The overall purpose of the 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, with the aim of encouraging those jurisdictions' compliance with the Code of Conduct2 screening criteria on fair taxation and transparency.
The new provision will not be applicable from 1 January 2021 as initially estimated in the draft of the Law, but rather, from 1 March 2021.
- Limited scope of the new rule: The application of the new paragraph 5 of Article 168 of the LITL is subject to the following conditions: i) the Luxembourg taxpayer is a collective entity within the meaning of Article 159 of the LITL; ii) the payment is made to a related entity (i.e., the beneficial owner of the payment); and iii) the beneficial owner is located in a non-cooperative tax jurisdiction.
- Notion of related parties: The identification of the “related entity” should be monitored carefully in accordance with Article 56 of the LITL based on the entity’s control rather than on the shareholding’s threshold.
- Safeguard provision: Taxpayers will be allowed to exclude the application of the measure to the extent they can demonstrate that the operations at stake are implemented for "valid business reasons which reflect economic reality.”
- EU list of non-cooperative tax jurisdictions3: The list includes American Samoa, Anguilla, Barbados, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu and Seychelles.
The Law has been amended due to the Council of State’s formal opposition. Indeed, in its early commentaries dated 16 June 2020, the Council of State raised an issue with respect to the retroactivity of the proposed provision. In the first draft of the Law, the non-deductibility of interest and royalty applied not only to payments paid, but also to payments due to related parties.
Retroactivity in itself is not forbidden, to the extent it introduces measures which favorably affect validly acquired and consolidated legal situations and do not offend the rights of third parties. However, when these situations or rights are affected by a new provision, the Council of State has always taken the position that retroactivity constitutes a breach of the principle of legal certainty and of the principle of legitimate expectations.
The legislator has therefore amended the draft of the Law accordingly to prevent a retroactive effect.
The new provision introduced by Luxembourg complies with international and European tax standards. However, as highlighted by the Chamber of Commerce in its commentaries on the draft of the Law, there are no clarifications on the definitions of “beneficial owner,” “related enterprise” or “valid commercial reasons which reflect economic reality,” which are important concepts when assessing the risks for companies. More details may be provided at a later stage through a circular from the Luxembourg tax authorities.
We highly recommend that companies operating or envisaging to operate in the above listed non-cooperative tax jurisdictions do assess risks and potential negative tax consequences linked to this new measure. Our Baker McKenzie tax experts would be delighted to answer any question you may have.
1 The first vote was cast on 28 January 2021 while the second vote was waived on 29 January 2021. The Law was not yet published in the Memorial at the time of publication.
2 The Code of Conduct is a non-binding EU instrument that aims at proposing political commitments to be applied by EU member states.
3 EU list of non-cooperative tax jurisdictions as of 7 October 2020.