Tax In Distressed Situations Luxembourg

DEBT RESTRUCTURINGS

GENERAL

1. Does debt have a specific meaning for tax purposes?

The notion of debt is not specifically defined for Luxembourg tax purposes.

Instead, the general principle of substance over form applies to determine the tax classification of an instrument as debt or equity, requiring an economic and financial analysis of each transaction. Based on parliamentary documents and case law, certain features of a loan such as, for instance, the absence of an interest rate and absent or unclear repayment modalities, could justify a requalification of the loan as an equity instrument for tax purposes. While the accounting and legal treatment of the instrument is technically not decisive, in practice an instrument that legally and accounting wise does not qualify as debt is more likely to also not qualify as debt from a tax perspective. Because of the considerations above, the tax qualification of debt instruments is subject to a case-by-case analysis.

Unless specified otherwise, the remainder of this commentary assumes that the instrument is treated as debt for Luxembourg tax purposes and does not have particular equity-like features (e.g., profit participation).

2. Do derivatives have a specific meaning for tax purposes?

The notion of derivative is not specifically defined for tax purposes.

In application of the general principle of substance over form, the tax treatment of derivatives should be determined on a case-by-case basis.

3. Generally, are intra-group debts treated differently to external debt for tax purposes?

In principle, intra-group debt is treated in the same manner as external debt. However, in an intragroup context, specifically where the debt is contracted between “associated enterprises”, additional tax considerations should be taken into account.

The creditor and the debtor will be considered to be “associated enterprises” if one company participates, directly or indirectly, to the management, control or capital of another company, or if the same persons participate, directly or indirectly, to the management, control or capital of the same two companies.

In such cases, key tax considerations are the arm’s length character of the debt, as well as, in case of any challenge to the debt qualification of the instrument, the application of withholding tax or exemptions thereof and interest deductibility rules.

4. Does it make a difference if debt is owed by a partnership or other pass-through entity in distress to third parties versus to its partners?

The tax consequences applicable in case debt is owed by a partnership are different depending on whether the partnership is treated as opaque or transparent for tax purposes.

In the case of a tax transparent partnership, the debt payable by the partnership (regardless of whether the debt is distressed or not) to one of its partners is disregarded with respect to this partner for tax purposes. The debt payable by the partnership to a third-party is considered (for tax purposes) payable pro-rata by each of the partners of the partnership to the third-party.

DEBT IMPAIRMENT

1. What are the key tax considerations on a debt impairment for the creditor?

For tax purposes, receivables are in principle valued at their cost price, unless their market value is lower than the cost price, in which case the tax balance sheet can reflect such lower market value and an impairment can be booked.

If economically justified, the impairment of a debt receivable is deductible from the corporate tax base of a Luxembourg creditor. However, it is noted that such impairments must be reversed if the reasons having motivated the impairment cease to exist, i.e., if the debtor’s economic situation subsequently improves. The reversal of such impairments is fully taxable in the hands of the creditor.

2. What are the key tax considerations on a debt impairment for the debtor?

The impairment of a debt receivable by the creditor should generally not trigger adverse tax consequences at the level of the debtor.

However, the position of the tax position of the debtor could in certain situations be impacted. This would be the case if the impairment is followed by an actual debt waiver to the benefit of the Luxembourg debtor (see below under “Does the release of debt trigger taxable income for the debtor? If so are there any reliefs or exemptions?”). If the terms of the instrument are such that the repayment obligation is adjusted on a periodic basis prior to maturity, this could also have an impact on the tax position of the debtor.

DEBT AMENDMENT, REFINANCING AND NOVATION

1. What are the key tax considerations on a debt amendment?

Unless it qualifies as a novation or refinancing, a debt amendment should generally not give rise to adverse tax consequences at the level of a Luxembourg debtor or creditor. Key tax issues to be considered in the context of a debt amendment are transfer pricing principles (in case of an intercompany debt amendment), as well as more specifically from the perspective of the debtor, any impact on the withholding tax position and tax deductibility of interest payments.

2. Does the deferral of any payments of interest or repayments of principal trigger tax consequences?

For Luxembourg corporate tax purposes, interest income and expenses are generally accounted on an accrual (rather than a cash) basis. Therefore, only the deferral of interest accrual can have a tax impact, notably on the timing of recognition of any interest income and expenses, as opposed to the deferral of actual interest payments.

Unless the deferral has the effect of giving rise to accounting adjustments (see above), the deferral of any repayment of principal should in principle not trigger adverse Luxembourg corporate income tax consequences for the debtor.

The deferral of any repayment of principal should not trigger adverse Luxembourg corporate tax consequences, unless no interest would be applied during the deferral period (which could be considered non-arm’s length).

Assuming the debt was not discounted and has not been impaired by the creditor, repayment of principal should not give rise to any adverse Luxembourg corporate income tax consequences for a Luxembourg debtor or creditor. Where a debt was issued or acquired at a discount (or impaired), any repayment of principal which exceeds the tax value thereof, would be taxable in the hands of the creditor.

3. What are the key tax considerations on a debt refinancing?

The repayment of the existing debt should neither give rise to withholding tax, nor impact the deductibility of interest payments. For new debt, the general tax considerations for debt instruments apply. If a debt refinancing results in a formal or economic waiver of debt, this may give rise to taxable debt waiver income at the level of the debtor (see below under “Does the release of debt trigger taxable income for the debtor? If so are there any reliefs or exemptions?”).

Furthermore, the refinancing of foreign currency denominated debt may trigger a taxable foreign exchange result. When debt is refinanced in intra-group situations the arm’s length character of the debt refinancing (and the terms and conditions of the debt itself) should be analysed.

4. Does rolling up interest or satisfying interest through issuing “payment in kind” notes give rise to any tax consequences?

For Luxembourg corporate tax purposes, interest income and expenses are accounted generally on an accrual (rather than a cash) basis. Accordingly, neither the capitalisation, nor issuance of payment-in-kind (“PIK”) notes should per se have adverse Luxembourg corporate tax consequences for either a Luxembourg creditor or a Luxembourg debtor.

As a principle, no withholding tax is levied on arm’s length interest payments made to corporate Luxembourg resident or non-resident creditors, thus it should be irrelevant for Luxembourg (withholding) tax purposes whether interest is paid in cash, is accrued to the principal amount or is paid in kind. Withholding tax may still be applicable in specific cases, e.g., where the debt instrument is requalified as an equity instrument, or where the interest payment is made to an individual beneficial owner resident in Luxembourg.

5. Does the novation of debt by a debtor to another group company trigger any adverse tax consequences?

The novation of debt involving a change of the debtor should trigger the realisation of any unrealised capital gains or losses at the moment of the novation.

Assuming that the novation to the new debtor is carried out in compliance with arm’s length conditions, it should not trigger adverse Luxembourg tax consequences at the level of the initial Luxembourg debtor. Upon the novation of debt, the original debtor will ordinarily owe the new debtor an amount equal to the debt assumed by the new debtor. Generally, this will take the form of a new intercompany balance between the two entities. With respect to the new intercompany balance and the new debtor, the general points to consider in respect of intercompany debt would be equally applicable (e.g., arm’s length conditions, debt/equity treatment, interest deductibility).

6. Are there any specific tax considerations to bear in mind where the security / guarantee package is amended as part of the debt amendment / refinancing?

For a Luxembourg debtor benefitting from a guarantee, no adverse Luxembourg tax consequences should arise on entry into, or amendments to, a guarantee by a Luxembourg guarantor or on the taking of security over a Luxembourg-based asset.

However, where a guarantee is provided by a Luxembourg guarantor in an intra-group context, applying transfer pricing principles, it should be determined whether the Luxembourg guarantor should be remunerated for having provided that guarantee for the benefit of the borrower. In particular, in case the guarantee increases the borrowing capacity of the debtor, it should be analysed (in light of OECD guidance) whether for transfer pricing purposes a portion of the loan (corresponding to the increased borrowing capacity) should rather be considered as a loan from the lender to the guarantor, followed by a capital contribution from the guarantor into the borrowing entity.

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