Securities lending transactions - The lender of the shares does not retain economic ownership, says the Luxembourg Administrative Court - Implications for the participation exemption regime

Background of the case 

The relevant facts of the case are as follows:

• The taxpayer (hereinafter LuxCo) is a Luxembourg company which, in 2014, entered as lender into securities lending agreements with a French bank (hereinafter (B) S.A.) and a Luxembourg bank (hereinafter (D) S.A.) as borrowers.

• The securities lending agreements provided that the borrowers would pay a fee to the lender, that the lender would retain the right to receive 85% of the dividends and the voting rights attached to the shares, and that the borrower would have an obligation to return equivalent shares at the end of the lending period or at the request of the lender.

•  In 2015 and 2016, LuxCo filed its tax returns for Corporate Income Tax (CIT), Municipal Business Tax (MBT) and Net Wealth Tax (NWT), claiming (i) the participation exemption on dividends in respect of the shares it lent based on Article 166 of the Luxembourg Income Tax Law (LITL) and (ii) the participation exemption for NWT based on § 60 of the Valuation Law (BewG). In this respect, it is noted that, during the course of January 2014, the taxpayer filed a ruling request to confirm the application of the participation exemption regime to the securities lending transaction, but this ruling request was refused on the grounds that the analysis was not in line with the tax law.

• In 2019, the Luxembourg Tax Authorities (LTA) issued tax assessments to LuxCo rejecting the aforementioned exemptions on the grounds that LuxCo did not have economic ownership of the shares.

• The LTA also assessed the NWT on the basis of the Fair Market Value (FMV) of the shares (and not on the basis of the acquisition cost of those shares).

• In 2020, LuxCo filed a claim against the tax assessments with the director of the direct tax authorities, arguing that the securities lending agreements did not constitute a transfer of ownership and that it therefore remained the legal and economic owner of the shares¹.

• This claim was rejected by the director, who confirmed the position of the tax office in charge of LuxCo and also stated that LuxCo should have recorded receivables from the borrowers at a value equal to the FMV of the shares lent.

• As a result, LuxCo brought an action before the Administrative Tribunal which, on 10 February 2023 (n°45567), confirmed the position of the LTA.

Decision of the Administrative Court

In its decision dated 6 February 2024, the Administrative Court upheld the judgment of the Administrative Tribunal, confirming that LuxCo had retained neither the legal nor the economic ownership of the shares it had lent.

The Court's reasoning and its application of the tax law to the facts are as follows:

• Both Article 166 LITL and § 60 BewG require the holding of a participation.

• The Court is of the opinion that the holding of a participation in principle implies the legal ownership of the participation, since the holding of a participation requires the retention of the essential rights and risks associated with the quality of shareholder.

• In the present case, referring to French (and Belgian) doctrine, as well as to recent Luxembourg doctrine, the Court is of the view that the securities lending agreements are to be considered as consumer loans (“prêts à la consommation” within the meaning of article 1893 of the Civil Code), and had the effect to transfer the legal ownership of the shares to the borrowers.

• As such, the Court rejected LuxCo's arguments that (i) the securities lending agreements did not constitute a transfer of legal title because they did not meet the requirements of the Luxembourg Civil Code for a valid contract of sale, and (ii) the accounting treatment of the shares as such in its balance sheet was indicative of its economic ownership.

• In this respect, the Court also held that tax law does not necessarily follow civil law or accounting law, but has its own rules and principles, and that the tax authorities were entitled to reassess a transaction on the basis of the general provision of § 11(4) of the Luxembourg Tax Adaptation Law (StAnpG), which provides that income is taxed in the hands of the economic owner (“Eigenbesitzer”) of the asset.

• In the present case, after examining the various provisions of the securities lending agreements and in the light of a German administrative circular and German case law, the Court ruled that the economic ownership of the shares had also been transferred to the borrowers. In this respect, an important point in this assessment, in the view of the Court, depends on whether the borrower has economic use of the securities. It is noteworthy how the LTA and the Court analysed the facts and the technical details in depth and how they referred to several court cases and extracts of the German circular that the taxpayer did not invoke.

• There is a technical debate in the decision as to the value to be retained for NWT purposes in relation to the receivables to be recognised in replacement of the shares. Finally, the Court also confirmed the assessment of the NWT based on the FMV of the underlying shares as this value reflected the estimated realisation value of the shares, which is the relevant criterion for the NWT, and as the taxpayer did not provide any evidence to the contrary.

• In the present case, the Court indicated that it was not in a position to confirm whether the values retained by the LTA corresponded to the said FMV and referred the case back to the tax director for further examination of this point.

Note: ¹ LuxCo also argued that the LTA violated the principles of legality, equality and legitimate expectations. However, these arguments are not discussed further here.