On 19 June 2018, the Luxembourg Government tabled a draft Bill (n°7318) before the Luxembourg Parliament (Chambre des Députés) that would implement ATAD 1 as Luxembourg domestic law. Following a number of amendments, mostly technical in nature but more material in a few instances, on 18 December 2018 the Chambre des Députés voted to approve these measures, and they will now become law.
The new legislation will come into force on 1 January 2019 with respect to the following measures:
The revised exit tax rules (Article 5 of ATAD 1) will come into force on 1 January 2020.
The new legislation also includes two additional amendments to the domestic law, both not directly linked to the ATAD 1 text. These measures concern tax neutral exchanges, and the domestic definition of permanent establishment.
A recent statement by the Minister of Finance indicated that it is now likely that details of proposed further legislative changes, to clarify the application of ATAD 1, will be published in the first part of 2019. These changes, which should also have effect from 1 January 2019, are in particular expected to extend the current new legislation to allow the application of the interest limitation rules on a group basis in cases where a fiscal unity has been elected.
The Directive amending ATAD 1 regarding hybrid mismatches with third countries (“ATAD 2”) is not part of the current new legislation, but will be implemented during 2019, in order to come into force in Luxembourg from 1 January 2020. However, the current new legislation has transposed the original ATAD 1 measures concerning intra-EU hybrids, meaning that these measures are only likely to apply for the 2019 tax year.
Interest limitation rules
The new legislation introduces a new Article 168bis into the text of the principal legislation (the Income Tax Law of 4 December 1967 (“LITL”)), setting out new interest deduction limitation rules in line with Article 4 of ATAD 1.
The interest limitation rule applies to corporate taxpayers resident for tax purposes in Luxembourg and subject to corporate income tax (“impôt sur le revenu des collectivités”), and to Luxembourg permanent establishments of companies resident in another EU Member State or a third country.
Consistent with the options offered by Article 4(7) and 4 (3) (b) of ATAD 1, the new Article 168bis (8) excludes from the scope of application of the interest limitation rules “financial undertakings” and “standalone entities”, each defined in the same way as in ATAD 1.
The financial undertakings listed in the Article 168bis (1) item 7 are each types of entities regulated by an EU Directive or Regulation:
The new legislation adds to the list of types of financial undertaking set out in ATAD 1, securitisation vehicles that are governed by Article 2 point 2 of Regulation (EU) 2017/2402 (“simple, transparent and standardised securitisation”). It should be noted that under the new Article 168bis as now voted all other securitisation vehicles remain within the scope of Article 168bis. However, during the final debate in the Chambre des Députés prior to the vote on the legislation, there were some indications that this position could be clarified retrospectively by subsequent legislation and the motion issued by the Chambre des Députés on 18 December 2018 expressly invites the Luxembourg Government to further analyse the situation of securitisation vehicles in compliance with ATAD 1. .
A stand-alone entity is a taxpayer that is not part of a consolidated group for financial accounting purposes, and which has no associated enterprise or permanent establishment situated in a country other than Luxembourg (Article 168bis (1) item 6).
Taxpayers not excluded from the scope of application of the interest limitation rule are to be subject to a limitation of the deductibility of interest and many other broadly similar types of costs, together referred to as “borrowing costs” (see below).
The limitation will apply to “exceeding” borrowing costs. These are defined as the tax deductible borrowing costs that are in excess of the taxable interest revenues and other economically equivalent taxable income of the taxpayer.
ATAD 1 stipulates that “interest revenue and other economically equivalent taxable income” is to be defined under Member States’ domestic law. However, Article 168bis (1) item 3 does not provide any definition or guidance for interpretation of what constitutes interest revenue and other economically equivalent taxable income under Luxembourg domestic law. Nevertheless, it is expected that interest revenue should be defined by symmetry, and thus include at least the items listed below in the definition of “borrowing costs”.
Borrowing costs are defined by Article 168bis (1) item 2 as interest expenses on all forms of debt and other costs economically equivalent to interest and expenses incurred in connection with the raising of finance. The new Luxembourg legislation includes precisely the same non-limitative list of elements as set out in ATAD 1 that are to be considered as borrowing costs.
This list includes:
The rule applies to any financing, irrespective of whether provided by related parties or third parties.
As a result, borrowing costs are fully deductible up to the amount of interest revenues and other economically equivalent taxable income of the taxpayer. Only borrowing costs in excess of interest revenue are “exceeding” borrowing costs that are subject to the interest limitation rule.
The exceeding borrowing costs of a taxpayer will be deductible in any tax period only up to the higher of i) 30 % of the taxpayer’s net revenues before interest, tax, depreciation and amortisation (“EBITDA”); or ii) EUR 3 million (Article 168bis (2)).
Exempt income, and expenses connected to such exempt income, are not to be taken into account for the computation of EBITDA, as defined by Article 168bis (1) item 4. Depreciation and amortisation added back for the computation of EBITDA are the amounts of depreciation and amortisation deductible for tax purposes.
Grandfathering of loans concluded before 17 June 2016
When determining the amount of exceeding borrowing costs, a taxpayer may exclude exceeding borrowing costs arising from debt concluded before 17 June 2016. The exclusion shall not extend to any subsequent modification of the debt.
Little further guidance has been given during the legislative process on how this rule is to be interpreted. However the final form of wording of the measure (Article 168bis (7)(a)) is identical to the ATAD 1 wording, and so the guidance in Recital (8) to ATAD 1 should apply. The grandfathering rule should thus cover existing loans to the extent that their terms are not subsequently modified, i.e. in case of a subsequent modification, the grandfathering would not apply to any increase of exceeding borrowing costs arising from the modification but would be limited to the original terms of the loan.
Long-term infrastructure projects
When determining the amount of exceeding borrowing costs, a taxpayer may exclude exceeding borrowing costs arising from long-term infrastructure projects where the project operator, borrowing costs, assets and income are all in the European Union (Article 168bis (7)(b)). If this exclusion applies, then all income from the project must be excluded from the EBITDA calculation. Article 4 (4) (b) of ATAD 1 clarifies that a long-term infrastructure project is a project to provide, upgrade, operate and/or maintain a large-scale asset that is considered to be in the general public interest by a Member State.
Groups within fiscal unity arrangements
The new Article 168bis as now voted does not contain any provisions that allow the interest limitation rules to be applied at the level of a fiscal unity group, rather than on an entity by entity basis. However (see Flash News dated 12 December 2018) the Minister of Finance has confirmed that further legislation, to have effect from 1 January 2019, will be introduced in order to allow application of the rules at a fiscal unity level. The motion issued on 18 December 2018 invites, in this regard, the Luxembourg Government to present a bill of law addressing the tax unity point in the first quarter 2019.
Group equity ratio
A taxpayer that is a member of a consolidated group for financial accounting purposes may, on request, deduct in full its exceeding borrowing costs, if it can demonstrate that the ratio of its equity to its total assets is equal to or higher than the equivalent ratio of the group (Article 168bis (6))). The equity ratio of the taxpayer can be considered as equal to or equivalent if it is lower than the equity ratio of the group by up to 2 %. The comparison has to be made based on the same valuation method at both the taxpayer and group level, either under IFRS or under the financial information system of a Member State.
Exceeding borrowing costs not deductible in a tax period may be carried forward without time limitation, and may then be deducted in any later tax period in which borrowing costs of that later period itself are fully deductible.
Unused interest capacity can only be carried forward for 5 years, and is to be utilised on an “oldest first” basis (Article 168bis (5)).
Interaction with other provisions of Luxembourg law
It is clear that “exceeding borrowing costs” do not take into account interest expenses that are otherwise non-deductible under Luxembourg legislation. The new legislation however does not provide for any amendment to other, pre-existing, Luxembourg tax provisions limiting deductions of interest, such as the “recapture” rules within the participation exemption regime. Interaction between these measures (and other rules limiting deduction) and the new Article 168bis will thus have to be considered.
Controlled Foreign Company measures
The new legislation introduces a new Article 164ter into the LITL, setting out new controlled foreign company (“CFC”) rules, in line with Articles 7 and 8 of ATAD 1.
Luxembourg has opted for option B, as foreseen by Article 7 (2) (b) of ATAD 1, thus targeting non-distributed income of CFCs arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage.
The CFC rules apply to corporate taxpayers resident for tax purposes in Luxembourg and subject to corporate income tax (“impôt sur le revenu des collectivités”), and to Luxembourg permanent establishments of companies resident in another EU Member State or a third country.
Definition of a Controlled Foreign Company
Two cumulative conditions have to be fulfilled before an entity or permanent establishment can be considered as a CFC.
An entity is a controlled entity if the taxpayer by itself, or together with its associated enterprises, holds a direct or indirect participation of more than 50% of the voting rights or capital, or is entitled to receive more than 50% of the profits, of that entity (Article 164ter (1) condition 1). With respect to a permanent establishment, the control test is met by definition.
For the purpose of the CFC regime, a specific definition (Article 164ter (2)) of the term associated enterprise applies:
If an individual, or any entity (including a partnership), resident or not, holds directly or indirectly a participation of 25% or more in both a taxpayer and one or more entities, all the entities concerned, including the taxpayer, shall also be regarded as associated enterprises.
Effective tax rate (“ETR”) Test
There will be a CFC if the actual corporate income tax paid by the entity or permanent establishment on its profits is lower than 50% of the corporate income tax charge which would have been payable in Luxembourg under Luxembourg domestic tax rules, had the entity or permanent establishment been resident or established in Luxembourg (Article 164ter (1) condition 2).
The comparison is made by reference to the corporate income tax rate applicable in Luxembourg (18% in 2018), and hence by reference to a rate of 9% in 2018. We cannot exclude the possibility that this rate might decrease in the coming years – a 1% rate cut for the 2019 tax year has already been announced in early December 2018 as part of the coalition programme of the incoming Government.
When an entity or permanent establishment meets the control test and the ETR test, the taxpayer must include in its taxable basis as “CFC income” the non-distributed income of the entity or permanent establishment, to the extent arising from non-genuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage (Article 164ter (2)).
The inclusion is only to be made for the purposes of corporate income tax. The new legislation specifically excludes CFC income from the scope of Municipal Business Tax (§9 item 3a Trade Tax Law).
Non-genuine arrangement test
Article 164ter (3), in line with Article 7 (2) (b) of ATAD 1, provides that an arrangement or series thereof shall be regarded as non-genuine to the extent that the CFC would not own the assets or would not have undertaken the risks which generate all, or part of, its income if it were not controlled by the taxpayer where the significant people functions linked to those assets and risks, are carried out and play an essential role in generating the controlled company’s income.
Some commentators take the position that the assessment of the genuine character of the arrangement may have to be made in the light of the EU “freedoms”, and may not extend beyond criteria set by the ECJ in the Cadbury Schweppes judgement (C-196/04).
CFCs as follows are excluded from the scope of the application of the new measures (Article 164ter (1)):
i) those with accounting profits of no more than EUR 750,000; or
ii) those for which the accounting profits amount to no more than 10% of their operating costs for the period. The costs of goods sold outside the country where the entity is resident or where the permanent establishment is established, and payments to associated enterprises, cannot be included as operating costs.
The rules determining the amounts that a Luxembourg taxpayer must include as a result of the application of the CFC regime are listed in Article 164ter (4).
A Luxembourg taxpayer having a CFC with income arising from a non-genuine arrangement will have to include in its taxable base the non-distributed income of the CFC, up to a limit of the amount of such income that is generated through assets and risks which are linked to “significant people functions” carried out by the taxpayer.
The identification of the “significant people functions”, and the attribution of profit thereto, is to be assessed based on the arm’s length principle included in the LITL under Article 56 and 56bis.
The net income included is considered to be commercial profit. Expenses economically linked to the CFC income included are deductible.
In the event that the CFC has negative income, no inclusion is made. The losses of the CFC may be carried forward and used to offset future positive income of the CFC. Only the negative net income of the CFC generated after the entry into force of Article 164ter is deductible.
The CFC income to be included in the tax base of the taxpayer is to be calculated in proportion to the taxpayer’s participation in the CFCs (direct or indirect).
The CFC income must be included in the tax period of the taxpayer in which the tax year of the CFC ends.
Avoidance of double taxation
Luxembourg may have to grant a credit for the tax paid by the CFC against the tax on the income included in the Luxembourg tax base of the taxpayer.
When the CFC distributes a dividend, or the Luxembourg taxpayer realises directly or indirectly a gain on the shares of the CFC, and the dividend or gain is taxable under Luxembourg domestic laws, the income already included as CFC income may be deducted when computing the amount of the dividend or gain subject to Luxembourg tax.
Many commentators had taken the position that the rules dealing with "hybrid mismatch" situations set out in Council Directive (EU) 2017/952 (“ATAD 2”), to be transposed into domestic law by 1 January 2020, completely superseded Article 9 of ATAD 1, and hence that EU Member States did not have to implement any "hybrid mismatch" measures before 1 January 2020.
Nevertheless, the Luxembourg Government has decided to introduce the ATAD 1 anti-hybrid provisions for calendar year 2019, covering only intra-EU hybrid instruments and hybrid entity mismatches, in a new Article 168ter LITL. The hybrid mismatches measures of ATAD 2, covering a wider range of intra-EU mismatches, but also mismatches with third countries, will be included in a subsequent law, expected to be legislated in the course of 2019, and having effect from 1 January 2020.
Article 168ter LITL closely follows Article 9 of ATAD 1. A “hybrid mismatch” is defined (Article 168ter (1)) as arising when differences in the legal characterisation of a financial instrument or entity in an arrangement structured between the taxpayer and a party in another Member State, or when the commercial or financial relations between a taxpayer and a party in another Member State, give rise to the following consequences:
A taxpayer for the purpose of these provisions is either a corporate entity resident in Luxembourg within the meaning of Article 159 LITL, or a Luxembourg permanent establishment of an entity not resident in Luxembourg covered by Article 160 LITL.
For the purposes of Article 168ter LITL, and where the mismatch involves a hybrid entity, the definition of “associated enterprise” as set out in the new CFC legislation of Article 164ter also applies, although modified so that the 25% requirement is replaced by a 50% requirement (Article 168ter (3)).
The elimination of the tax advantage arising from a hybrid mismatch, as defined above, is to be effected under Article 168ter (2) as follows:
a) To the extent that a hybrid mismatch results in a double deduction, and the deduction is given in another Member State where the expense has its source, the Luxembourg taxpayer may not deduct the expense;
b) To the extent that a hybrid mismatch results in a deduction without inclusion in another Member State, the payer (being the Luxembourg taxpayer) may not deduct the expense arising from the payment.
Upon a request by the Luxembourg tax authorities, the taxpayer has to be able to provide a declaration of the issuer of the financial instrument, or any other relevant material such as tax returns, other tax documents or certificates issued by tax authorities of the other Member State, evidencing the tax treatment of the income or expense or loss in the other Member State (Article 168ter (4)).
General Anti-Abuse Rule
The legislation adapts and modernises Luxembourg’s existing general anti-abuse rule (“GAAR”), as set out in §6 of the Adaptation Law (“Steueranpassungsgesetz” or “StAnpG”) of 16 October 1934. “Abuse of law” criteria and general practice have been developed progressively over recent years by authors and judges.
The four criteria set by case law are as follows:
The text of §6 StAnpG paragraph 1 is now augmented, to define more precisely what constitutes an “abuse of law” within the meaning of the existing paragraph 1.
Under the new text, 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.
The legal route, which may comprise more than one step or part, shall be regarded as non-genuine to the extent that it was not used for valid commercial reasons which reflect economic reality. It should however be noted that, whilst broad, this provision is not an exhaustive definition of “non-genuineness”.
The new text, while adapted to reflect the content of Article 6 of ATAD 1, is designed to preserve legal certainty derived from existing case law on the subject. It is therefore expected that it should not change materially the criteria and general practice as developed to date by Luxembourg authors and judges.
Luxembourg already has exit tax rules, as introduced by a law of 26 May 2014, compliant with EU law. The legislation as now revised modifies these existing rules, by fully restating the existing Article 38 LITL to cover expressly all the cases foreseen by ATAD 1, and amends the existing taxation deferral rules of § 127 of the General Tax Law (“Abgabenordnung” or “AO”) to provide for a payment of tax in instalments over 5 years.
The payment of the Luxembourg tax arising on the gains upon transfer of assets outside Luxembourg in any of the circumstances listed in ATAD 1 may be made in instalments over a period of 5 years.
However, this is possible only where the transfer is to an EU Member State, or an EEA State with which Luxembourg has an agreement on the recovery of taxes.
According to the newly revised legislation, the entitlement to payment in instalments over a period of 5 years is also available to individuals transferring assets that form part of their business wealth.
No guarantee will be required from, nor will interest be charged to, taxpayers opting for payment of tax in instalments.
The right to deferral of payment of tax is however to be immediately discontinued, and the balance of the tax debt becomes immediately recoverable in the event of:
These amendments to the existing Luxembourg legislation with respect to exit tax rules are to apply to transfers occurring during tax years starting after 1 January 2020.
Existing tax deferrals, granted by application of § 127 paragraphs 2 and 3 AO before 1 January 2020, remain unaffected by the above amendments to the legislation.
The legislation voted includes two additional amendments to the Luxembourg tax legislation that are not directly connected to the transposition of ATAD 1.
Modification of Article 22bis LITL dealing with tax-free exchanges
The legislation deletes Article 22bis (2) (1) LITL. This currently allows tax neutrality on an exchange of assets arising from the conversion of convertible debt into shares. The conversion of a convertible debt into shares will is to be considered as a sale of the convertible debt at fair market value, followed by the acquisition of shares at fair market value. For financial years beginning as from 1 January 2019, the capital gain arising from this transaction may no longer be rolled-over into shares received in exchange, but must be treated as realised and subject to tax at the time of conversion.
Modification of § 16 of the Luxembourg Adaptation Law
§ 16 StAnpG of 16 October 1934 defines a permanent establishment under Luxembourg domestic law.
§ 16 StAnpG is amended, by adding a new paragraph 5, designed to resolve conflicts of interpretation on the existence of a permanent establishment resulting from the interaction between the provisions of domestic law and the provisions of the relevant double tax treaty.
This new paragraph 5 provides that the definition of a permanent establishment is to be construed solely on the basis of the criteria mentioned by the double tax treaty.
Under this new paragraph 5, the Luxembourg tax authorities may request from the taxpayer a confirmation from the other Contracting State, through any relevant document, that it effectively recognises the existence of a permanent establishment in its territory.
The relevance of this amendment to §16 StAnpG on the application of the exemption method for the avoidance of double taxation provided for in the majority of the double tax treaties concluded by Luxembourg, in the absence of any modification of the relevant double tax treaties themselves, remains to be analysed in more detail.
Entry into force
For taxpayers within its scope, the new legislation will apply for taxable periods starting as from 1 January 2019, except for the provisions relating to exit tax, which apply to taxable periods starting as from 1 January 2020. The revised GAAR wording has effect from the 2019 tax year in situations involving salaries, pensions, rental, investment or other income of taxpayers.
This significant new legislation is further clear indication of Luxembourg’s willingness to comply fully with EU tax initiatives and to adapt fully to a “post-BEPS” international tax environment.
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