Implementation of Anti-Tax Avoidance Directive (ATAD 1)

On 19 June 2018 the bill of law 7318 (“Bill”) was introduced to the Luxembourg parliament relating to the transposition of measures included in EU anti-tax avoidance Directive 2016/1164 (“ATAD 1”) into national legislation. The Bill contains the ATAD 1 provisions concerning the following measures:

• Interest limitation rules (Art. 4 of ATAD 1)
• Exit taxation (Art. 5 of ATAD 1)
• General anti-abuse rule (“GAAR”, Art. 6 of ATAD 1)
• Controlled foreign company (“CFC”) rule (Art. 7 and 8 of ATAD 1);
• Intra-EU anti-hybrid rule (Art. 9 of ATAD 1)

Based on the ATAD 1, these measures have to be implemented by the EU Member States by 31 December 2018.

With the exception of the provisions on exit taxation which should apply as of 1 January 2020, it is expected that the above measures should come into force on 1 January 2019.

The Bill targets taxpayers subject to Luxembourg corporate income tax, with the exception of the GAAR and the exit tax provisions which apply to all taxpayers.

The Bill also includes additional BEPS-related provisions proposing amendments to the Luxembourg domestic tax legislation in relation to the following aspects:

• the tax neutral conversion of debt into shares; and
• the recognition of foreign permanent establishments (PEs) under tax treaties.

The proposed provisions are still subject to amendments before the final vote by the Luxembourg Parliament.

Key features

For each proposed amendment by the Bill, we have briefly developed what we deem to be its salient points and features:

• Interest limitation rules

The Bill introduces a new Article 168bis according to which the deductibility of exceeding borrowing costs (i.e., interest expenses exceeding interest income and other similar taxable income) should be limited to the higher of:

1. (i) 30% of the taxpayers taxable earnings before interest, tax, depreciation and amortisation (“EBIDTA”); or
2. (ii) EUR 3,000,000.

Tax exempt income as well as expenses related to such exempt income is excluded from the EBIDTA computation.

Exceeding borrowing costs that cannot be deducted in a given tax period can be carried forward without time limitation. Unused interest capacity may be carried forward for up to five years.

Luxembourg however excludes from the scope of application of the interest limitation rules “financial undertakings” and “standalone entities”, as defined in ATAD 1.

The financial undertakings listed in the Bill are entities subject to EU Directives or Regulations and include amongst others credit institutions, investment firms, UCITS, alternative investment funds (“AIFs”), insurance and reinsurance undertakings and securitisation vehicles that are governed by Regulation (EU) 2017/2402. 

Standalone entities (i.e., entities that are not part of a consolidated group for financial accounting purposes and have no associated enterprise or permanent establishment situated in a country other than Luxembourg) and financial undertakings as defined in the draft law (e.g. credit institutions or investment firms regulated by an EU Directive or Regulation) are excluded from the scope of the interest limitation rule.

Luxembourg opted for the grandfathering provision offered through the ATAD 1 to the EU Member States according to which borrowing costs related to loans concluded before 17 June 2016 (in exclusion of subsequent modifications of the debt instrument) are not taken into account for the exceeding borrowing costs computation. Loans used to fund an EU long-term public infrastructure will also be excluded, subject to certain conditions.

• Exit taxation

The Bill modifies the existing exit taxation rules allowing a tax deferral to provide for a payment of tax in instalments over five (5) years.  .

Further to the amendments introduced by the Bill, in case of a migration of a corporation to Luxembourg or a transfer of a business performed by a PE from a country other than Luxembourg, assets must be valued based on the value determined by the other State (with some exceptions) while keeping the historical acquisition date.

For outbound migrations, the current rule allowing for unlimited deferral of exit tax (under certain conditions) will be amended. The unlimited deferral will be replaced by a payment in equal instalments over a maximum period of five years and will be limited only to migrations to EU or EEA countries with which Luxembourg has concluded an agreement on mutual assistance for the recovery of tax claims equivalent to the mutual assistance provided for in Council Directive 2010/24/EU.

It is worth noting that the amendments regarding exit taxation will apply for fiscal years starting on or after 1 January 2020 and will not affect transfers made (or deferrals granted) before that year.

• General anti-abuse rule

§6 of the Adaptation Law (Steueranpassungsgesetz) currently including the Luxembourg general anti-abuse rule will be amended and enriched in order to define more precisely, in accordance with the ATAD 1, what may constitute an abuse of law.

The new wording reflects the content of Article 6 of ATAD 1 but is also designed to preserve legal certainty derived from existing case law. Hence, it is expected that it should not change materially the criteria and general practice as developed by Luxembourg authors and judges.

• Controlled Foreign Companies (“CFC”) measures

The Bill proposes the introduction to the Luxembourg income tax law of a new Article 164ter defining the conditions and mode of application of the new CFC rule.

Based on the Bill, CFC provision targets non-distributed income generated by low taxed CFCs arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage (option B, as foreseen by Article 7 (2) (b) of ATAD 1).

The CFC rules apply to Luxembourg tax resident corporates and to Luxembourg permanent establishments (“PE”).

This non-distributed CFC income must be included in the taxable basis of the Luxembourg taxpayer in the year in which the financial year of the CFC ends.

CFC will be considered an entity or a PE that fulfils the following cumulative conditions:

• In the case of an entity the Luxembourg taxpayer alone or together with its associated enterprises holds directly or indirectly a participation of more than 50 percent of the voting rights or capital or is entitled to receive more than 50 percent of the profits of that entity; and
• The entity or PE is taxed at an effective tax rate which is lower than 50 percent of the Luxembourg corporate income tax that the entity or PE would have paid under the provisions of the Luxembourg tax law. The comparison is made by reference to the current corporate income tax rate (18%), and hence by reference to a rate of 9%.

Entities or PEs with accounting profits of no more than EUR 750,000 or 10 percent of operating costs for the tax period shall be excluded from the scope of the CFC definition.

• Intra-EU anti-hybrid rule

A new Article 168ter is expected to be introduced into the Luxembourg income tax law with the purpose of eliminating double non-taxation resulting from entities or financial instruments implemented between associate enterprises that are treated differently in two or more EU Member States.

In particular, where a hybrid mismatch results in a double deduction, the deduction shall be provided only in the Member State where the payment has its source. As a consequence, should Luxembourg be the recipient of the payment, it has to deny the deduction of the expenses relating to the deductible payment in the other State. Furthermore, where a hybrid mismatch results in deduction without inclusion, the deduction shall be denied in the source state. As a consequence, if Luxembourg is the source State of the payment, it has to deny the deduction of such a payment.

It’s worth mentioning that the above provisions, which are applicable as at 1 January 2019, are related only to intra-EU hybrid mismatch situations as required by the text of ATAD 1. However, it is expected that subsequent amendments introduced by the Council EU Directive 2017/952 (“ATAD2”) amending ATAD 1 and extending the scope of hybrid mismatch provisions to third countries will be transposed with a separate law. The provisions of ATAD2 need to be transposed by the EU Member States by 31 December 2019 and applied as of 1 January 2020.

• Additional measures

Modification of §16 of the Luxembourg adaptation law (PE definition):

§16 StAnpG defines a permanent establishment under Luxembourg law. The Bill proposes the insertion of an additional paragraph under this article clarifying the recognition of a foreign permanent establishment in a country having concluded a double tax treaty with Luxembourg. It is proposed that in such a case the definition of a PE should be based solely on criteria set forth by the double tax treaty only in cases where the tax treaty does not contain a provision opposed to the recognition of the PE. In this regard, it is mentioned that the existence of a PE in a contracting State is dependent upon the exercise by the taxpayer of an independent activity which represents a participation in the general economic life in that other contracting State.

In addition, under the new provision, the Luxembourg tax authorities reserve the right to request from the taxpayer confirmation that the other State recognises the existence of a PE. The latter only in the cases where there is no “switch-over” clause in the tax treaty i.e., a provision in the treaty authorising Luxembourg to tax the income or wealth generated or held in the other contracting State when that other contracting State exempts the income based on another provision of the tax treaty.

Modification of Article 22bis of the Luxembourg income tax law (rollover relief):

the current provision allowing for tax neutral conversion of convertible debt into shares will be abolished. As from 1 January 2019, any such conversions should be seen as a sale of the debt at fair market value followed by the acquisition of shares at fair market value.