Luxembourg securitisation vehicles with main income sources other than interest income like capital gains or non-performing loans may not effectively use their tax neutrality.
On 1 January 2019 Luxembourg implemented the EU's Anti-Tax Avoidance Directive which is also designed to combat "aggressive" tax planning. One core measure of the Directive - the Interest Limitation Rule (ILR, BEPS Action 4) - has resulted in uncertainty in the Luxembourg securitisation market due to the limits it can place on tax deductions against borrowing costs and entities with non-interest income streams.
In a nutshell, the rule means that securitisation vehicles (SVs) with a main source of income through capital gains, non-performing loans and so on, may not be able to achieve tax neutrality which is a standard for all such vehicles.
However, there are some exemptions such as grandfathering, EU securitisation and standalone entities. Contact our local experts to find out if they apply to you, and read on for a general overview.
Interest Limitation Rules
These new rules put a limit on interest expense deductions on debts to the amount of 30% of the earnings before EBITDA (earnings before interest, taxes, depreciation, and amortization).
Only taxpayers whose collective interest expenses exceed €3m annually are subject to the EBITDA limitation, however there may be some exceptions to the rule. For SVs it is important to note that €3m threshold is at company level and not at compartment level.
SVs can be exempt where they are covered by EU Securitisation regulation 2017/2042, or where all borrowing agreements concluded before 17 June 2016.
As a hypothetical scenario, let's say you have a non-performing loan structure with distressed debt through any bank or other financial institution. Under the accounting treatment for example, any revenue or income coming from that is not treated as interest income but 'other' income. You can therefore deduct 30% of EBITDA or €3m as a deductible tax expense, and the remainder will be considered as not tax deductible.
In the four months since the implementation of ATAD 1, we have seen the effect of the potential for a tax bill in the local market. It has created uncertainty among existing players and led to some second-guessing by new entrants. There is a push for amendments to the law to allow for additional exemptions for Luxembourg SVs, but at the time of publishing this article if - and when - they may happen is not clear.
Originators, investment managers and sponsors in conjunction with SV directors should therefore – if they have not already – examine the profit and loss and income streams of their SVs to ascertain whether they are entitled to any exemption. If not, a 'buffer' should be created to mitigate any surprises when it comes time to filing the 2019 tax return in 2020.
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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.