On June 19, 2018, Luxembourg’s government sent draft legislation (Project Law No. 7318) to the Chamber of Deputies (i.e., Parliament) for consideration, which, if approved, would implement the EU Anti-Tax Avoidance Directive (ATAD 1) (2016/1164) that the ECOFIN Council approved on June 21, 2016. ATAD 1 includes anti-hybrid, controlled foreign company (CFC), and interest expense limitation rules that all EU member states must implement by December 31, 2018.
Editor’s Note: ATAD 1 includes additional 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)
Chapter 1, Article 2 of Project Law No. 7318 includes the ATAD 1 anti-hybrid rules that target hybrid mismatches between EU member states. Hybrid mismatches could 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, the member state of the payer would 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.
Except for imported mismatches and dual resident mismatches, as a minimum standard, all mismatches involve EU member states only or an EU member state and a third country. Imported mismatches require a payment by a taxpayer from a member state to a non-EU country, and the involvement of at least another third country. Dual resident mismatches require that the taxpayer is a resident for tax purposes in both a member state and a non-EU country.
CFC Rules (BEPS Action 3)
Chapter 1, Article 2 of Project Law No. 7318 also includes the ATAD 1 CFC measures, which define a CFC by reference to a 50% direct (or indirect) participation, ownership, or entitlement to an interest in profits.
Where the entity is treated as a CFC, the Luxembourg taxpayer would have to include in its tax base the undistributed 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.
Interest Expense Limitation (BEPS Action 4)
Chapter 1, Article 2 of Project Law No. 7318 also includes the ATAD I interest deduction limitation rules, which limit interest expense deductions on related party debts to 30% of the debtor’s (Luxembourg company or a Luxembourg permanent establishment (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.
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