On 20 June 2018, the Luxembourg government released the bill of law regarding the implementation of the Anti-Tax Avoidance Directive (“ATAD“). ATAD was adopted by the Council of the EU on 28 June 2016. The ATAD foresees in minimum standards, allowing Member States to choose certain options, leaving some flexibility for the Member States to implement the provisions from the ATAD. Therefore there may be significant differences in the implementation of the ATAD from one Member State to the other.
According to the ATAD, Luxembourg will have to introduce Controlled Foreign Corporation (“CFC“), interest deduction limitation and anti-hybrid rules. It will furthermore have to modify its existing exit tax provisions and General Anti-Abuse Rule (“GAAR“).
Most of the provisions of the bill of law will only apply to corporate taxpayers subject to corporate income tax, except for the provisions concerning GAAR and exit tax provisions. The new provisions of the amended GAAR will apply to all taxpayer, the new provisions concerning the exit tax will apply to entrepreneurs in general.
Once approved by the Luxembourg Parliament, which is expected for next week, the new provisions will apply as from 1 January 2019, except for the provisions regarding to the amended exit tax rules, which will apply as from 1 January 2020.
The CFC Rules allow Member States to include non-distributed income of a CFC of the taxpayer into the tax base of such taxpayer. A CFC is defined as an entity or a PE whose income is not taxable or exempt in Luxembourg:
(i) in which the taxpayer by itself or together with its associated enterprises, holds a direct or indirect participation of more than 50%. The threshold is determined in terms of participation in the share capital, voting rights or the entitlement to profits; and
(ii) whose actual corporate tax paid on its profits is less than 50% of the Luxembourg corporate income tax it would have paid applying the provisions of the Luxembourg Income Tax Law.
Member States can choose to include the income of the CFC pursuant to two different computation rules, option A or option B. The Luxembourg ATAD bill implements option B.
This option requires that the CFC derives its income from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage. An arrangement or a series thereof shall be regarded as non-genuine to the extent that the entity or PEs would not own the assets or would not have assumed the risks which generate all, or part of, its income if it were not controlled by a company where the significant people functions, which are relevant to those assets and risks, are carried out and are instrumental in generating the controlled company’s income.
If there is such a non-genuine arrangement, Luxembourg corporate taxpayers will be taxed on the undistributed net income of a CFC, pro rata to their ownership, to the extent such income is related to significant functions carried out by the Luxembourg corporate taxpayer.
It is not expected that this rule will have a significant impact on the application of the Luxembourg participation exemption, if only, because, currently, a subsidiary of a Luxembourg entity already disqualifies for the Luxembourg participation exemption if its actual corporate tax paid on its profits is less than 50% of the Luxembourg corporate income tax (interpretation of the correspondingly taxed test).
Interest Deduction Limitation Rules
The new general rule of the ATAD foresees that net borrowing costs are only deductible up to 30% of the taxpayer’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The net borrowing costs correspond to the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest, revenue and other economically equivalent taxable revenues.
Tax-exempt income as well as expenses economically related to such tax-exempt income, will be excluded from the EBITDA. The EBITDA-based limit will not apply if exceeding borrowing cost do not exceed € 3 million. Where companies form a fiscal unity, the above rules will apply on a consolidated basis (an additional bill of law will be filed next year to reflect this).
The new interest limitation rule applies to corporate taxpayers who are resident for tax purposes in Luxembourg and subject to corporate income tax, and to Luxembourg PEs of companies resident in another EU Member State or a third country. Luxembourg excludes standalone entities and financial undertakings from the scope of interest limitation.
The limitation of the interest deduction will apply to exceeding borrowing costs. Borrowing costs are defined by the bill of law. The new provisions will apply to any financing, irrespective of whether provided by related parties or third parties.
Loans entered into force before 17 June 2016 will not be affected, to the extent the features of the borrowing instrument are not modified.
The unused interest capacity and non-deductible exceeding borrowing costs may be carried forward indefinitely under certain conditions. Unused interest capacity exceeding € 3 million can be carried forward for five years.
Especially for debt funds or in general where Luxembourg companies (also securitization vehicles) have acquired non-performing loans, these rules may have significant impact as it is at the moment unclear to what extent for example taxable income resulting from a repayment of principal above the acquisition cost qualifies as economically equivalent to interest income.
The Luxembourg bill of law contains hybrid mismatch rules that apply to hybrid mismatches between domestic legislations by hybrid instruments or entities, allowing for double non-taxation. Where a mismatch results in a double deduction, Luxembourg will deny the deduction. Where a hybrid mismatch results in a deduction without inclusion, Luxembourg will deny the deduction of expenses if the relating income is not taxed in the other Member State.
The anti-hybrid rules only apply to mismatches between EU Member States. Hybrid mismatches with non-EU Member States (third countries) are included in ATAD 2. The hybrid mismatch rules of the ATAD 2 will have to be implemented by 31 December 2019.
Exit Tax Rules
The existing Luxembourg provisions will be limited and brought in line with the ATAD. According to the new ATAD rules, a five year deferral will apply to transfers to an EU or European Economic Area (“EEA“) jurisdiction, whereas under the current provisions, the deferral applies until the underlying asset is disposed of.
While the current Luxembourg provisions provide a deferral until the assets transferred are subsequently sold, the new exit tax rule imposes an immediate payment of the exit tax, but with a possible five year deferral. Tax deferrals granted before 2020 will continue to apply and will not be impacted by the new rules.
The existing Luxembourg general anti-abuse rule will be brought in line with the ATAD’s wording, introducing the concept of non-genuine arrangement. It will suffice for a tax advantage to be one of the main purposes of the arrangement to be caught under the GAAR.
The meaning of ATAD’s GAAR is close to the domestic wording and will require case law to further refine its interpretation.