Carry forward losses and advance tax clearance regarding a financing activity

Luxembourg Administrative Court, 16 May 2023, No. 48,366C 

The deduction of losses carried forward is only permissible to the extent that the losses could not be offset against other net income during the tax year corresponding to the financial year in which these losses arose. Moreover, tax losses must be utilised as promptly as possible, and a taxpayer is not entitled to spread them over multiple years in the presence of positive taxable income. 

A company is not permitted to carry forward losses accrued during the years covered by a prior advance tax clearance. Consequently, they cannot offset them with positive income generated from the first year not covered by such advance tax clearance. 

Should you have any inquiries or require expert guidance pertaining to the information provided, our tax team is available to assist you. Please feel free to contact us.  

A practical guide on debt financing for a Luxembourg holding company: 10 tax situations to monitor

Please find hereafter a high-level (and non-exhaustive) summary of some tax aspects of debt financing at the level of a Luxembourg holding company (here referred to as “LuxCo”). In our scenario, LuxCo is an ordinary (holding) company, not subject to any exemption provided by special laws on investment companies (such as RAIF, SICAR, SPF,…). Based on the following scenarios, here are the possible consequences related to interest expenses accounted for by LuxCo:

1) LuxCo makes an interest payment, and such expense is connected with a tax-exempt income received by LuxCo (such as a dividend or capital gain covered by the participation exemption regime):

  • The interest payment may not be (fully) deductible for tax purposes, leading to a potential increase in the company’s taxable income.

2) LuxCo has on its liability side a specific debt item, and this debt instrument is requalified into an equity instrument (by application of the “substance over form” principle):

  • The interest payment may become non-deductible, and a withholding tax of 15% may apply.
  • The deduction of this liability for net wealth tax purposes may be denied, potentially impacting the company’s overall tax position.

3) LuxCo has a specific debt item on its liability side, and this debt instrument finances an equity participation in excess of the 85:15 debt-to-equity ratio:

  • Interest on the exceeding portion may be non-deductible for tax purposes.
  • The non-deductible interest may also be subject to a 15% withholding tax.

4) LuxCo makes an interest payment to an affiliated entity. The amount of interest paid is deemed too high in comparison with uncontrolled transactions and/or not supported by benchmark analysis:

  • The excessive portion of interest may be non-deductible for income tax purposes.
  • The non-deductible portion may also be subject to a 15% withholding tax.

5) The amount of interest paid by LuxCo is higher than the amount of interest income it receives from its activity:

  • Interest by LuxCo (accrued) may not be fully deductible if LuxCo’s “net borrowing cost” exceeds a certain limit (30% of LuxCo’s EBITDA or €3 million).

6) LuxCo makes an interest payment and mainly receives real estate income or income not covered by the participation exemption:

  • Interest by LuxCo (accrued) may not be fully deductible if LuxCo’s “net borrowing cost” exceeds a certain limit (30% of LuxCo’s EBITDA or €3 million).

7) LuxCo makes an interest payment, but such payment receives a different tax qualification in the hands of the creditor (so-called “hybrid instrument”):

  • The interest payment may not be deductible.

8) LuxCo is in a so-called “back-to-back” situation, i.e. it gives a loan to an affiliated company, and is itself financed by a loan:

  • LuxCo becomes subject to intra-group financing compliance rules, such as maintaining sufficient equity at risk, arm’s length remuneration, and substance requirements.

9) LuxCo has issued bonds (obligations) with a return/yield contingent on the accounting profits of the issuer (e.g. the yield under the bonds is equal to 2% of the issuer’s profits):

  • The interest payment on such bonds may be non-deductible and subject to a 15% withholding tax.

10) LuxCo makes an interest payment to a company established in a blacklisted jurisdiction (cf. EU black list):

  • The interest expense may not be deductible for tax purposes.

Should you have any inquiries or require expert guidance pertaining to the information provided, our tax team is available to assist you. Please feel free to contact us.

Is the Luxembourg Minimum Net Wealth Tax fully in line with constitutional rules?

Administrative Tribunal­­ – 18 April 2023 (n. 45910)

Minimum Net Wealth Tax (MNWT) – preliminary ruling by the Constitutional Court:

The Constitutional Court is now tasked with ruling on the validity of the legal provisions that apply to companies whose total balance sheet falls between EUR 350,001 and EUR 2,000,000. Specifically, the Court will assess whether entities with more than 90% of their assets composed of “financial assets” being subjected to a higher MNWT than those with less than 90% of such assets constitutes an infringement of the equality principle under Article 10bis of the Luxembourg Constitution.

If you require additional information, please don’t hesitate to contact our tax team.

EU Advocate General advises against Commission's view on Luxembourg's tax rulings

In a recent development related to Luxembourg’s tax rulings, Advocate General Kokott suggested that the European Court of Justice (ECJ) dismiss the European Commission’s verdict, which accused Luxembourg of providing illegal state aid.

Although her recommendations are not binding, they could significantly influence the ECJ’s ultimate decision. If the ECJ accepts the Advocate General’s viewpoint, it could deeply affect the future methodology of state aid investigations by the Commission.

Please note that the final judgment in the cases awaits, with the ECJ being the ultimate authority.

A.G. Kokott expressed her opinion in the following terms:

“The Commission and the General Court proceeded on the basis of an incorrect reference framework. They had assumed that the Luxembourg tax law in force at the time contained a principle of correspondence, according to which a tax exemption for participation income at the level of the parent company is contingent on taxation of the underlying profits at the level of the subsidiary. Such a link is not, however, apparent and cannot simply be interpreted into Luxembourg law because it might be preferable. The EU institutions cannot use State aid law to shape an ideal tax law.”

“Not any incorrect tax ruling, but only tax rulings which are manifestly erroneous in favour of the taxpayer may constitute a selective advantage and be considered an infringement of State aid law “

If you require additional information, please don’t hesitate to contact our tax team. 

Group restructuring – Abuse of law: Luxembourg Administrative Tribunal of 15 May 2023, n° 46.042

In 2011, a Luxembourg company (Company A) granted a profit participating loan (Loan) to its Belgian subsidiary (Company B), which held debt securities issued by another entity (the Securities). On January 1, 2018, Company B repaid the outstanding loan in kind by transferring the Securities to Company A at their nominal value.  

On the same day, Company A transferred the Securities to another group entity (Company G), at their market value.  

Company A claimed that no taxable capital gain should be accounted on this last transfer for tax purposes. They argued that the transfer from Company B to Company A should be treated as a hidden dividend distribution made by Company B, exempt in the hands of Company A as the recipient.  

The tax authorities claimed the entire 2018 operation constituted an abuse of law, aiming to circumvent the special anti-abuse rules enacted in the Parent-Subsidiary Directive enforced in Luxembourg law as of 1 January 2016.   

The fact, for Company B, of repaying the Loan in kind by assigning the Securities at their nominal value and thus renouncing the possibility of realizing a capital gain, instead of selling the Securities directly at their market value to Company G and using the proceeds of this transfer to the repayment of the Loan, cannot be justified from a commercial perspective. It was furthermore admitted that a third party, not bound by a shareholding relationship, would not have agreed to transfer the Securities at their nominal value, which was lower than their market value. The Tribunal confirmed that this constituted an abuse of law. 

For more information on the decision of the Administrative Tribunal, click here. 

If you require additional information, please don’t hesitate to contact our tax team. 

Updated FAQ guide on DAC 6 mandatory disclosure rules in Luxembourg

On 30 June 2023, the Luxembourg tax authorities (LTA) released an update to their FAQ regarding DAC 6 (the Updated FAQ).

The main takeaways are as follows:

Notification obligation for intermediaries protected by legal privilege

As a rule, intermediaries bound by legal privilege are exempt from reporting obligations but are required to notify such relevant reporting obligations to other intermediaries or the affected taxpayer as the case may be.

However, the ECJ decided in case C-694/20 (dated 8 December 2022) that the notification obligations (regarding persons who are not their clients) to which lawyers were subjected are invalid with respect to Article 7 of the Charter of Fundamental Rights of the European Union.

In that decision, the Court acknowledged that the reporting obligation on other intermediaries who are not subject to legal professional privilege and, if there are no such intermediaries, that obligation on the relevant taxpayer, guarantees that the tax authorities are ultimately informed and are empowered to seek information from the taxpayer or conduct an audit.

The updated FAQ indicates that the notification obligations under Luxembourg law are subject to the above-mentioned ruling from the ECJ.

The practical implications of this interpretation still need to be clarified. For instance, the French Conseil d’Etat recently determined that the rules allowing the client to authorize their lawyer to proceed with the declaration, as well as those providing for an obligation to notify the affected taxpayer in the absence of any other intermediary, are not in violation of European law.

Hallmark C.1.a and determination of tax residency

Here, tax residency should be determined in application of a relevant double tax treaty or, absent such treaty, article 4 of the OECD model convention. By reference to the commentaries to the OECD Model, a person who is liable to tax in theory, but not in practice, should still be considered as a tax resident.

This hallmark will be triggered when an entity is not resident for tax purposes in any jurisdiction based on the above rules.

Hallmark E.3 – Intragroup cross-border transfer of assets, risk and/or functions

This hallmark E3 applies to arrangements involving an intragroup cross-border transfer of functions and/or risks and/or assets, if the projected annual earnings before interest and taxes (EBIT), during the three-year period after the transfer, of the transferor or transferors, are less than 50 % of the projected annual EBIT of such transferor or transferors if the transfer had not been made.

Under this hallmark, cross-border transactions such as liquidation or mergers may be subject to reporting obligations, where a relevant transfer of assets/risk/function occurs and from which result a substantial reduction of the entity’s EBIT.

The updated FAQ indicated that the transfer should consist of a change in legal ownership and not in a change of ownership as determined for tax purposes. Therefore, when all other conditions are met, a transaction involving a tax transparent entity (as transferor and/or transferee) would be caught by this hallmark, even if it is disregarded for tax purposes. On the other hand, a transfer between a head office and its permanent establishment would not be subject to this hallmark.

Furthermore, intra-EU mergers, in which all assets and liabilities of the absorbed entity are transferred within a permanent establishment maintained/created by the absorbing entity situated in the jurisdiction of the absorbed entity, shall not be regarded as a cross-border transfer of assets, risks, or functions, as per hallmark E.3.

By applying this legal approach to transactions (rather than the “tax” approach), the updated FAQ states that company migrations, where the legal personality of the entity is maintained, or changes in the statutory seat are not treated as cross-border arrangements subject to hallmark E.3 since there is no transfer (i.e., there is no transferor).

Another condition of this hallmark is that the relevant transfer of assets/risks/functions should lead to the reduction of at least 50% of the EBIT, defined as “earnings before interest and taxes”. Such EBIT must be defined according to Luxembourg GAAP as the profit shown in the profit and loss account, (i) increased by interest expenses and tax expenditures, and (ii) reduced by interest income and tax income. Therefore, the mere transfer of assets producing interest income such as bonds or loans should not impact the projected EBIT as defined for DAC 6 purposes and therefore not be caught by the hallmark E.3.

Please contact our tax team to obtain assistance and advice with respect to your DAC 6 obligations.

Free movement of capital upheld: ECJ ruling condemns German tax treatment of Luxembourg specialised investment funds

Luxembourg fund – German corporate tax – Free movement of capital

  • In the case at hand, a Luxembourg fund governed by the “Specialized Investment Fund” (or SIF) regime held directly properties in Germany, received rental income therefrom and became liable to corporate tax in Germany according to German law (while “comparable” German funds were exempt of such tax). 
  • ECJ rules (C/537-20) that the “legislation of a Member State [here, Germany] which makes non-resident [Luxembourg] specialized property funds partially liable to corporate income tax in respect of the income from property which they receive in the territory of that Member State [i.e. Germany], whereas resident [German] specialized property funds are exempt from that tax” is a restriction on the free movement of capital between Member States. 

If you require additional information, please don’t hesitate to contact our tax team.

Challenging an administrative decision: Insights from the Administrative Tribunal of 3 March 2023

When taxpayers decide to file their request through regular mail, they must therefore organize themselves in such a way that the document containing the request is effectively delivered to the Tribunal’s clerk before the relevant deadline. A request is not admissible simply because it would have been given to the postal services before the deadline set out by the law (i.e. within 3 months). 

If you require additional information, please don’t hesitate to contact our tax team.

Hidden dividend distribution in Luxembourg: Insights from the Administrative Tribunal

Administrative Tribunal – 30 March 2023 (n. 45984)

The non-deductibility of corporate expenses and subsequent application of a withholding tax on the grounds of hidden dividend qualification: it should be demonstrated that a “special” relationship between the (i) payee and (ii) a shareholder or an interested person exists, and that it can be proven and documented that the payee has granted an advantage which exceeds arm’s length terms and conditions.

Abuse of law and carried forward tax losses: The use of a company, having substantial tax losses, in order to conduct a taxable real estate transaction, while such a company has been dormant for a few years and had no such activity prior to that, is considered as an abuse of law for tax purposes, since it allowed a reduced overall tax cost for the company’s shareholder. The consequence is that such carried-forward losses are denied for such a transaction.

Administrative Tribunal – 28 March 2023 (n. 44851)

In the context of a company car: the use of a leased car was requalified as hidden dividend distribution granted to the company’s sole shareholder (subject to 15% withholding tax and non-deductibility of leasing expenses linked to such car). Why? The vehicle logbook as well as client bookings were poorly documented and led to believe that the car was used only for private purposes.

Administrative Tribunal – 22 November 2022 (n. 43535)

Payments made under a total return swap, where the receiver is annually awarded 85% of the net profits from a Luxembourg company (in exchange for a fee and the obligation to provide interest-free financing) are treated as a hidden dividend distribution when the payee is the beneficial owner of the company and such remuneration is not supported by properly documented transfer pricing study.

If you require additional information, please don’t hesitate to contact our tax team.

Luxembourg tax treatment of the redemption of 'alphabet' share classes: Insights from the Administrative Tribunal

On 27 January 2023, the Luxembourg low-tier administrative court (Tribunal Administratif) issued an interesting ruling on many levels, and greater emphasis should be put on the tax treatment of alphabet shares.

A reminder of the basic facts would be necessary here: a Luxembourg private limited company (hereafter, the Company) proceeded in 2014 to a share buy-back and further cancellation (within 4 weeks) of the entire shares of a given class of shares. It is worth noting that:

  • the entire shares of the Company were held by a single shareholder, an entity based in the Cayman Islands;
  • the implementation of the alphabet shares mechanism occurred post-incorporation of the Company (in 2013);
  • each class of alphabet shares carried the same legal features, but redemption was to be made in reverse alphabetical order as per the Company’s articles;
  • the share capital of the Company was composed of 12,500 ordinary shares and 10 classes of alphabet shares, each class being composed of 1,425 shares having a nominal value of EUR 1. Therefore, each class represented slightly more than 5% of the share capital.

Now that we have set the scene, let’s go to the issue at stake.

Having proceeded to the redemption of the Class J shares followed by their cancellation (the exact price is not disclosed but seems to follow the rules provided by the Company’s articles and in practice is more or less equal to the amount of cash available to the Company) and given the facts and circumstances described above, the Luxembourg tax authorities considered that the corresponding payment by the Company to its shareholder should be treated entirely as a dividend distribution, in which case a 15% withholding tax would be due.

Conversely, the Company claimed that such operation should actually be analyzed as a disposal by the shareholder, irrespective of the further cancellation of the shares, in application of a ruling by the Administrative Court (Cour Administrative) dated 23 November 2017 (number 39193C).

The use of alphabet shares is a mechanism well-known to reward shareholders as a reliable alternative to dividend distribution, along full shareholder withdrawal or share capital depreciation or share capital reduction.

The decision actually provides a helpful reminder of the global tax treatment of the different mechanisms set out under articles 97, 100 and 101 of Luxembourg income tax law (LITL).

A first angle for the Luxembourg tax authorities was to consider that, given the implementation process of the alphabet shares as well the absence of distinctive legal features other than reverse alphabetical features, the operation could not be qualified as a partial liquidation under article 101 LITL.

Therefore, the Luxembourg tax authorities would then conclude that the redemption of the shares followed by the immediate cancellation of those shares was an undue way to circumvent the appropriate way to reward the shareholder, which would have been according to the authorities either through an ordinary dividend distribution or share capital reduction.

And of course, the existence of an abuse of law could then justify that the tax treatment applicable to (hidden) dividend distribution would then be substituted to the capital gain qualification by the taxpayer.

However, the Tribunal Administratif took another position, which follows the 2017 ruling referred to above: the acquisition by a company of its own shares from one of its shareholders must be treated as a disposal from the perspective of the latter and therefore the dividend withholding tax has to be ruled out. Based on the Tribunal Administratif’s arguments, the qualification as “disposal” would apply irrespective of the terms and conditions of the alphabet shares, i.e. the presence (or absence) of specific legal and economic terms attached to each class of shares or time of implementation.

Indeed, one of the conclusions from the Tribunal Administratif here, following the Court’s 2017 ruling is that whenever the substance of the participation is altered and/or when the beneficiary loses ownership of the asset which generates the income, then the transaction has to be qualified as a disposal, and the relevant income thereof should be qualified as a gain. And the circumstance that the shares are then self-owned by the Company and immediately cancelled and/or the fact there is a single shareholder does not change that qualification.

Notwithstanding the above, the legal and economic features of each class of shares will play a key role in probably the biggest issue at stake: the valuation of the redemption price.

The 2017 decision already ruled that redemption of shares was an acceptable practice, provided that the redemption price was set at arm’s length terms.

The same conclusion is drawn by the Tribunal Administratif in its decision here: the valuation of the proper market value of the redemption price will set the threshold above which the 15% withholding tax will apply. Indeed, any amount paid in excess of an arm’s length price will then be considered a hidden dividend distribution.

The Tribunal Administratif, unfortunately, does not give any guidance on how the appropriate (market) price should be determined, even though it gives an interesting element: the mere inclusion of reverse alphabetical order does not per se justify that the first redeemed class sweeps the entire (net asset) value of the company. So then comes another question: how can the redemption of 5% of the issued shares justify catching more than 5% of the company’s value? In practice, the use of tracking shares (i.e. tracking a specific underlying asset or income) or actual differentiated economic rights for each class may solve that issue. Further guidance and confirmation by the tax authorities or the Court would help in this respect.

As a conclusion, this decision has to be welcomed as it validates the alphabet shares mechanism. Taxpayers should however be able to justify the redemption price and value of the shares redeemed.

If you require additional information, please don’t hesitate to contact our tax team.