Luxembourg: Law Implementing ATAD Enters Into Force

Last Updated: 18 March 2019
Article by Oliver R. Hoor and Samantha Schmitz-Merle

OUR INSIGHTS AT A GLANCE

  • The law of 21 December 2018 implements the EU Anti-Tax Avoidance Directive ("ATAD"), the aim of ATAD being to implement the BEPS (Base Erosion and Profit Shifting) recommendations made by the OECD and the G20 in October 2015 at EU level.
  • The new law introduces the following ATAD measures: a limitation to the tax deductibility of interest payments, an amendment to the current general anti-abuse rule, the introduction of the non-genuine arrangement CFC rule, a new framework to tackle hybrid mismatches and exit taxation rules.
  • Non-ATAD (but still BEPS-related) measures included in the law are an amendment to Luxembourg rules so that the conversion of debt into shares no longer falls within the scope of tax neutral exchange operations and a new permanent establishment definition.
  • Overall, Luxembourg has made the right choices, using all options provided by ATAD in order to remain competitive, even though, on some aspects the Luxembourg government has taken positions which are even stricter than ATAD. Additional work remains to be done in order to clarify the impact of some of the new measures on existing tax law.

The Luxembourg Parliament has now adopted the 2019 tax reform implementing the EU Anti-Tax Avoidance Directive ("ATAD") and other anti-BEPS-related measures into Luxembourg tax law. More precisely, the 2019 tax reform includes tax law changes in the following areas:

  • Interest limitation rules;
  • General anti-abuse rule (GAAR);
  • Controlled foreign companies (CFCs);
  • Hybrid mismatch rules;
  • Amendment of the exit tax rules;
  • Amendment of the roll-over relief; and
  • Amendment of the permanent establishment definition.

The interest limitation rule

Since 1 January 2019, Article 168bis of the Luxembourg Income Tax Law ("ITL") limits the deductibility of "exceeding borrowing costs" generally to a maximum of 30% of the corporate taxpayers' earnings1 before interest, taxes, depreciation and amortisation ("EBITDA"). The scope of the interest limitation rule encompasses all interest-bearing debts irrespective of whether the debt financing is obtained from a related party or a third party. However, exceeding borrowing costs up to an amount of EUR 3m may be deducted without any limitation (that is a safe harbour provision).

"Exceeding borrowing costs" correspond to the amount by which the deductible "borrowing costs" of a taxpayer exceed the amount of taxable "interest revenues and other economically equivalent taxable revenues". Borrowing costs within the meaning of this provision include interest expenses on all forms of debt, other costs economically equivalent to interest and expenses incurred in connection with the raising of finance including, without being limited to:

  • payments under profit participating loans;
  • imputed interest on instruments such as convertible bonds and zero-coupon bonds;
  • amounts under alternative financing arrangements, such as Islamic finance;
  • the finance cost element of finance lease payments;
  • capitalised interest included in the balance sheet value of a related asset, or the amortisation of capitalised interest;
  • amounts measured by reference to a funding return under transfer pricing rules where applicable;
  • notional interest amounts under derivative instruments or hedging arrangements related to an entity's borrowings;
  • certain foreign exchange gains and losses on borrowings and instruments connected with the raising of finance;
  • guarantee fees for financing arrangements;
  • arrangement fees and similar costs related to the borrowing of funds.

As far as interest income and other economically equivalent taxable revenues are concerned, neither ATAD nor Luxembourg tax law provides for a clear definition of what is to be considered as "revenues which are economically equivalent to interest". However, given that borrowing costs and interest income should be mirroring concepts, the latter should be interpreted in accordance with the broad definition of borrowing costs.

Corporate taxpayers who can demonstrate that the ratio of their equity over their total assets is equal to or higher than the equivalent ratio of the group can fully deduct their exceeding borrowing costs (the so-called escape clause that should protect multinational groups that are highly leveraged).

Moreover, according to a recent announcement of the Luxembourg government, the optional provision under ATAD according to which EBITDA and exceeding borrowing costs can be determined at the level of the consolidated group (in case several companies form a fiscal unity) will be introduced within the upcoming six months with retroactive effect as from 1 January 2019.

Footnotes

1 Tax exempt income such as dividends benefiting from the Luxembourg participation exemption regime is to be excluded when determining the EBITDA.

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