Higher Administrative Court decision of 4 June 2024
On 4 June 2024, the Higher Administrative Court (n° 49203C) delivered its decision on abuse of law in the context of the repurchase and cancellation of classes of shares.
The Higher Administrative Court confirmed the decision of the Lower Administrative Court finding that the operation constituted an abuse of law resulting in the requalification of the operation as a hidden dividend distribution subject to a 15% withholding tax.
Case leading to the decision
The case involved a Luxembourg company (“LuxCo”) held by two non-Luxembourg resident individuals. During the last two months of financial year 2017, LuxCo received dividend distributions from its subsidiaries, restructured its share capital previously composed of ordinary shares into 20 classes of shares providing each for the same economic rights. In December 2017, LuxCo repurchased and cancelled two classes of shares and amended its by-laws to grant different economic rights to each class of shares (i.e., preferential dividends). Please see our previous newsletter for more background.
LuxCo considered the repurchase as a partial liquidation not subject to withholding tax (“WHT”). The Luxembourg tax authorities (“LTA”) challenged this qualification on the grounds of abuse of law and such position was confirmed by the Lower Administrative Court on 14 June 2023 (see our previous newsletter).
Abusive use of the partial liquidation mechanism
The Higher Administrative Court confirmed that the case presented all the characteristics to fall within the abuse of law as defined under paragraph 6 of the Steueranpassungsgesetz.
Use of legal forms and reduction of the tax liability
Regarding the use of legal forms, several have been used, notably the split of the share capital from ordinary shares to 20 classes of shares as well as the repurchase and cancellation of shares.
Regarding the reduction of the tax liability, while the distribution of dividends by LuxCo to its non-resident shareholders would have been subject to a 15% WHT, the repurchase of shares falling within the partial liquidation regime would not have attracted WHT. The Higher Administrative Court dismissed several arguments put forward by the taxpayers, notably regarding the possibility to repatriate the funds through share capital reduction. The judges recalled that even in such alternative the operation would have triggered a 15% WHT in the absence of serious economic reasons to reduce the capital and such reasons being generally absent in the presence of distributable reserves (which was the case of the company).
Inadequacy of the chosen legal route and absence of non-tax motives:
On the inadequacy of the chosen legal route, the Higher Administrative Court recalled that the unusual character of a legal route does not automatically make it inadequate considering the freedom of the taxpayer to choose the least taxed solution. However, the unusual route becomes inadequate when the economic objective achieved, in its specific context, results in tax consequences that were not intended by the legislator. The Higher Administrative Court notably relied on the:
- Equivalence to a dividend distribution: The Higher Administrative Court followed the Lower Administrative Court in its analysis deeming equivalent to a dividend distribution the proportional repurchase of shares from all shareholders with the sole motive of transferring funds received as dividends to the shareholders. Such analysis also relied on the fact that the redeemed classes provided for the same rights than ordinary shares previously in issuance.
- Flow of funds: The Higher Administrative Court outlined that the notes to the financial statements mentioned that the share capital reduction resulted in the distribution of LuxCo’s annual profits. The Higher Administrative Court additionally analysed the overall operation as a mere intention to transfer funds received under the form of dividend income two months earlier by LuxCo from its subsidiaries to the LuxCo’s shareholders.
As to the existence of non-tax motives, the taxpayer put forward several arguments notably that the funds needed to be repatriated in the absence of plans to reinvest the proceeds in line with its investment/financial management policy. The Higher Administrative Court dismissed these arguments in the absence of evidence of such policy (reference to LuxCo’s corporate object being insufficient) and noted that the operation could not be analysed as a divestment from an underlying investment as the repurchased and cancelled shares granted the same legal/economic rights to each shareholder, rights identical to those granted by the ordinary shares initially issued and no divestment from an underlying investment effectively took place.
Key takeaways
As a matter of coincidence, this decision is delivered a couple of weeks after the submission of a draft law to clarify the application of the partial liquidation regime in the context of classes of shares (see our newsflash). The draft law requires the classes of shares to have different economic rights in order for their repurchase and cancellation to be considered as a partial liquidation and the commentary to the draft law recalls that the operation can still fall within the abuse of law where the conditions are met.
In this context, this case law provides useful insights on the importance of the economic substance of the operation which would remain relevant even after the legislative update.
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