Depreciation rates must be consistent with economic reality. The depreciation must be calculated on the total acquisition cost, bearing in mind the normal life of the asset and the estimated residual value. As generally provided by the Luxembourg tax law, the accounting depreciation should be followed for tax purposes.
Depreciation normally is calculated using the straight-line method. However, the declining-balance method is permitted for fixed assets, other than buildings and intangible assets. The depreciation rate may not, however, exceed three times the rate applicable according to the straight-line method, or 30% (four times the applicable rate in the case of assets used exclusively for scientific and technical research, or 40%).
It is permissible to change from the declining-balance method to the straight-line method, but the opposite is not allowed.
In the event of a sale of a depreciated asset, the net book value at the moment of the disposal must be compared with the sales price of that asset. If this comparison indicates a profit, corresponding income tax may be due unless the sales price is reinvested in eligible assets. Capital losses are deductible.
Under certain conditions, fixed assets with a value of less than EUR 870 or an economic life that is not in excess of one year can be expensed fully in the year of acquisition. Special accelerated depreciation on 80% of the cost of fixed assets is available for assets that protect the national environment, save energy in Luxembourg, or permit the development of workplaces for handicapped workers, under certain conditions.
The rules governing depreciation of fixed assets for tax purposes have been amended as of 2017 in order to offer the possibility for taxpayers to defer deductions related to depreciation for any given tax year. For this purpose, a specific request needs to be made when filing the tax return for the year concerned.
The deduction can be deferred until, at the latest, the end of the depreciation life of the asset (i.e. any depreciation amounts deferred from previous years have to be deducted at the latest for the last year for which depreciation is allowed).
The application of this measure could potentially result in a timing difference that would increase the CIT and municipal business tax to be paid by a taxpayer for any given year. However, this might allow the taxpayer to reduce its NWT base, assuming certain conditions apply and that the taxpayer decides to book a special NWT reserve to reduce its NWT liability for the year concerned. This measure might also allow taxpayers to use investment and other tax credits during a tax year, whereas the company might otherwise have been unable to do this because it was in a tax loss position.
Goodwill is generally amortised over its useful life. In cases where its lifespan cannot be reliably estimated, goodwill cannot be amortised for a period longer than ten years. The Luxembourg tax treatment will follow the applicable accounting treatment.
Formation expenses can either be directly charged to the profit and loss account of the year in which they are incurred or depreciated on a straight-line basis over a five-year maximum period. The accounting treatment is followed for Luxembourg tax purposes.
Interest payments are, in principle, deductible to the extent they comply with the arm’s-length principle (see Transfer pricing in the Group taxation section).
Non-deductibility of the interest payments may arise in case they depend on the profits realised by the company or are derived from loans structured in the form of bonds or similar securities. Also, the deductibility will be limited in cases where the company is considered as being thinly capitalised (see Thin capitalisation in the Group taxation section).
Interest limitation rules
The Law implementing ATAD 1 into Luxembourg domestic law and applicable as of tax years starting on or after 1 January 2019 introduces 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) EUR 3 million.
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.
On 8 January 2021, the Luxembourg tax authorities issued an administrative circular (the 'ILR Circular') providing some guidance on their interpretation of the ILR. More specifically, the ILR Circular sets out the Luxembourg tax authorities' interpretation and intended practical application of Article 168bis LITL as regards the concepts of borrowing costs, exceeding borrowing costs (EBC), the fiscal EBITDA, and also provide some guidance on the carry forward of EBC, the unused interest capacity, the grand-fathering rule, and the specific exemption applicable to long-term infrastructure projects. An amended ILR Circular was issued on 28 July 2021, which provides further elements on the application of the group ratio rule.
ATAD 1 anti-hybrid provisions were introduced for calendar year 2019, covering only intra-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, have been voted in December 2019. The Luxembourg Law generally follows the text of ATAD 2 rather closely, adapting it mainly to integrate with the structure and terminology used in the Luxembourg Income Tax Law (“LITL”). Luxembourg ATAD 2 Law in general applies to tax years starting as from 1 January 2020, with the additional “reverse hybrid” measures applying from the 2022 tax year, i.e. to tax years closing in 2022. For taxpayers having a tax year diverging from the calendar year, this means ATAD 2 provisions may apply to them already in 2021.
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 net 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.
Post 2021 reverse hybrid mismatches
With effect as from the 2022 tax year, Luxembourg transparent partnerships will become liable to corporate income tax in relation to net income to the extent that such income is not otherwise taxed under the Luxembourg domestic tax law or the laws of any other jurisdiction, provided one or more associated non-resident entities (i) holding in aggregate a direct or indirect interest in 50% or more of the voting rights, capital interests or rights to a share of profit in the Luxembourg partnership (ii) consider the Luxembourg partnership to be a taxable person.
In such a situation, the Luxembourg Law confirms that, while the Luxembourg partnership will be considered as a tax resident for corporate income tax purposes, it will be exempt from Net Wealth Tax.
In line with the exclusion provided for in ATAD 2, collective investment vehicles are out of the scope of this provision. For the purpose of this rule, collective investment vehicles are defined as an investment fund or vehicle that is widely-held, holds a diversified portfolio of securities and is subject to investor-protection regulation in the country in which it is established.
Provisions for bad debts are generally tax deductible.
Gifts for scientific, charitable, or public purposes to institutions of general interest are deductible, subject to a maximum of 20% of the net income or up to an amount of EUR 1 million (the minimum being EUR 120), with a possibility to spread the deduction over two years in case of excess.
Expenses connected to the business activity of a taxpayer are, in principle, tax deductible. However, expenses linked to a shareholding qualifying for the participation exemption, including write-downs in the value of the shareholding booked as a consequence of a dividend distribution, are not deductible, up to the amount of the exempt dividend.
In the event of disposal of a shareholding financed by debt, recapture rules may apply. Basically, the effect of this rule is that the proceeds will become taxable up to the amount of the aggregate expenses and write-downs in relation to the participation deducted during the year of disposal and the previous years.
Luxembourg resident companies are subject to the NWT based on their net wealth.
Severance payouts or 'golden handshakes'
Severance payouts or ‘golden handshakes’ are deductible for CIT and municipal business tax purposes, up to EUR 300,000.
Fines and penalties
Fines and penalties suffered by the taxpayer are not considered as operating expenses and are therefore not tax deductible.
Several taxes are deductible in determining income subject to CIT, including the registration duties and real estate tax. Also, certain taxes are credited against the computed amount of income tax owed, including taxes withheld from Luxembourg dividend income received, tax withheld abroad from dividend and interest income received by a Luxembourg corporation (subject to limitations), and investment tax credits (see the Tax credits and incentives section). Foreign taxes are also deductible as expenses if not otherwise credited.
The main non-deductible taxes are CIT, municipal business tax, and NWT, as well as interest and penalties for late payment of said taxes.
Net operating losses
Losses generated as of 1 January 2017 will only be able to be carried forward for a maximum period of 17 years. Losses that arose before 1 January 2017 are not affected by this limitation. Losses cannot be carried back.
Payments to foreign affiliates
Royalties, management service fees, and interest charges paid to foreign affiliates by a Luxembourg company are deductible items, provided they are equal to what the company would pay an unrelated entity for comparable services (application of the arm’s-length principle).
Payments to EU black-listed entities
Interest or royalties due to related parties as of 1 March 2021 are not tax deductible if their recipients are corporate entities established in countries that are 'black-listed' as being 'non-cooperative' for tax purposes.
The application of this legislation is limited in the following ways:
- Only interest and royalties expenses paid or due to 'associated enterprises', as defined for the purposes of applying Luxembourg’s transfer pricing regime, are in scope.
- The measure only applies if the recipient is a corporate entity that would be regarded as 'opaque' under Luxembourg tax law.
- The measure does not apply to operations that can prove that they can satisfy the 'valid commercial reasons that reflect economic reality' requirement. These are not defined in the specific context and will need to be assessed on a case-by-case basis.
The definitions of interest and royalties for the purposes of this measure are in line with those used in the relevant articles of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention and with those used in most of Luxembourg’s double tax treaties (DTTs).
The new provision applies as of 1 March 2021 for jurisdictions that are listed in the most recent version of the 'Annex 1' list published in the Official Journal of the EU. The list is by no means a static one. Please note the following:
- If a jurisdiction is added to the list and is still on the latest list to have been published in the Official Journal before the next subsequent 1 January, then the provision applies to expenditure accruing as due, but only as of that following 1 January.
- If a jurisdiction is removed from the list, then the provision ceases to apply to expenditure accruing as due as of the date of publication of the version of the list confirming that that the jurisdiction concerned has been removed.
- It should also be noted that, since the 2018 tax year, Luxembourg companies have already been required to indicate in their tax returns whether they have undertaken any transaction with any related party located in any of the EU 'Annex I' jurisdictions. This existing requirement is not affected by the new provision.