The Luxembourg tax administration has issued Circular L.I.R. n° 164/1 on January 29, 2025, replacing the previous circular dated March 23, 1998. This update provides revised guidelines regarding the applicable interest rates for overdrawn current accounts held by shareholders or associates in entities subject to corporate income tax. 

Key changes and clarifications 

Shareholder or associate as a natural person 

• The applicable interest rate must reflect market conditions that would be imposed on a similar loan agreed between independent parties under arm’s length principles, as per Article 164, paragraph 3 of the amended Income Tax Law of December 4, 1967. 

• As a simplification measure, an interest rate aligned with annual consumer credit rates, evidenced through reliable sources, is deemed acceptable. 

• Entities may refer to the average consumer credit rates published by the Central Bank of Luxembourg for the relevant financial year. 

• Interest accrual is assumed to occur at the end of the fiscal year, calculated based on standard banking practices. 

• If the current account remains overdrawn throughout the financial year, the interest can be calculated using the arithmetic average of the debit balances at the beginning and end of the year. 

• If the account was not consistently overdrawn, or if significant fluctuations occurred, the arithmetic average of month-end balances should be considered. 

• The provisions of Service Note L.I.R./N.S. n° 164/1 of June 9, 1993, remain applicable concerning criteria for a repayable overdrawn current account. 

Shareholder or associate as a related company 

• For intercompany receivables arising from relationships between related entities, such as parent-subsidiary or group-affiliated entities, the interest rate must be determined on a case-by-case basis in accordance with the arm’s length principle, as outlined in Articles 56 and 56bis L.I.R. 

• Factors influencing the interest rate include the currency of the receivable, exchange rate risks, hedging risks, refinancing costs, and the term of the receivable. 

Implications for businesses 

This revised circular underscores the Luxembourg tax administration’s commitment to applying arm’s length principles consistently across related-party transactions. Entities should ensure compliance by: 

• Documenting the rationale for the applied interest rates. 

• Monitoring published consumer credit rates for reference. 

• Reviewing and adjusting intra-group financing arrangements to align with market conditions. 

Feel free to reach out to our team if you have any questions.

The European Court of Justice, rendered on 21 December 2023, a decision regarding the classification of directors’ activities within the framework of Luxembourg VAT law. It established that members of the board of directors of a public limited company is not deemed to act independently, as per the relevant provision, when they receive their income directly, act on behalf of the company without assuming personal economic risks, and are not subject to hierarchical subordination. This decision deviates from the stance previously held by Luxembourg VAT authorities, impacting both directors and companies.

The practical implications of this ruling are multifaceted. Directors, under the new interpretation, may deregister for VAT, ceasing invoicing and VAT collection processes. Consequently, administrative burdens would diminish, though the ability to deduct VAT on costs would be forfeited, potentially leading to reimbursements to the VAT authorities. Notably, directors of investment funds are unlikely to be affected due to existing exemptions.

The Court’s decision directly challenges Circular 781 issued by the Luxembourg VAT authorities, published on 30 September 2016, which subjected directors’ services to VAT.

Consequently, the Luxembourg VAT authorities have suspended this circular following the ruling, offering guidance for VAT refund requests dating back to 2018. Practical measures include issuing rectifying invoices and preparing for a forthcoming regularization process through the administrative web portal.

As directors reassess their VAT status and compliance obligations, a case-by-case analysis becomes imperative to determine optimal strategies in light of the legal developments.

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.  

William Jean-Baptiste, Tax Partner at Chevalier & Sciales, co-authored a recent article published for Bloomberg Industry Group. The article delves into the intricacies of navigating Luxembourg’s anti-hybrid partnership rules.

To read the full article, click here. (This article should not be republished or redistributed.)

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.

Reproduced with permission from Tax Management International Journal, 11/9/2023. Copyright @ 2023 by Bloomberg Industry Group, Inc. (800-372-1033) http://www.bloombergindustry.com

Administrative Tribunal, 26 July 2023, n. 45.706 and 46.555 

Background

A Luxembourg-based company entered into a licensing agreement as the licensee (Licensee), with a licensor (Licensor) regarding intellectual property rights. The agreement granted the Luxembourg company the right to grant sub-license for the IP rights to company of the group situated within the European Union.

Subsequently, the company claimed the partial income tax exemption as outlined in Article 50bis of the Luxembourg Income Tax Law (LITL) and an exemption from net wealth tax.

To qualify for the partial exemption regime under Article 50bis LITL (Luxembourg Income Tax Law), the taxpayer must be recognised as the owner of the relevant intellectual property rights.

In principle, both legal and economic ownership of an asset are vested in the same entity. If this is not the case, the Luxembourg tax principles (cf. paragraph 11 (4) of the Tax Adaptation Law (StAnpG)) stipulate that where there’s a misalignment between economic and legal ownership of an asset, the economic owner is treated as the asset’s owner under Article 50bis LITL.

Tribunal’s opinion

According to the Tribunal, in this particular instance, the intention of the parties within the licensing agreement must be deemed unequivocally clear, as the Licensor had no intention to transfer control over the IP rights, nor did they intend to transfer any fraction of their ownership rights to the Licensee. The right to exploit the IP rights is strictly limited by the licensing agreement and sub-license agreements, with the Licensor retaining control over exploitation.

The argument that the 25-year duration of the licensing agreement, automatically renewable, implies a definitive transfer of the IP rights has not been accepted by the Tribunal. The Tribunal indeed highlighted that the licensing agreement explicitly specifies termination provisions which are not typically found in a sale agreement.

The Tribunal states that it is not possible for a taxpayer to use the principle of economic ownership in order to contradict its own unambiguous documentation, as it should be noted that this principle, as outlined in Paragraph 11 of the StAnpG, solely aims to allow tax authorities and administrative judges to look beyond legal appearances in tax matters and assess the economic reality underlying legal structures. However, as in the present case the true intent of the parties is unambiguous and clearly indicated in the contract, there is no basis to requalify the licensing agreement.

Consequently, the Licensee cannot be considered the owner of the IP, either legally or economically, for the purpose of the IP Box regime.

Furthermore, the alternative argument according to which the Licensee acted solely as an intermediary agent (therefore not entitled to the income generated by the IP assets) as it did not engage in arm’s length transactions with the Licensor under the licensing agreement, so that the Licensee could receive the income generated by the IP assets from a tax perspective, was not deemed convincing by the Tribunal.

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.

Administrative Tribunal, 26 July 2023, n. 46.269 

A Luxembourg resident taxpayer granted a licence to a Luxembourg company in which he was a shareholder and director, for the use of his patents in exchange for a licensing fee. This fee was composed of four types of royalties to be paid by the latter. These royalties include:

(i) An initial fixed unique fee upon contract signing.
(ii) A variable fee based on the licensee’s direct use of the patents.
(iii) A variable fee on sublicenses granted by the licensee.
(iv) Optionally, an annual minimum guaranteed fee in case the variable fee related to the direct or indirect exploitation of the patents by the licensee falls below this amount.

The tax authorities denied the partial tax exemption of related income arising from the use of the patents, on the grounds that:

(i) They considered that the payments made by the licensee to the taxpayer did not qualify as “royalty” for the purposes of Article 50bis LITL, based on Article 12 §2 OECD Model Convention.
(ii) Some of the fees were not linked to the use of the patent; and
(iii) Some of the fees were not at arm’s length.

Court’s opinion

The determining factor for whether payments qualify as royalties for the purpose of Luxembourg IP box rules is the direct link they have to the utilisation of the corresponding intellectual property rights, irrespective of their frequency or recurrence. This implies that even one-time payments can be categorised as eligible royalties according to Article 50bis LITL, as long as they are directly related to the granted or non-granted use of an eligible intellectual property right.

The Court also stated that any transfer pricing issue in relation to the amount of the royalties only concerns the taxation of the licensee and is unrelated to the personal tax situation of the licensor regarding the application of the tax regime provided by Article 50bis LITL to the royalties received by the latter. Even in the event of excessive payments made in accordance with the licensing contract, this circumstance cannot automatically render the inapplicability of the said tax regime to the licensor.

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.

Shareholdings – Value impairment – Deduction from taxable basis – Operating value 

In a notable decision by the Luxembourg Administrative Court on 9 August 2023 (n. 47.826C), key clarifications on shareholding value assessments were made. Pursuant to Luxembourg accounting and tax rules, a company’s shareholdings are to be valued at their acquisition cost in its balance sheet. Nevertheless, taxpayers are permitted, but not obligated, to value them at their operating value (valeur d’exploitation) if the latter is lower. Conversely, recognizing a value impairment is mandatory if the impairment is expected to continue. If the operating value further increases (after a value impairment), the taxpayer is required to consider a relevant increase of the assessed value and set it at the new (higher) operating value, provided it does not exceed the acquisition cost. 

With regard to the timing of evaluating a shareholding, the Court referred to article 22 (2) of Luxembourg Income Tax Law. According to this article, the situation as at the closing date of the accounting period is key for year-end valuation. Facts and circumstances that existed on that date, and were only revealed subsequently but before the establishment of the balance sheet date, can be considered. In the case at hand, in order to justify the disputed value impairment, the taxpayer should have demonstrated that, as of the closing date of its 2012 accounting period, there was sufficient evidence to support the assertion that the operating value of its participation in its subsidiary was lower than the acquisition price. 

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.  

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.  

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.