Corporate - Income determinationLast reviewed - 03 January 2023
Inventories generally are valued at the lower of actual cost or market cost. There is no statutory specified method. In general, the first in first out (FIFO), the last in first out (LIFO), and the weighted-average costs methods of inventory valuation are acceptable for income tax purposes, provided the method is in accordance with the facts.
Dividends received by a Luxembourg resident company (or by a domestic PE of a non-resident company in certain cases) should, in principle, be subject to CIT.
Participation exemption regime
Dividends received may be tax exempt in Luxembourg, according to the so-called ‘participation exemption’ regime, if the conditions described below are satisfied:
- The distributing company is:
- a collective entity falling within the scope of the EU Council ‘Parent Subsidiary Directive’ (Gibraltar companies are not to be considered as entitled to benefit from this exemption as of 1 January 2021)
- a Luxembourg resident joint-stock company, which is fully taxable and does not take one of the forms listed in the Luxembourg Income Tax Law (LITL), or
- a non-resident joint-stock company that is fully liable (in its state of residence) to a tax corresponding to the Luxembourg CIT (i.e. as a general rule, it is required that the foreign tax is compulsorily levied at a rate of at least 8.5%, on a basis similar to the Luxembourg one).
- The beneficiary company is:
- a Luxembourg resident collective entity, which is fully taxable and takes one of the forms listed in the LITL
- a Luxembourg resident joint-stock company, which is fully taxable and does not take one of the forms listed in the LITL
- a domestic PE of a collective entity falling within the scope of the Parent Subsidiary Directive
- a domestic PE of a joint-stock company that is resident in a country with which Luxembourg has concluded a DTT, or
- a domestic PE of a joint-stock company or of a cooperative company, which is a resident of a European Economic Area (EEA) member state (other than an EU member state).
- At the date on which the income is made available, the beneficiary has been holding or undertakes to hold, directly (or through a tax transparent entity, see Transparent entities below), for an uninterrupted period of at least 12 months, a participation in the share capital of the subsidiary of at least 10% or with an acquisition price of at least EUR 1.2 million.
Nevertheless, consistent with the general principle under the LITL, which denies the deductibility of expenses connected to exempt income, any expenses incurred during the year in which a dividend is received, and which have a direct economic connection to the exempt participation, may only be deducted insofar as they exceed the exempt dividend for the year in question, subject to interest limitation rules.
General anti-avoidance regime (GAAR)
The Luxembourg participation exemption regime has been amended in order to introduce anti ‘hybrid instruments’ and GAAR rules derived from the amended EU Parent/Subsidiary Directive. These provisions apply to income distributed or received after 31 December 2015.
The GAAR rule precludes Directive-based benefits whenever there are any arrangements that, having been put into place with a main purpose of obtaining a tax advantage that defeats the object or purpose of the Directive, are ‘not genuine’. A ‘not genuine’ determination should be based on all relevant facts and circumstances. For the GAAR rule, an arrangement should be considered ‘not genuine’ insofar as it was not structured for ‘valid commercial reasons that reflect economic reality’.
The Luxembourg tax authorities have not provided any substantive guidance or interpretation of these EU-driven measures.
However, if the GAAR rule is determined to apply, the exemption from Luxembourg WHT obligations provided by Article 147 2. (a) (or (d)) LITL will not apply to a distribution made to a corporate entity in another EU member state, even if the participation would otherwise be considered a qualifying participation to which this specific exemption should apply. Exemption under other sub-parts of article 147 2. remains available, notably for distributions to a corporate entity that is fully liable for a tax similar to the Luxembourg CIT and which resides in any country (including one within the European Union) that maintains a tax treaty with Luxembourg.
Dividends received from a corporate entity in another EU member state that normally would qualify for the participation exemption of article 166 LITL will be denied this exemption if the GAAR rule applies. However, if the corporate entity paying the dividend also is fully subject to a tax similar to the Luxembourg CIT, the participation exemption will remain available, since this alternative provision granting the exemption is not subject to the new anti-avoidance rule.
The Article 166 LITL exemption will not be available if the income flow creates a corresponding tax-deductible expense (i.e. a hybrid mismatch) at its source when the source is a corporate entity in another EU member state.
These measures do not affect capital gains or NWT components for Luxembourg corporate entities.
Capital gains (and losses) generally are taxed as ordinary income (or losses). It is possible to defer the taxation of gains on certain fixed assets where the proceeds are used to acquire replacement items. Under certain conditions, capital gains and hidden reserves may be deferred or exempted and remain untaxed in a merger or another form of reorganisation of resident companies or other EU companies.
In general, capital gains on the disposal of qualifying shareholdings held by entities eligible to the participation exemption regime are tax exempt, provided (i) the shareholding constitutes at least 10% of total ownership in the share capital or an acquisition price of at least EUR 6 million and (ii) the disposing company has held or intends to hold a qualifying shareholding for at least 12 months.
A recapture system exists wherein the capital gain realised will become taxable up to the amount of the aggregate expenses and write-downs in relation to the participation deducted during the year of realisation of the exempt capital gain and in previous years.
The purpose of the system is to avoid a taxation vacuum, which would be the result if the deductibility of expenses and write-downs connected to the participation was allowed, while the income arising from the participation is tax exempt. This system should, in principle, remain tax neutral, as the company should have available carryforward losses for an equivalent amount resulting from the aforementioned deductions (unless previously used to offset other taxable income).
Taxation of non-resident corporate investors on gains upon disposal of shares
In case a non-resident corporate investor (non-treaty protected) derives income from the disposal of an important participation (i.e. representing at least 10% of the share capital) in a Luxembourg company within six months of its acquisition, said capital gain will be subject to CIT in Luxembourg unless a tax treaty provides otherwise.
Non-resident investors are not subject to the aforementioned capital gains tax upon disposal of shares in a Luxembourg Société d'Investissement à Capital Variable (SICAV), Société d’Investissement en Capital à Risque (SICAR), and Société de gestion de Patrimoine Familial (SPF).
Under Luxembourg accounting and tax principles, interest income is recognised on an accrual basis and is fully subject to CIT and municipal business tax.
As a matter of principle, royalty income and expenses derived from intellectual property (IP) assets acquired or developed after 30 June 2016 are subject to the standard tax regime (i.e. CIT and municipal business tax) and rates. For additional details in this respect, see Intellectual property (IP) regime in the Tax credits and incentives section.
From a Luxembourg tax perspective, a transparent entity is seen as having no legal personality distinct from that of its partners (those transparent entities are commonly referred to as ‘partnerships’) for CIT and NWT purposes, although it may be regarded as a separate legal entity from a civil/corporate law point of view. Provided that the partnership carries out a commercial activity, however, it may be liable to municipal business tax on its own.
A Luxembourg tax resident company is liable for CIT on its worldwide income. Foreign-source income is therefore taxable in Luxembourg, unless a DTT provides for an exemption.
Dividends from foreign subsidiaries are taxed when received, except when exempt as mentioned above (under conditions, the exemption method applies in many DTTs of Luxembourg). Profits of a foreign branch that are not exempt by means of a DTT may benefit from a foreign tax credit. Any foreign taxes paid in excess of the tax credit are deductible as expenses. Luxembourg is using the exemption method in most of its DTTs.