The Luxembourg Income Tax Code assesses Luxembourg taxpayers differently, depending upon whether they realise business income or income from private financial wealth management. In case of business income, any capital gain will be taxable, as a matter of principle, contrary to capital gains realized in the course of private wealth management, which are tax-exempt as a general rule. Conversely, capital losses are deductible in case of business income, and may be offset against any other income of the taxpayer, whereas such losses are neither deductible nor offsettable, if they occur in the course of private financial wealth management. Hence, it is important to distinguish the two types of activities. The Luxembourg Income Tax Code provides for an autonomous definition of business income. This means in practice, that financial capital income will be taxed according to the private financial wealth management rules, if the conditions set forth by the Income Tax Code for business income are not met. Setting forth the principle however is easier than applying it in practice. The dividing line particularly poses problems in two areas: real estate activities and management of financial assets. Following constant case-law, real estate income is business income, if the main purpose of the investment is the generating of capital gains, the rental income merely being a means to increase the return of the investment until its sale. Conversely, if the main purpose of the holding of the real estate is the realisation of rental income, the buying and selling of the real estate only being the necessary steps undertaken by the taxpayer in order to generate such income, no business income will be realised by the taxpayer. Absent any specific rules applying to the management of private financial wealth management, practitioners always considered the real estate vs. business income case-law to equally apply to the former. That however led to uncertainties in practice, given the fact that, due to its nature, a financial portfolio typically is subject to a more frequent reshuffling than a real estate portfolio. Hence, the tax position of high net worth individuals often was subject to controversy, if they had entrusted their bank with a mandate to manage their portfolio in a somewhat more dynamic manner than the ordinary person. Could those persons be subject to the business income taxation rules?
This is exactly the situation the Higher Administrative Court (Cour administrative) had to deal with in its February 8th 2018 ruling (No. 39.274). It confirmed on that occasion that the case law in real estate matters also applies, by way of analogy, to transactions involving the purchase and sale of financial assets. The Higher Administrative Court, however, further added that the specificities of financial private wealth management should get taken into account, too, so that the analogy would not be total. Hence, just as in the case of real estate management, it is thus necessary to determine whether the management of the financial assets is mainly focused on the realisation of regular income (dividends, interest), or if the investment strategy is centred on the realization of capital gains, the collection of dividends and interests only constituting ancillary income for the taxpayer. However, the Court added that the management of financial assets cannot be fully equated with management of real estate assets. Indeed, according to the Court, it is of the very nature of this type of management that the taxpayer is primarily interested in the total return on his investment, which comprises both the regular income and price fluctuations, rather than its two components separately. As a result, unlike what is the case for real estate assets, a regular rebalancing of the financial portfolio does not lead to business income for the taxpayer. This means in practice that taxpayers may more frequently than in the case of real estate, buy and sell their financial assets, without becoming subject to the business income tax rules. According to the Court, this would only occur in extreme cases, characterised by a large volume of transactions.
This Higher Administrative Court ruling is spot on in terms of its analysis, since it accurately takes into account structural differences between the management of real estate and financial assets, so as to avoid unduly subjecting private financial wealth management to the business income tax rules. Furthermore, as a result of the way it is written, the Court’s decision will clearly become a precedent, in the legal sense, having a value beyond the matter dealt with by the Court. There should be no doubt that all the tax courts will be guided by it going forward, as should the tax authorities, though in the latter case probably with some delay.
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