The list of non-cooperative tax jurisdictions for the purpose of the Bill of Law will be provided by the Luxembourg Government by the end of the year with the draft 2021 budget law. The Luxembourg list of non-cooperative tax jurisdictions will be based on the latest EU list of non-cooperative tax jurisdictions as approved by the EU Finance Ministers, which will be available at that time.
The new tax measure will be introduced in a new paragraph (5) of Article 168 of the Luxembourg Income Tax Law (LITL)1 and will enter into force as of 1 January 2021.
Objective of the Bill of Law
The objective of the Bill of Law is to respond to the recommendations of the EU Council to apply a legislative defensive measure in taxation regarding the listed non-cooperative tax jurisdictions as of 1 January 2021, with the aim of encouraging those jurisdictions' compliance with the Code of Conduct2 screening criteria on fair taxation and transparency.
The Bill of Law is consistent and complements other tax measures already adopted by Luxembourg in this area, such as the obligation to notify (via the Luxembourg tax returns) the Luxembourg tax authorities of any intra-group transactions carried out by Luxembourg taxpayers with related parties resident in non-cooperative tax jurisdictions (Circular L.G. – A n°64 dated 7 May 2018).
Conditions of non-tax deduction
The proposed Article 168 (5) LITL provides that interest or royalties, paid or accrued, shall not be tax deductible at the level of the Luxembourg taxpayer if the following conditions are cumulatively observed:
- The beneficiary of the interest or royalties is a collective entity in the sense of Article 159 LITL3. Only the beneficial owner shall be considered for this purpose.
- The beneficial owner of the interest or royalties is an associated enterprise in the sense of Article 56 LITL4.
- The beneficial owner of the interest or royalties is located in a country or territory included in the list of non-cooperative jurisdictions for tax purposes.
It is further provided that the disallowance of interest or royalties deduction shall not apply if the Luxembourg taxpayer is able to prove that the operation to which interest or royalties correspond has been put in place for valid commercial reasons reflecting the economic reality.
Points of attention
Luxembourg taxpayers should consider the following:
- The current EU list of non-cooperative tax jurisdictions published in the EU Journal on 27 February 2020 includes 12 jurisdictions: American Samoa, Cayman Islands, Fiji, Guam, Oman, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu and Seychelles. It is expected that the EU Finance Ministers will review and update this list of non-cooperative tax jurisdictions in October 2020 ("New EU List"). It remains to be seen whether this New EU List will be available when the Luxembourg Government issue the draft 2021 budget law by the end of the year. We note that the Luxembourg Government will propose any updated list of non-cooperative tax jurisdictions on a yearly basis (applicable as of 1 January of the relevant year).
- Although payments to tax transparent foreign partnerships should be excluded from the scope of this new defensive tax measure, these rules could have an impact on, among others, Luxembourg private equity structures where fund raising is often organized, e.g., in the Cayman Islands. We note that the Cayman Islands aim to be removed from the current list upon the next revision by the EU Finance Ministers planned for October 20205.
- In line with its defensive nature, this new tax measure should apply automatically if the conditions are met. The fact that the operation is supported by valid commercial reasons reflecting the economic reality would need to be evidenced upfront by the Luxembourg taxpayer, irrespective of any tax audit, for instance, by way of a fact finding functional analysis. The Bill of Law or the commentary (Commentaires des Articles) do not specify if this evidence would need to be provided spontaneously to the Luxembourg tax authorities (e.g., in the Luxembourg tax returns) or if this evidence would only need to be provided to the Luxembourg tax authorities upon request. This point would need to be clarified during the legislative process.
- The term "beneficial owner" is not defined in the Bill of Law nor in the commentary. The Luxembourg Government explains that this inclusion is required to ensure the practical effectiveness of this tax measure (in line with the EU Council's guidance on defensive measures). In the absence of a definition provided in the Bill of Law, we would anticipate the interpretation of the term "beneficial owner" to follow the meaning of the term, as developed at the level of the OECD and the EU, among others, in the Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States ("IR Directive") and interpreted by the Court of Justice of the European Union. This would need to be clarified during the legislative process.
- The Bill of Law provides for autonomous definitions of the terms "interest" and "royalty". The commentary provides that these terms should be interpreted by reference to the IR Directive, Article 11 (interest) and Article 12 (royalty) of the OECD Model Tax Convention as applicable in most of double tax treaties concluded by Luxembourg.
- If the deduction of interest is completely and definitively refused in application of this new tax measure, it is specified in the commentary that the interest deduction limitation rule (Article 168 bis LITL6) no longer applies.
- It is worth noting that this new tax measure is limited to the non-tax deduction of interest or royalties in specific cases but does not introduce any new Luxembourg withholding tax.
Contrary to the already existing Luxembourg tax provisions that limit the tax deductibility of payments of interest or royalties (e.g., non tax deduction of expenses against tax exempt income, non-arm's length payments, interest deduction limitation rules), this new tax measure will only apply when interest or royalties are due or are paid between associated enterprises and when the beneficial owner of the income is located in a limited number of tax jurisdictions.
The measure does not introduce a new Luxembourg withholding tax.
Companies organizing IP activities, treasury activities, fund raising, or other, offshore must assess the actual impact of this new provision and subsequently monitor closely any updates to the future Luxembourg list of non-cooperative tax jurisdictions.
1 This article provides the list of business expenses that are not tax deductible for corporate income tax purposes.
2 The Code of Conduct is a non-binding EU instrument that aims at proposing political commitments to be applied by EU Member States.
2 This article provides the list of Luxembourg tax resident corporate entities.
2 This article embedded the arm's length principle in domestic law.
2 The removal of the Cayman Islands from the list of non-cooperative tax jurisdictions will need to be monitored closely as it could also affect the scope of the reporting obligations of Luxembourg intermediaries or taxpayers under the law implementing the Council Directive EU 2018/822 (the DAC 6 Law). Under the DAC 6 Law, it is required to report to the Luxembourg tax authorities any cross-border arrangements involving tax-deductible cross-border payments made between associated enterprises when the recipient is resident for tax purposes in a non-cooperative tax jurisdiction (hallmark C1 (b) ii), which does not require the main benefit test to be met. Please refer to our client alert dated 10 September 2019 for more information on DAC 6.
2 This article implemented the interest deduction limitation rule set forth in the EU anti-avoidance directive of 12 July 2016 (ATAD 1) in domestic law.