Implementation of EU Anti-Tax Avoidance Directive and Ratification of Multilateral Instrument in Luxembourg
The bill of law introduces controlled foreign corporation, interest deduction limitation and anti-hybrid rules. It also modifies the existing general anti-abuse rule and exit tax provisions. A change of interpretation of the permanent establishment concept and an abrogation of the roll-over relief for certain lenders are expected.
The bill of law to implement the provisions of the EU Directive 2016/1164 on anti-tax avoidance (ATAD) in Luxembourg law was made available on 20 June 2018. Subject to parliamentary approval, Luxembourg will introduce controlled foreign corporation (CFC), interest deduction limitation and anti-hybrid rules. It will also modify its existing general anti-abuse rule and, exit tax provisions. Additionally, Luxembourg will change its interpretation of the permanent establishment concept to avoid mismatches and will abrogate the existing roll-over relief for a lender converting loans into shares issued by the debtor. The new rules will apply as from 1 January 2019, with the exception of the amended exit tax rules, due to enter into force on 1 January 2020.
Separately, the bill of law ratifying the OECD Multilateral Instrument (MLI) will also be made available and submitted to Parliament for approval shortly.
- Where a CFC has been put in place essentially for the purpose of obtaining a tax advantage, Luxembourg corporate taxpayers will be taxed on the undistributed net income of a CFC, pro rata to their ownership or control of the foreign branch or the (directly and indirectly held) subsidiary, to the extent such income is related to significant functions carried out by the Luxembourg corporate taxpayer (option B as provided for by the ATAD). CFC rules will apply for corporate income tax, but not for municipal business tax purposes.
- Expected impact: To the extent that a Luxembourg company can establish that it does not perform significant functions related to the CFC’s activities, there should not be an adverse tax impact in Luxembourg. In all cases, adequate documentation of activities and/or functions is recommended.
Interest Deduction Limitation rules
- To the extent interest (and assimilated) expenses exceed interest (and assimilated) income, the deductibility of the exceeding borrowing costs will be capped at the higher of 30% EBITDA or EUR 3 million. The rule does not differentiate between intragroup and third party debt. Financial undertakings, defined in the bill of law similarly as in the ATAD, and standalone companies will be exempt from this rule. Subject to conditions, where the company belongs to a group that has on a consolidated basis a higher debt/equity ratio, the cap does not apply. A surplus of deduction capacity and non-deductible exceeding borrowing costs may be carried forward under certain conditions. Borrowings entered into prior to 17 June 2016 will not be affected, to the extent the features of the borrowing instrument are not modified.
- Expected impact: The rule should not impact the deductibility of interest in relation to back-to-back financing activities on a standalone basis. All companies that have other activities should assess the impact of this rule, and where necessary adapt. This rule does not affect the generally applicable absence of withholding tax on interest, nor the debt qualification for net wealth tax purposes.
- An anti-hybrid rule will apply to intra-EU hybrid mismatches resulting from differences between two EU Member States in the characterisation of a financial instrument or an entity, which give rise to double deductions or a deduction without a corresponding inclusion.
- Expected impact: Intra-EU hybrid mismatches were already targeted by the denial of the Luxembourg participation exemption if the payment was deductible at payer level. Under the new rules, Luxembourg payer companies may be confronted with the non-deductibility of interest. This rule does not affect the generally applicable absence of withholding tax on interest, nor the debt versus equity qualification of financial instruments for Luxembourg net wealth tax purposes.
General Anti-Abuse Rule (GAAR)
- The wording of the existing domestic GAAR provision is brought in line with the ATAD’s wording, introducing the concept of non-genuine arrangement. It will suffice for a tax advantage to be one of the main purposes of the arrangement to be caught under the GAAR. The revised GAAR applies to all direct taxes, for corporate as well as individual taxpayers.
- Expected impact:The wording of the new GAAR is close to the old domestic wording and will require case law to further refine its interpretation.
Exit Tax rules (as from 2020)
- The scope of the exit tax payment deferral will be limited and brought in line with the ATAD, i.e., a 5-year deferral will apply to transfers to an EU/EEA jurisdiction, whereas under the current rules, the deferral applies until the underlying asset is alienated. The situations in which exit tax is due are extended to cover the transfer of isolated assets abroad. No guarantee requirement or interest will apply to the deferral. Exit tax payment deferrals granted for periods ending before 1 January 2020 will not be affected.
Conversely, companies migrating to Luxembourg or transferring their assets to Luxembourg will explicitly benefit from a step-up. The stepped up value to be recognised equals the fair market value as applied in the Member State of exit, unless that value is not at arm’s length.
- Expected impact: The 5 year limit on the payment deferral may adversely impact migrations and transfer of activities to another EU/EEA member state. Conversely, the explicit entitlement to a step-up equal to the arm’s length exit value in the Member State of exit may provide welcome certainty for such transactions.
In addition to the implementation of the ATAD, the bill of law includes:
- an amendment to the domestic interpretation of the permanent establishment concept, in order to mitigate the possibility of double non-taxation with tax treaty jurisdictions, and
- the abolishment of the domestic roll-over relief for a lender that converts loans into shares issued by its debtor.
The bill of law to ratify the MLI has been announced but is not yet made available. This will cover the 81 bilateral tax treaties concluded by Luxembourg and is expected to reflect the choices made by Luxembourg when signing the MLI (click here for an overview). The timing of entry into force of the MLI provisions will depend on the speed of the ratification process. Moreover, a tax treaty is amended by the MLI only if both parties have ratified the MLI and, save exceptions, made the same choice with respect to a given provision.
The bill of law will now be debated in Parliament and is expected to be adopted prior to year-end, in line with the timing for implementation laid down in the ATAD. An extension of the anti-hybrid rules to non-EU cases and to a wider array of hybrid mismatches (including, e.g., imported mismatches) can be expected next year, as requested by the 2017 amendments to the ATAD.
We will keep you updated on further developments. For further information and/or to get support on impact assessments, please contact your trusted adviser at Loyens & Loeff.