On 31 July 2024, the Higher Administrative Court (Cour administrative) applied for the very first time, the special anti-abuse provision laid down in Article 166(2bis) of the Luxembourg income tax law dated 4 December 1967, as amended (the “LITL”) (case n° 49080C).
Background
In the case at hand, a Luxembourg resident company (“L” or the “Appellant”) granted, back in 2011, a profit participation facility (the “PPF”) to a Belgian resident company (“B”). According to the terms of the PPF the variable interest due by B corresponds to B’s net profit less a margin of 1/8%.
While such instrument was considered as a debt instrument under Belgian law, the Luxembourg tax authorities granted a ruling to L, confirming the treatment as equity under Luxembourg tax law. As a result, any income derived from such instrument should be considered as income from participation in Luxembourg while tax deductible interest expenses in Belgium.
In 2018, the PPF was repaid in advance by B, in kind, via the allocation of promissory notes (the “DUSH NOTES”) that B held toward a US resident company.
As admitted by the parties, the nominal value of the DUSH NOTES on the date of their transfer to the Appellant, i.e. 1 January 2018, was significantly lower than the market value of these securities.
On the same day, the Appellant transferred the DUSH NOTES acquired as part of the repayment of the PPF granted to B to a Swiss company (“CH”).
The said sale of the DUSH NOTES, at their market value, enabled the Appellant company to generate, a gain in relation to the nominal value of these securities, qualified as a hidden distribution of dividends for which it claimed the benefit of the exemption provided for in Article 166 of the LITL.
The Luxembourg tax authorities denied to L the application of the Luxembourg participation exemption. Such denial was further confirmed by the Lower Administrative Court (Tribunal administratif).
The Higher Administrative Court should then determine whether the transfer and subsequent disposal of the DUSH NOTES, as described above, constituted an abuse of law within the meaning of one of the two alternative conditions set out in Article 166 (2bis) of the LITL.
Grounds for decision
The Higher Administrative Court first held that the first judges erred in analysing the requirement set out in the general anti-abuse rule, instead of the special anti-abuse provision laid down in Article 166(2bis) of the LITL.
As a reminder, Article 166(2bis) of the LITL provides that : “By way of derogation from paragraph 2, point 1, [of Article 166 of the LITL] the exemption does not apply to income covered by Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, which derives from a holding held directly in the capital of a collective body which is a resident of another Member State of the European Union and covered by Article 2 of Directive 2011/96/EU, to the extent that they are deductible in that Member State or where they are allocated as part of a scheme or series of schemes which, having been put in place to obtain, as the principal objective or as one of the principal objectives, a tax advantage which runs counter to the object or purpose of that directive, is not genuine having regard to all the relevant facts and circumstances. For the purposes of this provision, a scheme, which may comprise several stages or parts, or a series of schemes shall be regarded as not genuine to the extent that the scheme or series of schemes is not put in place for valid commercial reasons which reflect economic reality.”
Since, in the case at hand, the repayment in kind of the PPF did not constitute a deductible expense in Belgian, the first alternative condition of the Article 166(2bis) of the LITL was not met.
With respect to the second alternative requirement set out in Article 166, paragraph (2bis) of the LITL, the Higher Administrative Court held that: “As for the concept of ‘non-genuine’, Article 166, paragraph (2bis), LITL defines it as referring to an arrangement or a series of arrangements that lack valid commercial reasons that reflect economic reality. In short, this condition is similar to the criterion measuring the existence of valid extra-tax reasons resulting from the application of § 6 StAnpG. In fact, as appears from the parliamentary work, the notion of ‘non-authentic’, included in paragraph (2bis) of Article 166 LITL, ‘essentially reflects the approach taken in Luxembourg case law, which has already held that the absence of valid extra-tax reasons is a constitutive element of abuse in tax matters (...).”
In the case at hand, none of the arguments brought forward by the Appellant convinced the Higher Administrative Court that the arrangement was genuine. In fact, a direct sale of the DUSH NOTES from B to CH would have been the normal route. The interposition of the Appellant in the arrangement could only be explained by a tax advantage. Indeed, since the implementation of the special anti-abuse rule under Article 166(2bis) of the LITL, any income generated under the PPF was no longer entitled to the benefit of the Luxembourg participation exemption regime (i.e. since such income would have been tax deductible in Belgium), so that the arrangement was not based any valid economic reasons.
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