax unity, with consequences for the concerned company and potentially for other members of the tax unity.

In the absence of indication in the law, and based on the current administrative practice, the absorption or liquidation of a subsidiary part of the fiscal unity into another entity of the fiscal unity, within the five-year period, should not lead to the end of the fiscal unity regime with retrospective effect provided assets and liabilities of the company merged or absorbed are, further to the operation, kept within an entity already party to the integration.

The situation of reorganisations at the level of the parent entity is less clear. Indeed, even though the assets and liabilities of the parent entity end up being taken over by another Luxembourg entity, or by a Luxembourg permanent establishment, which would become the new head of the tax unity, it seems that the tax administration recognises a predominant importance to the permanency of the legal personality of the head of the tax unity.

In the event of non-compliance with the conditions of the fiscal unity laid down in Article 164bis LITL, the fiscal unity regime could be ended with retrospective effect. Consequently, tax benefits resulted from the application of the fiscal unity regime will be denied by the Luxembourg tax authorities who will then retrospectively apply the individual taxation to each group company.

However, if the condition(s) for the application of the fiscal unity regime are no longer fulfilled by one of the subsidiaries, this entails the exit of that subsidiary from the fiscal unity, but does not entail the end of the regime for all entities.

This is based on the fact that a tax unity with several entities is considered as the sum of several individual tax unities between the parent entity and each of the direct and indirect subsidiaries.

From a practical perspective, the exit of one company from the tax unity entails the re-computation of previous years’ tax returns/assessments, since any “benefits” generated by that company during the period it remained in the tax unity would be lost for all companies. For instance, if the tax unity used losses created by the exiting company, tax would be recalculated as thought this company was never part of the tax unity.

D. Net wealth tax

Although only applicable for corporate income tax and municipal business tax, the adoption of the tax unity regime may affect the computation of the net wealth tax liability of the individual entities part of the unity.

Indeed, the Net Wealth Tax Law foresees the possibility of reducing the net wealth tax charge by allocating an amount corresponding to five times the reduced net wealth tax charge to a special reserve, before the end of the following accounting period. The reduction of net wealth tax may not, however, be higher than the amount of corporate income tax due for the same period (before tax credits).

The law also establishes that, within the framework of the fiscal unity, the global reduction of the net wealth tax for the different companies cannot exceed the amount of corporate income tax due by the group before tax credits. This provision constitutes a major drawback of the fiscal unity regime, when one of the companies is liable to net wealth tax and has individually enough results to reduce its net wealth tax charge, but is unable to do so because other group companies suffered losses that result in the group having a consolidated result insufficient to reduce its net wealth tax charge. Conversely, this is a major advantage when a loss-making company which would normally be required to pay net wealth tax may be discharged from the payment where the aggregate results of the unity are sufficient to cover it.

In conclusion, groups willing to adopt the tax unity regime should monitor the situation of each potential member to check the possibility of further tax savings or potential net wealth tax risks.

E. Tax liability responsibility

In principle, group companies realising an individual profit should book, on a stand-alone-basis, a provision for tax that should be paid to the parent entity, since the parent company is the only entity liable to tax vis-à-vis tax authorities. Accounting wise, it could be envisaged not to book such a provision if the parent entity commits itself never to ask of its profit-making subsidiary, the payment of the tax due based on its profits. If the subsidiary books a provision and the parent entity does not request its subsidiary to pay the tax due in accordance with its profits, this provision should be subsequently reversed which will lead to realise a profit in the accounts of the subsidiary (the question is to know when - at the exit of the tax unity, for instance?) To the extent that a provision is not deductible for tax purposes, the reversion should generate a non-taxable profit.

The rules on the fiscal unity regime also do not foresee whether the members of a tax unity could be considered jointly and severally liable for the taxes not paid, or whether each company would only be liable for that amount of tax corresponding to its own profits (if any). On the basis of a systematic interpretation of the provisions of the Luxembourg General Tax Law and the Tax Adaptation Law, a joint and several liability would only exist in relation to the municipal business tax, but not in relation to the corporate income tax.

A question may however arise where the parent is a holding company structurally in deficit and is unable to pay the tax owed by the group: should an agreement be obtained in advance from the Luxembourg tax authorities to ensure the compliance with the legal obligations of the parent company? Can the tax authorities require subsidiaries to issue a guarantee? Can it require a tax sharing agreement between the subsidiaries and the parent company in a loss position?

IV. Conclusion

The Luxembourg fiscal unity regime allows Luxembourg taxpayers to achieve important tax savings through the pooling of their profits and losses and consolidation of the tax results at the level of the parent entity only.

However, taxpayers willing to opt for the regime should be conscious of the constraints of the regime and the points to be monitored, adopting procedures to minimise inconvenience over the life of the tax unity and at the end of the regime. The drafting of an inter-company agreement with a view to establishing key rules for the administration of the unity would help to keep the process smooth. Issues like the funding of the tax payments to be done by the head of the unity, the contribution of losses to the unity, and the treatment of losses remaining at the end of the tax unity could be addressed in this document.

Finally, measures aiming to reduce uncertainties in the application of the regime, notably taking into account the group reorganisation needs and the economic reality of those operations, as well as an extension of the scope of the regime to net wealth tax and to allow horizontal integration would certainly be welcomed by Luxembourg taxpayers.

For further information relating to this article, please contact the authors Catherine Dupont, tax partner or Priscila Stela Mariano da Silva, tax manager by email at: catherine.dupont@lu.pwc.com or priscila.da.silva@lu.pwc.com