Distinction Between Rental and Commercial Income under Luxembourg Tax Law

In a recent decision (No.39731 dated July 10^th 2018), the Lower Administrative Court (“Tribunal administratif”), once again confirmed the principle that each tax year should be assessed independently.

In the case at hand, an SCI (“Société Civile Immobilière”), a type of tax transparent entity that is not automatically deemed to undertake a commercial activity for Luxembourg tax purposes, as opposed to a Société à responsabilité limitée or a Société anonyme that is always deemed to undertake such a commercial activity, solely held real estate assets from which it earned rental income. That by itself does not constitute a commercial activity leading to the recognition of commercial income, but rather a mere renting activity leading to the recognition of a rental income, which is not subject to municipal business tax. However, as the SCI sold several real estate assets over a short period of time in the previous years, the activity undertaken by the SCI was requalified into a commercial activity for those years as it exceeded the mere management of the SCI’s private wealth (please refer to our newsletter dated April 2018 on the limits of private wealth management under Luxembourg tax law). The question was thus in essence, whether the qualification retained for the activity undertaken in the previous years should be binding on the qualification of the activity in the subsequent years.

The Lower Administrative Court rightfully considered, in line with the principles of Luxembourg tax law and the Luxembourg Constitution, that the tax situation of a taxpayer should be analysed on a yearly basis, irrespective of the conclusions reached in the previous or following years, unless the tax authorities previously agreed to give a binding confirmation of the tax treatment of a transaction (e.g. in cases where an Advance Tax Agreement is granted). While this decision of the Lower Administrative Court is a welcome reconfirmation of long standing principles it unfortunately did not discuss the tax treatment resulting from this position, as the end of a commercial activity generally entails the taxation of all unrealized capital gains on the assets that are deemed to be retransferred back into the private assets of the taxpayer.