Chevalier & Sciales analyses Luxembourg anti-hybrid partnership rules in recent Bloomberg article
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. (T
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Clarifying intellectual property ownership: An insight from the Administrative Tribunal decision of 26 July 2023
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.
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Luxembourg IP Box Tribunal's insight on licensing and article 50bis LITL exemptions
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.
Assessing shareholding value: Implications of the Luxembourg Administrative Court's ruling on value impairment and taxation
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.
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.
