Luxembourg has introduced new legislation[1] disallowing the deduction of interest and royalties owed by Luxembourg corporate taxpayers to associated enterprises established in a jurisdiction included in Annex I of the European Union list of non-cooperative jurisdictions for tax purposes.
This new provision applies as of 1 March 2021.
Below is a summary of the main points covered by this law:
SCOPE OF THE LAW
The deduction of interest or royalties owed by Luxembourg corporate taxpayers is denied when the beneficiary of the interest or royalties meets all the following conditions:
- The beneficiary of the interest or royalties is a corporate entity according to Luxembourg Income Tax Law (opaque entities);
- The beneficiary is a related enterprise according to the Luxembourg transfer pricing provision[2], meaning any enterprise participating directly or indirectly in the management, control, or capital of another enterprise, or situations where the same persons participate directly or not in the management, control, or capital of two enterprises; and
- The beneficiary of the interest or royalties is established in a jurisdiction or territory that appears on the Annex I of the EU List.
SAFE HARBOR RULE
The law restricting the deduction of interest and royalties under the conditions described above does not apply if the Luxembourg corporate taxpayer can prove that the arrangements giving rise to the interest or royalty expense satisfy valid commercial reasons that reflect economic reality.
This test is not defined by the law but is part of Luxembourg’s general anti-abuse rule (GAAR) measures. Thus, a case by case analysis will be required. The parliamentary documents relating to the law tend to clarify the exception by explaining that it would not be sufficient to state economic reasons but must represent an economic advantage that exceeds a potential tax benefit resulting from the operation.
EU LIST UPDATED
For the purpose of the law, the beneficiary of the interest or royalties must be established in a jurisdiction which is included on the list of countries and territories that are deemed to be “non-cooperative” for tax purpose according to EU institutions. The countries and territories that appear on the Annex I list are the following:
- American Samoa
- Anguilla
- Dominica
- Fiji
- Guam
- Palau
- Panama
- Samoa
- Seychelles
- Trinidad and Tobago
- U.S. Virgin Islands
- Vanuatu
INTEREST AND ROYALTIES
The law provides a specific definition of “interest” and “royalties” for the application of the measure described above. These definitions are aligned with EU legislation[3] and with the Organization for Economic Co-operation and Development (OECD) Model Tax Convention.
The term “interest” refers to interest and arrears due in relation to receivables of any nature, whether secured by mortgage and whether carrying a right to participate in the debtor’s profits, and in particular interest and arrears from bonds or debentures, including premiums and prizes attaching to such securities. However, penalty charges for late payment are not regarded as interest for the purpose of this provision.
The term “royalties” refers to consideration of any kind owed for the use of, or the right to use, any copyright of literary, artistic, or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, and for information concerning industrial, commercial, or scientific experience.
The new rule applies to interest or royalties that are owed, meaning that interest or royalties that have accrued before this new legislation remain deductible upon actual payment.
CONCLUSION
Luxembourg corporate taxpayers will have to be careful at the time of considering the deduction of interest and royalty expenses incurred with non-cooperative jurisdictions as the EU list defining them might be regularly updated.
Yann Ricard was a contributing author to this insight.
[1] The legislation was published as the Law of 10 February 2021, and adds a new item 5 to Article 168 of the Luxembourg Income Tax Law of 4 December 1967 as modified. A revised version of this “non-cooperative” jurisdictions list was approved by the Council on 22 February 2021, and publication in the Official Journal of the EU of the revised list is expected imminently.
[2] Article 56 of the Luxembourg Income Tax Law.
[3] Directive 2003/49/EC of 3 June 2003.