On December 21, 2018, Luxembourg enacted the Law of December 21, 2018, to implement the EU Anti-Tax Avoidance Directive (ATAD 1) (2016/1164) of July 12, 2016, and to amend its domestic permanent establishment (PE) rules, among other changes. The amendments apply from January 1, 2019, in line with the ATAD 1 timeline. Each rule is addressed below.
Editor’s Note: The Law of December 21, 2018 implements other ATAD 1 tax rules, which we will not cover here as they do not relate to the OECD BEPS project (e.g., exit taxes for moving intellectual property and other assets outside an EU member state).
Anti-Hybrid Rules (BEPS Action 2)
Editor’s Note: Luxembourg has not yet implemented the EU Anti-Tax Avoidance Directive (ATAD 2) (2017/952) of May 29, 2017, which contains additional anti-hybrid rules involving mismatches with non-EU member states.
Article 2 of the Law of December 21, 2018 adds a new Article 168ter to Luxembourg’s Income Tax Act (ITA) to implement the ATAD 1 anti-hybrid rules that target hybrid mismatches between EU member states. Hybrid mismatches can include double deductions, deductions without inclusion, non-taxation without inclusion, or double tax relief at source.
To the extent that a hybrid mismatch results in a deduction without inclusion, Luxembourg will deny the deduction. If this does not happen, then the recipient would have to take the profit into account. In the case of a double deduction, the member state of the recipient would deny the deduction. If this does not happen, then the member state of the payer would deny the deduction.
The situations reflected above could have double deductions (DD), deductions without inclusion (D/NI), non-taxation without inclusion (NT/NI) or double tax relief at source (DTR) as an outcome.
Article 2 of the Law of December 21, 2018 also says that taxpayers must be able to document the non-deduction of the expense or taxation of the income in the other EU member state. Accordingly, a taxpayer must be able to submit, upon request, a declaration of the issuer of the financial instrument or any other relevant documents such as tax returns, other tax documents or certificates issued by the tax authorities of the other EU member state.
Controlled Foreign Company Rules (BEPS Action 3)
Article 2 of the Law of December 21, 2018 adds a new Article 164ter to the ITA to implement the ATAD 1 controlled foreign company (CFC) rules, which define a CFC by reference to a 50% direct (or indirect) participation, ownership, or entitlement to an interest in profits.
Luxembourg has adopted the Option B approach, which applies the ATAD 1 CFC rules to income from “non-genuine arrangements.” An arrangement is regarded as non-genuine to the extent that the CFC would not own the assets which generate all or part of its income, or would not have undertaken the risks if it were not controlled by a taxpayer who carries out the significant people functions which are relevant to those assets and risks. Accordingly, the non-distributed income of a CFC must be included in the tax base of the Luxembourg taxpayer, if the income arises from non-genuine arrangements put in place to obtain a tax advantage.
Where the entity is treated as a CFC, the Luxembourg taxpayer will have to include in the tax base the non-distributed income of the entity derived from the following categories:
- Interest, or any other income from financial assets.
- Royalties, or any income from intellectual property.
- Dividends, or any income from the disposal of shares.
- Income from financial leasing.
- Income from insurance, banking, and other financial activities.
- Income from “invoicing companies” that earn sales and services income from goods and services purchased from, and sold to, associated enterprises.
Article 2 of the Law of December 21, 2018 excludes companies with (1) accounting profits less than €750,000, (2) with accounting profits amounting to no more than 10% of their operating costs for the tax period from application of the Luxembourg CFC rules.
Interest Expense Limitation Rules (BEPS Action 4)
Article 2 of the Law of December 21, 2018 adds a new Article 168bis to the ITA to implement the ATAD 1 interest deduction limitation rules. The new rules will limit interest expense deductions on related-party debts to 30% of the debtor’s (Luxembourg company or a Luxembourg PE of a foreign company) earnings before interest, taxes, depreciation, and amortization (EBITDA), or 30% of interest paid (or payable) to related parties in the previous year, whichever is lower. Any excess interest expense can be carried forward, but not carried back.
The EBITDA limitation applies only to taxpayers whose collective interest expenses exceed €3 million each year. Several exceptions to the 30% limitation rule may apply.
Article 2 of the Law of December 21, 2018 follows the ATAD 1 definition of “borrowing costs,” which includes interest expenses on all forms of debt, other costs economically equivalent to interest, as well as expenses incurred in relation with the raising of finance.
Article 2 of the Law of December 21, 2018 includes a grandfathering clause to exclude interest on loans concluded before June 17, 2016. However, the exception will not apply to any subsequent modifications of such loans. The legislation also excludes interest on loans used to fund long-term public infrastructure projects, when the operator, borrowing costs, assets, and income are all located in the EU.
PE Amendments (BEPS Action 7)
Article 4 of the Law of December 21, 2018 adds a new Article 16(5) to Luxembourg’s PE rules, in Article 16 of the Tax Adjustment Act (TAA) (Steueranpassungsgeset), regarding the recognition of foreign PEs, which will be based on the criteria set out by the governing Luxembourg income tax treaty.
A taxpayer will be considered to have a PE in the treaty partner jurisdiction, if the activity performed in the treaty partner jurisdiction is an independent activity and represents a participation in the general economic life in the other jurisdiction.
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