CURATED
29 September 2023

A Practical Guide On Debt Financing For A Luxembourg Holding Company: 10 Tax Situations To Monitor

CS
Chevalier & Sciales

Contributor

Chevalier & Sciales is a Luxembourg law firm, founded in 2005, offering specialized expertise in a broad range of areas. These encompass investment funds, tax, litigation, arbitration and dispute resolution, banking, finance and capital markets, corporate transactions, and private wealth management.
Please find hereafter a high-level summary of some tax aspects of debt financing at the level of a Luxembourg holding company.
Luxembourg Finance and Banking

Please find hereafter a high-level (and non-exhaustive) summary of some tax aspects of debt financing at the level of a Luxembourg holding company (here referred to as "LuxCo"). In our scenario, LuxCo is an ordinary (holding) company, not subject to any exemption provided by special laws on investment companies (such as RAIF, SICAR, SPF,..). Based on the following scenarios, here are the possible consequences related to interest expenses accounted for by LuxCo:

1) LuxCo makes an interest payment, and such expense is connected with a tax-exempt income received by LuxCo (such as a dividend or capital gain covered by the participation exemption regime):

  • The interest payment may not be (fully) deductible for tax purposes, leading to a potential increase in the company's taxable income.

2) LuxCo has on its liability side a specific debt item, and this debt instrument is requalified into an equity instrument (by application of the "substance over form" principle):

  • The interest payment may become non-deductible, and a withholding tax of 15% may apply.
  • The deduction of this liability for net wealth tax purposes may be denied, potentially impacting the company's overall tax position.

3) LuxCo has a specific debt item on its liability side, and this debt instrument finances an equity participation in excess of the 85:15 debt-to-equity ratio:

  • Interest on the exceeding portion may be non-deductible for tax purposes.
  • The non-deductible interest may also be subject to a 15% withholding tax.

4) LuxCo makes an interest payment to an affiliated entity. The amount of interest paid is deemed too high in comparison with uncontrolled transactions and/or not supported by benchmark analysis:

  • The excessive portion of interest may be non-deductible for income tax purposes.
  • The non-deductible portion may also be subject to a 15% withholding tax.

5) The amount of interest paid by LuxCo is higher than the amount of interest income it receives from its activity:

  • Interest by LuxCo (accrued) may not be fully deductible if LuxCo's "net borrowing cost" exceeds a certain limit (30% of LuxCo's EBITDA or €3 million).

6) LuxCo makes an interest payment and mainly receives real estate income or income not covered by the participation exemption:

  • Interest by LuxCo (accrued) may not be fully deductible if LuxCo's "net borrowing cost" exceeds a certain limit (30% of LuxCo's EBITDA or €3 million).

7) LuxCo makes an interest payment, but such payment receives a different tax qualification in the hands of the creditor (so-called "hybrid instrument"):

  • The interest payment may not be deductible.

8) LuxCo is in a so-called "back-to-back" situation, i.e. it gives a loan to an affiliated company, and is itself financed by a loan:

  • LuxCo becomes subject to intra-group financing compliance rules, such as maintaining sufficient equity at risk, arm's length remuneration, and substance requirements.

9) LuxCo has issued bonds (obligations) with a return/yield contingent on the accounting profits of the issuer (e.g. the yield under the bonds is equal to 2% of the issuer's profits):

  • The interest payment on such bonds may be non-deductible and subject to a 15% withholding tax.

10) LuxCo makes an interest payment to a company established in a blacklisted jurisdiction (cf. EU black list):

  • The interest expense may not be deductible for tax purposes.

Should you have any inquiries or require expert guidance pertaining to the information provided, our tax team is available to assist you. Please feel free to contact us.

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.

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