OUR INSIGHTS AT A GLANCE

  • Further to the adoption of the first list of "non-cooperative" jurisdictions for tax purposes at EU level on 5 December 2017, the EU member states agreed on the introduction of at least one defensive administrative measure regarding listed countries ("Blacklisted jurisdictions").
  • In this context, by means of a circular dated 7 May 2018, Luxembourg introduced as from tax year 2018 a requirement, for Luxembourg corporate taxpayers, to indicate in their corporate tax returns whether they have concluded transactions with related parties located in Blacklisted jurisdictions.
  • On 5 December 2019, the European Council recommended to the member states to also apply at least one defensive legislative measure as of 1 January 2021 amongst a predefined list of measures. Following this recommendation, Luxembourg introduced a new article into the Luxembourg Income Tax law, which denies under certain conditions the corporate income tax deduction of interest and royalty expenses due as from 1 March 2021 to entities located in Blacklisted jurisdictions.
  • On 31 May 2022, the Luxembourg tax authorities released a new circular L.I.R. n°168/2 which replaces the former circular LG n°64 of 7 May 2018 with the aim of providing additional guidance on the application of this new defensive legislative measure. The content of the New Circular related to the defensive administrative measure remains unchanged.

Further to the adoption of the first list of "non-cooperative" jurisdictions for tax purposes at EU level (the "Blacklist") on 5 December 2017, the EU member states agreed on the introduction of at least one defensive administrative measure regarding listed countries ("Blacklisted jurisdictions").

In this context, on 7 May 2018, the Luxembourg tax authorities (the "Tax Authorities") issued the circular L.G. – A n°64 which implemented as from tax year 2018 a requirement, for Luxembourg corporate taxpayers, to indicate in their corporate tax returns whether they have concluded transactions with related parties (within the meaning of article 56 of the Income Tax Law, "ITL") located in Blacklisted jurisdictions (the "defensive administrative measure").

On 5 December 2019, the European Council recommended to the member states to also apply at least one defensive legislative measure as of 1 January 2021 amongst a predefined list of measures. Following this recommendation, Luxembourg introduced by the law of 10 February 2021 the new Article 168 n°5 of the ITL which denies under certain conditions the corporate income tax deduction of interest and royalty expenses due as from 1 March 2021 to entities located in Blacklisted jurisdictions.

On 31 May 2022, the Tax authorities released a new circular L.I.R. n°168/2 (the "New Circular") which replaces the former circular LG n°64 of 7 May 2018 with the aim of providing additional guidance on the application of the defensive legislative measure introduced by Article 168 n°5 of the ITL. The content of the New Circular related to the defensive administrative measure remains unchanged.

Based on Article 168 n°5 of the ITL, as from 1 March 2021, interest and royalties due to entities located in Blacklisted Jurisdictions are no longer tax deductible, if the following cumulative conditions are met:

  • The beneficiary of the interest or royalty is a collective undertaking within the meaning of article 159 of the ITL. If the beneficiary is not the beneficial owner, then the beneficial owner has to be taken into account;
  • The beneficiary of the interest or royalty is an associated enterprise within the meaning of article 56 of the ITL; and
  • The collective undertaking which is the beneficiary of the interest or royalty is established in a Blacklisted Jurisdiction.

Interest and royalties remain however tax deductible if the taxpayer can demonstrate that the operation which the interest or royalties relate to has been put in place for valid economic reasons which reflect economic reality.

The key guidelines provided by the New Circular are related to the scope and conditions of the application of this defensive legislative measure and are as follows:

Scope of application of the measure

The New Circular clarifies that the measure applies to Luxembourg tax resident entities and to non-Luxembourg tax resident entities taxable in Luxembourg on their Luxembourg source income.

As to the interest and royalties to be taken into account, the New Circular provides that:

  • The definition of interest and royalties within the meaning of Article 168 n°5 of the ITL is similar to the one contained in article 2 of the EU directive 2003/49/ CE (the so-called "Interest and royalties" directive) and also to the one contained in articles 11 and 12 of the OECD Model Tax Convention.
  • The interest and royalties are to be considered at the time they are accrued and cash payments are irrelevant for the application of the measure. This is because Article 168 n°5 refers to interest or royalties due and not to interest and royalties paid.

Beneficiary of the interest and royalties

The New Circular provides the following important clarifications with respect to the beneficiary of the interest and royalties:

  • When the interest or royalty is due to a tax transparent entity within the meaning of Article 175 of the ITL, a look through approach applies and the partners are considered as the beneficiaries of the interest and royalties in proportion to their participation in the tax transparent entity.
  • In addition, the beneficiary is understood to be the beneficial owner of the interest and royalties. The New Circular clarifies that the beneficial owner should be determined based on an economic approach. It is the economic owner of the interest and royalties which is the beneficial owner within the meaning of article168 n°5 of the ITL. For example, an agent or any other representative will not be considered as the beneficiary of the interest and royalties.
  • In order to determine whether the beneficial owner is a foreign collective undertaking within the meaning of article 159 of the ITL, it is necessary to analyse, on the basis of the specific characteristics of the foreign entity, as they result from the legal and statutory provisions applicable to it, whether it corresponds to a collective undertaking listed in article 159 of the ITL. Therefore, a comparative analysis based on legal and statutory characteristics is required.

Timing of the application of the measure

The measure applies to interest and royalties due as from 1 March 2021 to entities located in Blacklisted Jurisdictions based on the latest Blacklist available as of 1 March 2021, i.e. based on the Blacklist published on 26 February 2021, which includes the following twelve countries: American Samoa, Anguilla, Dominica, Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, US Virgin Islands and Vanuatu.

For subsequent years, the measure applies as of 1 January of each subsequent year with respect to the countries and territories listed in the latest version of the Blacklist available as of 1 January of the subsequent year in question. The EU Blacklist is generally updated twice a year, in February and October. For the year 2022, since the list to refer to is the latest available as of 1 January, the relevant Blacklist is the one published in the Official Journal ("OJ") of the EU on 12 October 2021, which, following the removal of Anguilla, Dominica and the Seychelles, includes the nine following countries: American Samoa, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands and Vanuatu.

Given that additions of countries to the Blacklist have only an effect as from the next calendar year whereas a removal of a country out of the list may only have an immediate effect under certain circumstances, the New Circular provides some useful examples to clarify the timing application of the measure in case countries are removed/added to the Blacklist:

  • If a country is added to the latest list available as of 1 January (i.e. the list released in October of the previous year), it will be taken into account for interest and royalties due as from 1 January of the following year (i.e. there will be no retroactive nor immediate effect but only an impact as from the following calendar year).
  • If a country is added to the Blacklist in the February update but is removed in the October update, interest and royalties due to this country will not be taken into account for the application of the measure in the given year and as of January 1st of the following year, so the change in February will have no effect. This is because the latest list available (i.e. the list released in October of the previous year) is the only list to refer to.
  • If a country is removed from the Blacklist in the February update but is added back in the October update, since the latest list available as from 1 January is always the list to refer to when applying the measure, the fact that the country was removed from the list in February will have no effect and the measure will apply with respect to interest and royalties paid to this country for the entire year as well as for the subsequent year.
  • If a country is removed from the Blacklist in the February update and is not added back to the Blacklist prior to 1 January of the subsequent year, this country will no longer be taken into account for interest and royalties due as from the date of the publication of the relevant Blacklist in the OJ of the EU (i.e. the removal will have an immediate effect as from February).
  • If a country is removed from the Blacklist in the October update, this country will no longer be taken into account for interest and royalties due as from the date of the publication of the relevant Blacklist in the OJ of the EU (i.e. the removal will have an immediate effect as from October).

Exception to the application of the rule

Interest and royalties remain tax deductible if the taxpayer can demonstrate that the operation which the interest or royalties relate to has been put in place for valid economic reasons which reflect economic reality.

The New Circular is not giving any real guidance with respect to the economic reasons which may be considered as valid for the application of this exception.

Based on the new Circular, it is not sufficient for the taxpayer to simply state some economic reasons for these reasons to necessarily be considered as valid by the tax authorities. It is necessary that these reasons, considering all the relevant facts and circumstances, can be considered genuine and providing sufficient economic benefits beyond any tax advantage. The tax authorities will appreciate the validity of such reasons on a case-by-case basis considering the relevant facts and circumstances.

In this respect, the New Circular also states that the taxpayer may request (under the usual tax ruling procedure) a tax ruling from the tax authorities in order to confirm (and so be exempt from the measure) that the operation to which the interest or royalties relate has been put in place for valid economic reasons which reflect economic reality.

Implications

While the New Circular does not introduce any additional defensive measure against Blacklisted Jurisdictions, Luxembourg corporate taxpayers should still keep on following closely the evolution of the legislation of jurisdictions under the radar of the EU Council in order to anticipate an addition to or a removal from the Blacklist in the future and thus a change in the scope of application of the Luxembourg defensive measures. In addition, Luxembourg corporate taxpayers with investments into and from Blacklisted Jurisdictions should seek advice from their tax advisers in order to analyse the impact on their investments and whether they should still be out of the scope of the legislative defensive measure because the operation which the interest or royalties relate to has been put in place for valid economic reasons which reflect economic reality. The possibility to submit a tax ruling request in order to get certainty on the existence of valid economic reasons and thus the exemption from the measure should also be considered.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.