Overview of corporate tax work
Luxembourg continues to be a global leader as a platform for international business, investment funds, and cross-border financing. At the outset of COVID-19, Luxembourg quickly reacted by enacting pragmatic emergency measures, allowing Luxembourg investment funds and companies to maintain operational efficiency despite the global lockdown and restrictions on working and travel. In terms of tax developments, Luxembourg continues to update its competitive tax laws in harmony with new European Union ("EU") and Organisation for Economic Co-operation and Development ("OECD") policies principally aimed at anti-abuse and aggressive tax planning.
Over the past year, Luxembourg transfer pricing has further increased in importance. Generally, the Luxembourg tax authorities have increased audits with respect to transfer pricing and this trend should continue into the future.
Luxembourg tax litigation has continued with a slight increase over the past 12 months and particular focuses of litigation included the Luxembourg intellectual property ("IP") box regime (prior to the OECD Base Erosion and Profit Shifting ("BEPS") reform) and director's liabilities for taxes. In early 2020, Luxembourg courts issued a new decision that addressed transfer-pricing challenges by the Luxembourg tax authorities.
The importance of robust economic substance in Luxembourg holding and financing structures continues to grow in the wake of the 2019 landmark 'Danish cases' of the European Court of Justice ("ECJ"). Already in 2020, EU Member State tax authorities have started rigorously applying the beneficial ownership and economic substance tests, as elaborated in these ECJ cases.
Significant deals and themes
With respect to alternative investment funds ("AIFs"), the Special Limited Partnership ("SCSp") continues to be the favoured investment vehicle, and the reserve alternative investment fund ("RAIF") continues as well to be the most-often chosen regulatory regime, while Luxembourg specialised investment funds ("SIFs") and Luxembourg investment companies in risk capital (commonly referred to as "SICARs") are less frequently chosen. Over the past year, AIFs focused in particular on private equity, nonperforming loans, and real estate.
For multinational corporate groups, Luxembourg remains a favoured location for holding and intragroup financing activities, particularly for investments, operations, and financing into the EU.
However, over the past 12 months, there has been a noticeable trend in the unwinding of Luxembourg cross-border financing for US multinationals using hybrid instruments (i.e., Convertible Preferred Equity Certificates, or "CPECs") in light of the anti-hybrid rules coming into force in both the USA and Luxembourg (i.e., EU Anti-Tax Avoidance Directive II, or "ATAD II").
Regarding the financing sector, Luxembourg tax resident companies ("Soparfis") in corporate form continue to be widely utilised as well as securitisation vehicles. Luxembourg has continued to be a top choice for cross-border financing for a variety of industries. To date, COVID-19 has not had a disruptive effect on Luxembourg financing structures, mainly due to the quick government responses, which urgently allowed more flexibility with respect to the management and reporting of these structures. Nonetheless, certain industries such as real estate and hospitality have witnessed a dramatic slowdown in activity since the COVID-19 lockdown began.
On the fund finance front, the volume of deals actually increased through March 2020 and then experienced a gradual slowdown. However, there continues to be increased financing activity for enlarging facilities, the expansion of new borrowers, and the renegotiations of extended terms and higher advance rates. We highlight that, at the time of writing, there has been no reported default on financing structures via Luxembourg towards institutional investors.
Key developments affecting corporate tax law and practice
Domestic cases and litigation
Exceptional corporate governance measures for Luxembourg companies
The Grand Ducal Decree of 20 March 2020 introduced exceptional temporary measures in order to maintain and facilitate the effective ongoing governance of Luxembourg companies as a rapid reaction to the challenges suddenly brought on by COVID-19.
These new emergency measures overrule the normal requirement for physical board and shareholder meetings. During COVID-19, the governing bodies of any Luxembourg company are allowed to hold board and shareholder meetings without requiring the physical presence of their members – even if the corporate governance documents expressly state the contrary. These meetings can be validly conducted by written circular resolutions, video conferences or other telecommunication means so long as the identification of the members of the corporate body participating in the meeting can be documented.
The emergency measures also authorise electronic signatures for validating corporate governance documents.
The new emergency measures also include an additional four months to file the annual accounts of a Luxembourg entity, thus deferring the filing deadline from 31 July 2020 (for 2019 accounts) up to 30 November 2020 before incurring a late fee.
Luxembourg tax administration emergency support measures
On 17 March 2020, the Luxembourg tax administration released a 'newsletter' that detailed support measures for Luxembourg taxpayers who may be impacted by COVID-19. These emergency relief measures include cancellations and delays for certain Luxembourg direct tax filing and payment obligations.
Tax and social security measures for Luxembourg cross-border workers
Many of Luxembourg's approximate 170,000 cross-border workers have benefitted from force majeure applying to the extended lockdown period in which they worked remotely in neighbouring Belgium, France and Germany. All three neighbouring jurisdictions have announced that days spent working remotely due to COVID-19 will not impact the percentage threshold tests for determining social security or personal tax regimes. Prior to COVID-19, Belgium, France and Germany had begun applying strict limits on workdays allowed for cross-border workers outside of Luxembourg before imposing local taxation on salaries. German residents who work in Luxembourg are allowed a maximum of 19 days, Belgium residents 24 days, and French residents 29 days per year outside of Luxembourg. Now, however, due to the application of force majeure, the maximum workdays outside of Luxembourg will not be exceeded during COVID-19.
Pre-2015 Luxembourg advance tax agreements no longer valid
On 14 October 2019, the Luxembourg government presented the 2020 draft budget law, which included as its principal measure that all advance tax agreements ("ATAs") issued prior to 1 January 2015 will no longer be valid as from 1 January 2020 onwards. The cancellations of these pre-2015 tax rulings are consistent with the updated Luxembourg tax ruling procedure, which limits the validity of ATAs for a maximum of five years. The new law allows taxpayers, who may be impacted, to obtain updated rulings under the new procedures.
New draft law on updating FATCA/CRS reporting rules
On 9 June 2020, the Luxembourg Parliament approved a new law aimed at updating Luxembourg rules on automatic exchange of information ("AEOI") with the guidelines set out in the Global Forum on Transparency and Exchange of Information for Tax Purposes. This new law also contributes to the harmonisation of AEOI for both the Foreign Account Tax Compliance Act ("FATCA") and the Common Reporting Standard ("CRS") rules under Luxembourg domestic laws. One of the highlights of the new law is that, in the absence of reportable accounts, it will now be mandatory to do a 'nil reporting' of such accounts for CRS from 2020 onwards (prior to this, such was only mandatory for FATCA). Additionally, fines for non-compliance have been included of up to EUR10,000 for incorrect or incomplete reporting, as well as up to EUR250,000 for the non-compliance of due diligence procedures. The law will enter into force by 1 January 2021. The effective date of the updated FATCA/ CRS rules is anticipated to be postponed by up to three months following an announcement on 3 June 2020 by the Luxembourg Ministry of Finance on deferrals of multiple new reporting laws (including the sixth Directive on Administration Cooperation, 2018/822 ("DAC 6")).
Luxembourg enacts ATAD II's expanded anti-hybrid rules
On 19 December 2019, Luxembourg voted to transpose its law on ATAD II, which expands the scope of the anti-hybrid rules as found in the EU's Anti-Tax Avoidance Directive I ("ATAD I") and also extends their application to countries outside the EU ("ATAD II Law"). All of the provisions of the new law apply for tax years beginning on or after 1 January 2020 with the exception of the reverse hybrid rule, which will not apply until 1 January 2022. ATAD II was largely inspired by the OECD BEPS Action 2 Report, and this Report should also be used as guidance for interpreting the application of the ATAD II Law.
The ATAD II Law's anti-hybrid rules aim to curtail perceived 'aggressive tax planning' by shutting down 'hybrid mismatch' outcomes for related party transactions within multinational groups. Examples of hybrid mismatch include when an item of income is deductible for tax purposes in one jurisdiction but not included in income in any other jurisdiction ("deduction/ no inclusion" or "D/NI"). Another example is when there is a double deduction ("D/D") for tax purposes in two or more jurisdictions arising from the same expense. A hybrid mismatch can result from differences of entity or instrument characterisation between two jurisdictions. A hybrid entity is generally considered tax transparent in one jurisdiction but tax opaque in another (e.g., Country A considers the entity a corporation, but Country B considers the same entity a transparent partnership). A hybrid instrument is generally considered equity in one jurisdiction but debt in another (e.g., Country A considers the instrument debt, thus giving rise to a taxable deduction, but Country B considers the same payment a dividend, and exempts the same item of income under its domestic laws).
The ATAD II Law significantly expands the scope of the prior ATAD I hybrid rules to include hybrid mismatches arising from the following cross-border scenarios involving at least one EU Member State:
- Hybrid instruments.
- Reverse hybrid entities.
- Structured arrangements.
- Dual residency or no residency situations.
- Hybrid permanent establishments.
- Imported hybrid mismatches.
A hybrid mismatch can only occur between associated enterprises, within the same enterprise (i.e., between the head office and/or one or more permanent establishments), or pursuant to a structured arrangement. Associated enterprises (entities or individuals) are defined by a 50% common threshold with respect to voting rights, capital, and/or rights to profits. The threshold is reduced to 25% with respect to mismatches involving hybrid financial instruments. The concept also applies if the entities are part of the same consolidated group for financial accounting purposes.
Associated enterprise also includes a taxpayer having a noticeable influence on the management of an enterprise and vice versa.
The ATAD II Law further expands 'associated enterprise' to apply to an individual or entity 'acting together' with another individual or entity in respect of the voting rights or capital ownership of an entity. In such case, the associated enterprise or individual should be considered as holding a participation in all of the aggregated voting rights or capital ownership that are held by the other individual or entity. However, the ATAD II Law has a rebuttable presumption that investors who hold less than 10% of the shares or interests in an investment fund, and are entitled to less than 10% of profits, are deemed not to be acting together.
Pursuant to ATAD II, Luxembourg will have an additional 'reverse hybrid rule' which comes into force as of 1 January 2022. Luxembourg's adaptation of this law provides that a Luxembourg transparent entity (such as an SCS or SCSp) can be recharacterised as being subject to Luxembourg corporate income tax if the following conditions are fulfilled:
- one or more associated entities hold in the aggregate a direct or indirect interest in 50% or more of the voting rights, capital interests, or rights to profits in the Luxembourg transparent entity;
- these associated entities are located in jurisdictions that regard the Luxembourg transparent entity as tax opaque; and
- to the extent that the profits of the Luxembourg transparent entity are not subject to tax in any other jurisdiction.
However, there is an exception to this reverse hybrid rule, which applies when the transparent entity is a 'collective investment vehicle', which is defined as an investment fund that is widely held, holds a diversified portfolio, and is subject to investor protection regulation in Luxembourg. The Luxembourg legislative notes suggest that Luxembourg regulated funds (UCITS, SIFs) and funds under regulated management (RAIFs), as well as alternative investment funds within the meaning of the EU Directive, should all qualify for this exemption.
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Originally published by Global Legal Group Ltd
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