New tax law for 2020
Law implementing the European Union (EU) Anti-Tax Avoidance Directive 2 (ATAD 2)
On 19 December 2019, the Luxembourg Parliament voted to approve the law implementing the EU Anti-Tax Avoidance Directive regarding hybrid mismatches with third countries (ATAD 2) into Luxembourg domestic law (the 'Law').
The 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).
The Law aims at preventing 'deductions without inclusion' and 'double deductions' caused by 'hybrid mismatch' tax treatments.
As anticipated by ATAD 2, the Law will in general apply to tax years starting as of 1 January 2020, with the additional 'reverse hybrid' measures that comprise Article 9a of ATAD 2 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 that Article 9a of ATAD 2 may apply to them already in 2021.
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 formally 'entered into force' for Luxembourg on 1 August 2019.
The dates on which the provisions of the MLI that apply to Luxembourg’s double tax treaty (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 (WHTs), for many of Luxembourg’s treaties these MLI measures 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.
DAC 6 Luxembourg Law
On 21 March 2020, the Luxembourg Parliament voted to approve the Bill (n°7465) implementing the Directive (EU) 2018/822 on mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements (commonly referred to as 'DAC 6'). The law dated 25 March 2020 follows the text of DAC 6 rather closely.
DAC 6 makes it mandatory for intermediaries (or taxpayers if there is no intermediary or intermediaries subject to professional secrecy as defined by EU member states' domestic laws) to report some cross-border transactions and arrangements to the domestic tax authorities, and will trigger the subsequent automatic exchange of information to tax authorities of all EU member states through access to a central directory.
During the Luxembourg legislative process, amendments were made to the initial provisions in relation to professional secrecy at the request of the State Council. As a result of these amendments, the benefit of professional secrecy, initially limited to lawyers, has been extended to auditors and qualified accountants. In most cases, and as further explained below, the reporting obligation to the Luxembourg tax authorities will therefore be shifted to other intermediaries or to the taxpayer.
Initially, to the extent that the first step of implementation of a project would happen between 25 June 2018 and 1 July 2020, the exchange of information would have to be made by 31 August 2020 for arrangements falling into the hallmarks (as per DAC 6, different reporting rules have to be respected depending on the status/timing of the restructuring, i.e. advise or implementation). On 24 June 2020, the European Council formally adopted an amendment to the Directive on the administrative cooperation in the area of taxation (DAC) allowing EU member states to defer by up to six months DAC 6 deadlines.
Controlled Foreign Company (CFC) Circular
On 4 March 2020, the Luxembourg tax authorities issued an administrative circular of 25 pages (the 'CFC Circular'), providing guidance on their interpretation of article 164ter of the LITL relating to CFC taxation.
The CFC Circular emphasises that its text complements the existing Luxembourg transfer pricing rules. In this sense, the CFC Circular introduces a transfer pricing documentation obligation for Luxembourg taxpayers to prepare, on an annual basis, a functional analysis covering any relationships with foreign entities or permanent establishments (PEs) that the CFC rules deem to be CFCs. Such documentation should be made available upon request to the Luxembourg tax authorities.
This functional analysis should include details of all directly and indirectly owned CFCs, and identify the 'significant people functions' (irrespective of their location) that manage and control the assets and associated risks of each CFC, where these functions are located, and how these functions play an essential role in generating that CFC’s income.
If some of these functions are carried out by the Luxembourg taxpayer, the relative contribution to the value creation and risk assumption of each of the 'significant people functions' carried out will need to be determined, based on domestic transfer pricing rules, to compute the CFC income attributable to the taxpayer in Luxembourg.
Draft law on non-deductibility of payments to EU 'black-list' non-cooperative jurisdictions
On 30 March 2020, the Luxembourg government tabled a Bill (n°7547) before the Luxembourg Parliament, setting out draft legislation that disallows the tax deduction of interest or royalties paid or due to related parties if these are corporate entities established in countries that are 'black-listed' as being 'non-cooperative' for tax purposes.
The application of the draft legislation is limited in several 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 OECD Model Tax Convention, and thus with those used in most of Luxembourg’s DTTs.
This measure is in line with guidelines of the Council of the EU, agreed at the Council of 5 December 2019. Assuming the measure is enacted, it will apply for expenses paid or due as of 1 January 2021.