On 8 January 2021, the Luxembourg Parliament voted to approve the Bill N°7547 (the “Bill”) implementing new provisions (with effect as from 1 March 2021) related to tax deductions vis-à-vis interest and royalty expenses (the “Law”) owed to affiliated corporations established in jurisdictions included on the EU list of non-cooperative jurisdictions for tax purposes.
The Law, amending Art.168 of the modified Luxembourg Income Tax Law (“LITL”) dated 4 December 1967, was signed on 10 February 2021 and published on the Luxembourg Memorial on 11 February 2021.
Context
The Law mostly follows the Bill which has been submitted by the Luxembourg Government on 30 March 2020 except that the final version of the Law draws up an identified and comprehensive list (“Annex I”) of non-cooperative jurisdictions for tax purposes by specially referring to the EU blacklist (so-called the “EU Blacklist”) as requested by the Luxembourg State of Council (Conseil D’Etat). Additionally and whilst the Bill initially aimed at an entry in force of the new provisions as from 1st January 2021, the Law entered in effect on 1st March 2021.
The Law was enacted further to the approval by the Economic and Financial Affairs Council of the EU (the “EU Council”) on 6 December 2019 of new guidelines released by the Code of Conduct Group through a report (the “Report”) dated 25 November 2019 (i.e., Report on the activity of Code of Conduct Group on business taxation - Annex 4). The Report has outlined guidance on further coordination of national defensive measures in the tax area towards non-cooperative jurisdictions business taxation. In a nutshell, such guidelines invite all Member States to apply a legislative defensive measure (outlined as below) in taxation vis-à-vis the listed jurisdictions as of 1 January 2021, aiming to encourage those jurisdictions’ compliance with the Code of Conduct screening criteria on fair taxation and transparency.
As per Annex 4 of the Report, at least one of the following measures in relation to payments made to and/or income derived from blacklisted countries should have been introduced into all Member States’ domestic law since 1st January 2021:
- Application of controlled foreign corporation rules;
- Limitation or disallowance of deductibility of costs;
- Limitation of any participation exemption on profit distributions; and,
- Withholding tax measures.
Luxembourg decided to solely transpose the second aforementioned measure through the enactment of the Law.
Scope of application of the Law
As per the revised version of Art. 168 LITL, tax deduction of interest and royalties expenses owed by a Luxembourg-based taxpayer should be disallowed under the following conditions (to be met cumulatively):
- The beneficiary of the interest or royalties is a collective undertaking within the meaning of Art.159 LITL (i.e., excluding tax transparent partnerships). If the recipient of the accruals is not the beneficial owner, it is the beneficial owner of the accruals that shall be considered for applying the rule;
- The collective undertaking is an associated enterprise within the meaning of Art.56 LITL; and,
- The collective undertaking is established in a country or territory appearing on the EU Blacklist.
a. Non-deductibility of interest and royalties
As opposed to the previous language used in the initial drafting of the Bill, the Law aims only at interest and royalties "due" and not at interest and royalties "paid or due” (1). Such revision of wording occurred following remarks (2) by the Conseil D’Etat as so addressed during the legislative process. As a result of this update, one should understand that:
- The current scope of the new provisions introduced under Art.168(5) LITL should apply to interest or royalties that are owed, irrespective of whether they are paid or remain due; and,
- Interest or royalties that have accrued before the entry into force of the Law should remain tax deductible (unless restricted under other tax provisions) upon actual payments.
The Law refers to Art.2 of the Directive 2003/49/CE (3) for the purpose of the definition of “interest” and “royalties”. The term interest means interest and arrears paid or due that relate to debt-claims of every kind, even if they are secured by mortgage or carrying a right to participate in the debtor's profits, and in particular interest and arrears from bonds or debentures, including premiums and prizes attaching to such securities. Penalty charges for late payment are disregarded as interest for the purpose of this provision.
The term royalties means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematograph films and software, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. It also includes payments for the use of, or the right to use, industrial, commercial or scientific equipment.
The aforementioned definitions foreseen under the Directive 2003/49/CE refer themselves to the terms of interest and royalties defined by Arts.11 and 12 of the OECD Model Tax Convention (4).
b. Concept of associated enterprise
Moreover, the collective undertakings targeted by the second condition of Art.168(5) LITL refers to Art.56 LITL which itself outlines transfer pricing principles under domestic law. In particular, the term of associated enterprise as defined under Art.56 LITL mirrors the definition of Art.9(1) of the OECD Model Tax Convention. For the purposes of the application of the Law, an associated enterprise should be understood as any collective undertaking, which has a direct, or indirection participation in the management, control or capital of a Luxembourg-based taxpayer.
c. Definition of beneficiary and beneficial owner of the expenses
Art.168(5) LITL aims at interest and royalty expenses owed to beneficiaries organized as collective undertakings. Under the scenario where the beneficiary of the expenses is not the beneficial owner, the beneficial owner should be taken into account for applying the new provisions.
With respect to this last point, the Conseil d’Etat has specified that no such concept of beneficial owner is currently defined under the LITL (5) and further clarifications should be brought in this regard.
For instance, the Conseil d’Etat (6) has further clarified that it is not the term of beneficial owner as defined under the Anti-Money Laundering Law dated 12 November 2004 that should be retained for the purposes of the application of Art.168(5) LITL. Instead, one should rather refer to the concept of beneficial owner identified in the context of interest payments as defined in the commentaries to Art.11 of the OECD Model Tax Convention (7). Concisely, the source country is not obliged to give up taxing rights over interest income merely because that income was paid directly to a resident of a country with which the source country had concluded a treaty. Additionally, the commentaries to Art.11 of OECD Model Tax Convention (8) underscore that the term of beneficial owner should not be used in a narrow technical sense but rather it should be understood in its context in particular in light of the object and purposes of the treaty, including avoiding double taxation and the prevention of fiscal evasion and avoidance. The Conseil d’Etat also refers to the latest EU case laws (9) (i.e., so-called “Danish cases”) of the CJEU in respect of the concept of beneficial owner retained in tax matters. To sum-up, the CJEU specifies that that the term “beneficial owner” concerns not a formally identified recipient but rather the entity which benefits economically from the interest received and accordingly has the power to freely determine the use to which it is put.
Nonetheless, in the light of the current wording of the Law, the recommendations from the Conseil d’Etat suggesting for the implementation of a precise definition of the beneficial owner have not been followed. As a result, the precise scope of application of Art.168(5) LITL under domestic law remains unclear and subject to interpretation.
d. The EU Blacklist
The EU Blacklist was recently updated by the EU Council on 22 February 2021. The list is currently composed of American Samoa, Anguilla, Dominica (new), Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu and Seychelles. Note that the Cayman Islands were removed from the EU Blacklist on 6 October 2020.
Since 2020, the EU Blacklist is updated twice a year in October and March and published in the Official Journal of the EU (“OJEU”) upon each amendment. The next revision of the EU Blacklist is scheduled for October 2021.
Considering that the EU Blacklist is constantly evolving, the Law specifies which version of the EU Blacklist a Luxembourg taxpayer should refer to in order to determine if interest or royalties owed by the latter should fall within the scope of Art. 168(5) LITL.
In the light of the current wording of the Law, the Annex I should be understood as - for the first year of application of the new provisions foreseen under Art.168(5) LITL - the latest published version of the EU Blacklist on 1 March 2021 with no possibility of amendments to the Annex I in the course of the year 2021.
From 1 January 2022 onwards, the Annex I foreseen under Art.168(5) LITL will be applicable for the latest version of the EU Blacklist as published in the OJEU before that date. In case of removals of countries from the EU Blacklist occurring within the same calendar year, provisions of Art.168(5) LITL will cease to apply as from the date of publication of the updated EU Blacklist on the OJEU. In practice, no revision to the provisions of Art.168(5) LITL through the enactment of amending laws will be required to take into account the updates to the EU Blacklist into domestic law.
Exception
In principle, the newly introduced provisions shall not apply if the taxpayer can demonstrate that the transaction generating the accrual of interest or royalties would be driven by sound commercial reasons that reflect the economic reality.
The aforementioned exception slightly recalls the wording of the general-anti abuse rule (“GAAR”) as foreseen in Paragraph 6 of the modified Luxembourg Tax Adaptation Law (10) and according to which arrangements, which have been put in place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of tax law and which are not genuine should be ignored (11).
The comments to the Bill (12) specify that the taxpayer should not merely assess economic reasons to justify the accrual of such targeted expenses by the provisions of Art.168 LITL. More specifically, a Luxembourg company would be required to demonstrate, taking into account all the facts and circumstances, that the economic reasons would be relevant by presenting a sufficient economic advantage beyond any tax advantage obtained through the operation. In case such a proof is being provided by the taxpayer, the new provisions of Art.168(5) LITL shall not apply. However, no further details are provided as regards the sort of proof, which is expected from the taxpayer in order to sustain the existence of valid commercial reasons.
The fact that the Law refers to the “transaction generating the accrual of interest or royalties” seems to indicate that one should look at the genuineness of the underlying transaction itself rather than focusing on the beneficiary of the payments.
Interaction of Art.168(5) LITL with other restrictive interest deduction rules
It is interesting to assess how the new provisions under Art.168(5) LITL would be interacting with other existing rules under Luxembourg domestic law already limiting tax deduction rights on interest expenses in direct connection with exempt income covered by the domestic participation exemption regime (i.e., Art. 166 LITL) and/or the interest limitation rules introduced by the Law dated 21 December 2018 implementing the EU Directive 2016/1164 (i.e., so-called ATAD 1).
The commentaries to the Bill precise that priority should be given to the provisions of Art. 168(5) LITL over existing restrictions such as the interest limitation rules vis-à-vis net financial charges foreseen under Art. 168bis .
Furthermore, the Conseil d’Etat specifies that the same rationale should apply in respect of interest expenses incurred in direct connection with dividends/liquidation proceeds tax exempt under Art. 166 LITL and exempt capital gain falling within the scope of the recapture rule should a denial of deduction right on interest expenses be fully definitive under Art. 168(5) LITL.
(1) Bill N°7547: Art.1er : “A l’article 168, numéro 4 de la loi modifiée du 4 décembre 1967 concernant l’impôt sur le revenu, le point final est remplacé par un point-virgule et il est inséré un nouveau numéro 5 libellé comme suit: « 5. les intérêts ou redevances payés ou dus lorsque les conditions suivantes sont simultanément remplies(…).“
(2) Opinion n°60.165 of the Conseil d’Etat issued on 16 June 2020 in respect of the Bill n°7547 - Art. 1 - page 4 : “Finalement, si l’intention des auteurs du projet de loi est néanmoins de prendre en considération le paiement des intérêts ou redevance le Conseil d’Etat relève que le texte en projet prévoit exclusivement la non-déductibilité des intérêts au titre de dépenses. Le Conseil d’Etat comprenant que sont visés plus spécifiquement les dépenses d’exploitation. Or, un paiement a pour effet d’éteindre une dette née d’un engagement contractuel qui prévoit une rémunération pour la mise à disposition de fonds (prêt) ou d’un bien matériel ou immatériel“.
(3) Comments to the Bill n°7547 - Art 1. - Page 5: “Dans ce contexte, il a été tenu compte de la portée que des définitions consacrées au niveau de l’Union européenne, à savoir à l’article 2 de la directive 2003/49/CE du Conseil du 3 juin 2003 concernant un régime fiscal commun applicable aux paiements d’intérêts et de rede-vances effectués entre des sociétés associées d’Etats membres différents, et au niveau de l’OCDE, à savoir aux articles 11 et 12 du modèle de convention de l’OCDE, attribuent aux termes « intérêts » et « redevances », en proposant des définitions dont la couverture y est similaire dans une large mesure“.
(4) Model Tax Convention on Income and on Capital dated 21 November 2017 of the Organisation for Economic Cooperation and Development (“OECD”);
(5) Opinion n°60.165 of the Conseil d’Etat issued on 16 June 2020 in respect of the Bill n°7547- Art 1. - Page 6 : “Il devra ainsi être déterminé, dans une première étape, la personne qui est à considérer comme le bénéficiaire effectif des intérêts ou redevances. Le Conseil d’État constate en premier lieu que le concept de « bénéficiaire effectif » n’existe dans aucune autre disposition de la LIR“;
(6) Opinion N°60.165 of the Conseil d’Etat issued on 16 June 2020 in respect of the Bill n°7547 - Art 1 - Page 6 : “Le Conseil d’Etat constate que le concept de « bénéficiaire effectif », tel que défini à l’article 1er, paragraphe 7, de la loi modifiée du 12 novembre 2004 relative à la lutte contre le blanchiment et contre le financement du terrorisme, comme « toute personne physique qui, en dernier ressort, possède ou contrôle le client ou toute personne physique pour laquelle une transaction est exécutée ou une activité réalisée », ne saurait servir de référence pour l’application du projet de loi sous avis : la définition de la loi précitée du 12 novembre 2004 vise à identifier la personne physique qui possède ou contrôle une entité, alors que le bénéficiaire (effectif) des intérêts ou redevances en matière fiscale désigne l’organisme à caractère collectif qui a le pouvoir de disposer librement des fonds qui lui sont versés“;
(7) Comments to Art.11 - Paragraph 2 in the OECD Model Tax Convention: “The requirement of beneficial owner was introduced in paragraph 2 of Article 11 to clarify the meaning of the words “paid to a resident” as they are used in paragraph 1 of the Article. It makes plain that the State of source is not obliged to give up taxing rights over interest income merely because that income was paid direct to a resident of a State with which the State of source had concluded a convention”;
(8) Comments to Art.11 - Paragraph 2 in the OECD Model Tax Convention: “The term “beneficial owner” is therefore not used in a narrow technical sense (such as the meaning that it has under the trust law of many common law countries), rather, it should be understood in its context, in particular in relation to the words “paid to a resident”, and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance”;
(9) Judgment of the European Court of Justice dated 26 February 2019 ( i.e., Joined Cases C-115/16, C-118/16, C-119/16 et C-299/16 and Joined Cases C-116/16 et C-117/16).
(10) Loi d’adaptation fiscale modifiée du 16 octobre 1934 - “Steueranpassungsgesetz“.
(11) Paragraph 6.1 of the modified Luxembourg Tax Adaptation Law: “ La loi fiscale ne peut pas être contournée par un abus de formes et d’institutions du droit. Il y a abus au sens de la première phrase si la voie juridique qui, ayant été utilisée pour obtenir, à titre d’objectif principal ou à titre d’un des objectifs principaux, un contournement ou une réduction de la charge d’impôt allant à l'encontre de l'objet ou de la finalité de la loi fiscale, n’est pas authentique compte tenu de l’ensemble des faits et circonstances pertinents. Aux fins de la présente disposition, la voie juridique, qui peut comprendre plusieurs étapes ou parties, est considérée comme non authentique dans la mesure où elle n’a pas été utilisée pour des motifs commerciaux valables qui reflètent la réalité économique".
(12) Comments to the Bill n°7547 - page 4: “Il ne suffit pas que le contribuable fasse simplement état de motifs économiques pour que ceux-ci doivent nécessairement être admis comme valables, mais il faut que ces motifs, compte tenu de l’ensemble des faits et circonstances pertinents, puissent être considérés comme réels et présentant un avantage économique suffisant au-delà d’un éventuel bénéfice fiscal obtenu à travers l’opération. Si une telle preuve est rapportée par le contribuable, la mesure défensive introduite par le présent projet de loi ne s’appliquera pas“;
(13) Art.166(5) LITL;
(14) Art.168bis LITL;
(15) Opinion N°60.165 of the Conseil d’Etat issued on 16 June 2020 in respect of the Bill n°7547 - Art 1. - Page 11 : “ Le Conseil d’État note également que le commentaire des articles précise que la règle de non-déductibilité des intérêts ou redevances s’applique par priorité à la règle de limitation de la déduction des intérêts de l’article 168bis LIR “;
(16) Opinion N°60.165 of the Conseil d’Etat issued on 16 June 2020 in respect of the Bill n°7547 - Art 1. - Page 11 : “Il devrait en être de même en ce qui concerne l’application de l’alinéa 5, point 1, de l’article 166 LIR : si la déduction des dépenses d’intérêts est intégralement et définitivement refusée en application du numéro 5 à introduire à l’article 168 LIR par la loi en projet, l’alinéa 5, point 1, de l’article 166 LIR ne vient plus à s’appliquer. Par extension, ces mêmes intérêts ne seront pas à inclure dans la somme algébrique des revenus de la participation lorsqu’il s’agit de déterminer le montant du revenu imposable dégagé par la cession d’une participation“;
(17) Art.166(9) LITL;
(18) Art.1(2) du Règlement grand-ducal du 21 décembre 2001 portant exécution de l'article 166, alinéa 9, numéro 1 de la loi modifiée du 4 décembre 1967 concernant l'impôt sur le revenu.
Share on
