A Luxembourg company had funded its subsidiary with an interest-free loan (IFL) in 2016. The two companies imputed notional interest applying transfer pricing rules, claiming a deduction at borrower level and declaring corresponding income at parent level.

The tax office initially denied the deduction. The tax director, when addressing the objection against the initial assessments, instead requalified the IFL into equity. This decision was upheld by the administrative tribunal but has now been overturned on appeal.

Debt vs. equity qualification

Case law in recent years has consistently listed a range of criteria to classify a financial instrument for Luxembourg tax purposes. These criteria are largely derived from parliamentary doctrine. The court recalled the need for a global assessment of the transaction, stressing that no single feature of the loan is determining. The transaction should be analysed according to the pre-eminence of the economic reality (substance over form). Nonetheless, the court did emphasise the repayment obligation and the existence of interest as typical debt features. As part of the global assessment, the fact that the lender is also the shareholder of the borrower needs to be taken into account.

Lessons to draw from this case notably include:

  • Documenting the loan after the funding can be acceptable, even if not ideal, because formalities are more flexible than with a capital increase. As such, a delay in documenting the funding as a loan could not be seen as an argument in favour of equity classification.
  • The debt/equity ratio in the case at hand was lower than the maximum 99/1 debt/equity ratio prevailing at the time in most cases based on the circular on intragroup financing activities that was then applicable. Accordingly, the Luxembourg borrower did not have a disproportionate debt/equity ratio. Moreover, to assess the debt/equity ratio, the tribunal was wrong to look at the total facility amount and should have looked at the actual drawdowns only.
  • The criteria of the absence of a right to participate in profits and liquidation proceeds and the absence of voting rights need to be assessed in respect of the quality as a lender, by looking at the terms and conditions of the instrument. The criterion would not be considered met just because the lender is also the shareholder and has such rights in his quality of shareholder.
  • A maturity of 8-10 years is not long term for purposes of the debt/equity analysis. Furthermore, in the case at hand, the IFL was repaid even much faster, confirming the intention to treat it as a debt instrument.
  • The court also confirmed that the limited recourse clause transfers risk to the lender but does not annul ex ante the repayment obligation, as the tribunal had construed in the case at hand. As such, it was not a feature to support an equity recharacterization of the IFL.
  • Subordination of shareholder loans to third party debt was not held as an equity feature, where such subordination is standard, as a bank would typically ask for its loans to rank senior to shareholder loans.


This judgment provides helpful clarifications for debt vs equity qualification, which is relevant to assess the tax consequences of not only IFLs but also a variety of other financial instruments used in Luxembourg. It also provides helpful guidance to analyse specific criteria which remained largely open to interpretation.

Please contact an author of this newsflash or our tax controversy team, should you have any further question on the case.