New tax law for 2019
Law implementing the EU Anti-Tax Avoidance Directive I (ATAD I)
On 19 June 2018, the Luxembourg government tabled a draft Bill (the 'Draft Law') that would implement ATAD I as Luxembourg domestic law. The Law was voted on 19 December 2018 and is applicable as of tax years starting on or from 1 January 2019. This new legislation includes the following measures:
This new legislation includes the following measures:
- Interest limitation rules.
- Controlled foreign company (CFC) rules.
- Intra-EU anti-hybrid rule.
- General anti-abuse rule (GAAR).
Additionally, the new Law includes an amendment concerning the domestic definition of permanent establishment (PE).
Interest limitation rules
The interest limitation applies to 'exceeding' borrowing costs. These are defined as the tax deductible borrowing costs that are in excess of the taxable interest revenues and other economically equivalent taxable income of the taxpayer.
The exceeding borrowing costs of a taxpayer are deductible in a tax period only up to the higher of (i) 30% of the taxpayer’s net revenues before interest, tax, depreciation, and amortisation (EBITDA) or (ii) 3 million euros (EUR).
Note that the Law provides for the following specific exceptions: (i) grand-fathering of loans concluded before 17 June 2016 and (ii) long-term infrastructure projects.
Exceeding borrowing costs not deductible in a tax period may be carried forward without time limitation. Interest capacity that cannot be used in a given tax period may be carried forward for five years.
Controlled foreign company (CFC) measures
Luxembourg opted for option B, thus targeting non-distributed income of CFCs arising from non-genuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage.
Two cumulative conditions have to be fulfilled for an entity or PE to be considered as a CFC.
An entity is a controlled entity if the taxpayer by itself or together with its associated enterprises holds a direct or indirect participation of more than 50% of the voting rights or capital, or is entitled to receive more than 50% of the profits of that entity.
With respect to a PE, the control test is by definition met.
Effective tax rate (ETR) test:
There will be a CFC if the actual corporate income tax (CIT) paid by the entity or PE on its profits is lower than 50% percent of the CIT charge that would have been payable in Luxembourg under Luxembourg domestic tax rules had the entity or PE been resident or established in Luxembourg.
When an entity or PE meets the control test and the ETR test, the taxpayer should include in its taxable basis the non-distributed income of the entity or PE, to the extent arising from non-genuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage.
The following CFCs are excluded from the scope of the application of these new rules:
- Those with accounting profits of no more that EUR 750,000.
- Those for which the accounting profits amount to no more than 10% of their operating costs for the period.
A Luxembourg taxpayer having a CFC with income arising from a non-genuine arrangement will have to include in its taxable base the non-distributed income of the CFC but within the limit of amounts generated through assets and risks that are linked to significant people functions carried out by the taxpayer.
The Luxembourg government has decided to introduce ATAD 1 anti-hybrid provisions for calendar year 2019, covering only intra-European Union (EU) hybrid instruments and hybrid entity mismatches. The hybrid mismatches measures of ATAD 2, covering a wider range of intra-EU mismatches, but also mismatches with third countries, will be included in a subsequent law expected in the course of 2019, and having effect from 1 January 2020.
A ‘hybrid mismatch’ is defined as arising when differences in the legal characterisation of a financial instrument or entity in an arrangement structured between the taxpayer and a party in another member state, or when the commercial or financial relations between a taxpayer and a party in another member state, give rise to the following consequences:
- A deduction of the same expenses or losses occurs both in Luxembourg and in another member state where the expenses or losses originated (‘double deduction’).
- There is a payment that is deductible in Luxembourg in which the payment has its source without a corresponding inclusion of the corresponding income in the total nets revenues in the other member state (‘deduction without inclusion’).
The elimination of the tax advantage arising from a hybrid mismatch, as defined above, is to be effected as follows:
- To the extent that a hybrid mismatch results in a double deduction, the deduction shall be given only in the member state where such payment has its source.
- To the extent that a hybrid mismatch results in a deduction without inclusion, the member state of the payer shall deny the deduction of such payment.
General anti-abuse rule (GAAR)
Under the new Law, Luxembourg is to adapt and modernise its existing GAAR. 'Abuse of law' criteria and general practice have been developed progressively over recent years by authors and judges.
Under the Law text, there is an abuse of law if the legal route that, having been used for the main purpose or one of the main purposes of circumventing or reducing tax contrary to the object or purpose of law, is not genuine having regard to all relevant facts and circumstances.
The legal route, which may comprise more than one step or part, shall be regarded as non-genuine to the extent that it was not used for valid commercial reasons that reflect economic reality.
The new text, while adapted to reflect the content of article 6 of ATAD 1, is designed to preserve legal experience derived from existing case law on the subject.
The new Law amends the existing provision defining the notion of PE in Luxembourg domestic law (§ 16 of the Luxembourg adaptation law).
This amendment is designed to resolve conflicts of interpretation on the existence of a PE resulting from the interaction between the provisions of domestic law and the provisions of the relevant double tax treaty (DTT).
This new provision provides that the definition of a PE is to be construed solely on the basis of the criteria mentioned by the DTT.
Under the new paragraph, the Luxembourg tax authorities may request from the taxpayer a confirmation from the other contracting state, through any relevant document, that it effectively recognises the existence of a PE in its territory. In certain situations, the confirmation is to be given upfront and must be attached to the annual tax return.
In 2017, Luxembourg was one of the original 68 jurisdictions to sign the Organisation for Economic Co-operation and Development (OECD)-sponsored Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS), commonly referred to as the ‘Multilateral Convention’ or ‘MLI’.
On 14 February 2019, Luxembourg’s Chambre des Députés voted to approve Bill No 7333, necessary to ratify the text of the MLI. No changes have been made to the original list of reservations and notifications submitted to the OECD.
Following this, on 9 April 2019 Luxembourg deposited with the OECD its instrument of ratification of the MLI. Under the provisions of the MLI, this formal action defines the subsequent timing for the MLI to begin to come into effect for Luxembourg’s network of tax treaties.
The MLI will now formally 'enter into force' for Luxembourg on 1 August 2019.
The dates on which the provisions of the MLI that apply to Luxembourg’s DTT network then actually come into effect are variable, as these also depend on the timing of ratification process for the MLI by each relevant treaty co-signatory. However, it is now clear that, insofar as the new 'Principal Purposes Test' in the MLI potentially limits the treaty benefits of reduced or zero rates of withholding taxes, for many of Luxembourg’s treaties these MLI measures will take effect on 1 January 2020.
Conversely, Luxembourg’s treaties with countries that have yet to sign the MLI, such as the United States (US), cannot be affected by any MLI modifications, unless and until the country concerned has both subsequently signed the MLI and gone through its ratification and deposit processes.
Luxembourg Budget Law 2019: Corporate tax rate reduction and revamp of tax unity regime
On 25 April 2019, the Luxembourg Parliament voted to approve the 2019 budget. The 2019 Budget Law includes two main corporate tax measures:
- A reduction of the CIT rate leading to a decrease in the overall corporate tax rate from 26.01% to 24.94% for companies in Luxembourg City.
- A complete rewrite of the legislation governing the Luxembourg tax unity regime, to permit the application of the ATAD 1 interest limitation rules at the Luxembourg group level.
The changes in the CIT rate are applicable for the 2019 tax year, while changes as regards the Luxembourg tax unity regime are applicable for accounting years starting on or after 1 January 2019.