As tax professionals in the world’s
second-largest fund hub, Simmons & Simmons’
Pierre-Régis Dukmedjian and Alejandro Dominguez explore
the potential impact for taxpayers.
undertakings’ subject to EU regulations
including UCITS will be outside the scope of the
The OECD's BEPS final report contained a number of action
plans to deal with base erosion and profit shifting.
Published on October 5 2015, these include neutralising the
effects of hybrid mismatch arrangements (Action 2),
computation of controlled foreign company income rules
(Action 3), limiting base erosion involving interest
deductions and other financial payments (Action 4), and
preventing the artificial avoidance of permanent
establishment (PE) status (Action 7).
The EU Council stressed the need to find solutions at an
EU level consistent with the OECD's BEPS conclusions.
Accordingly, EU directives were considered as the "preferred
vehicle" to implement such conclusions.
As a result, these action plans are reflected in the EU
Council Directive 2016/1164 of July 12 2016, laying down
rules against tax avoidance practices that directly affect
the functioning of the internal market (ATAD).
Accordingly, Luxembourg recently transposed the ATAD into
domestic law (ATAD Law) on December 21 2018. This law also
includes some additional measures not specifically mentioned
in the ATAD.
This article considers the main measures adopted in the
ATAD Law and what they mean in practice for taxpayers.
Hybrid mismatches rules
Hybrid mismatches exploit differences in tax treatment of
an entity, or a payment (financial instrument) under the
legal framework of two jurisdictions, which results in double
deduction (taxation) in two states or the deduction in one
state without inclusion in the other.
Luxembourg had already introduced measures to combat the
use of hybrid financial instruments by transposing the EU
Directive 2014/86/EU of July 8 2014, amending EU Directive
2011/96 on the common system of taxation applicable in the
case of parent companies and subsidiaries of different member
states. These amendments include a specific anti-abuse rule
and a "mirror rule", under which dividends received by a
Luxembourg company give rise to a deductible charge at the
level of an EU subsidiary, may not be exempt in
Under the ATAD rules, from January 1 2019, Luxembourg
closes the gap for the use of hybrid instruments and entities
in the context of qualifying related entities.
In effect, Luxembourg may deny a deduction for an interest
payment from a tax perspective in situations where the same
payment generates a double deduction or deduction (without
inclusion in Luxembourg and in another EU member state
For these purposes, Luxembourg's tax administration may
request evidence to prove that such payment didn't also give
rise to a deduction in the other EU member states, or that it
was subject to tax in such jurisdiction.
Controlled foreign company rules
Controlled foreign company (CFC) rules aim to mitigate the
risk of the income of CFC entities (i.e. companies and PEs)
not taxed, or those taxed at a significantly lower rate than
in the parent's jurisdiction.
Accordingly, from January 1 2019, undistributed income of
a CFC entity which arises from 'non-genuine' arrangements
that have been put in place for the essential purpose of
obtaining a tax advantage will be taxed at the level of the
An arrangement or a series of arrangements will be
regarded as 'non-genuine' to the extent that the CFC entity
would not own the assets or would not have undertaken the
risks which generate all (or part) of its income, if it were
not controlled by a company where important functions
relevant to those assets and risks are ensured and play an
essential role in generating the CFC income.
Scope of CFC rules
A CFC entity is an entity which is controlled by the
taxpayer either by itself or together with its 'associated
enterprises' through holding a direct or indirect
participation of more than 50% of the voting rights.
Alternatively, it may directly or indirectly own more than
50% of capital, or being entitled to receive more than 50% of
the profits of that entity. An 'associated enterprise'
requires a direct or indirect holding a 25% of voting rights,
capital or profit entitlement.
It is also a requirement that a CFC entity is taxed at a
low rate, meaning an effective tax rate below 9%.
The allocation of the CFC's net income should be carried
out by considering those assets and risks which are linked to
important functions carried out by the controlling company.
The attribution of CFC net income must be calculated in
accordance with the arm's-length principle.
Furthermore, CFC net income must be allocated on a pro
rata basis considering the participation on the CFC
entity. Only positive CFC net income is allocated, but a
carry forward of negative net income is possible. Effective
distributions by the CFC, as well as relevant capital gains,
must also be deducted from the tax base of the controlling
taxpayer if they were previously included as CFC net
Exclusions to CFC rules
The CFC rules do not apply to a CFC that makes a
commercial profit which does not exceed €750,000
($847,000) on its balance sheet, or that makes a profit which
does not exceed 10% of its operating expenses (determined by
special criteria) during the relevant fiscal period.
Interest limitation rules
The ATAD Law has introduced a restriction on interest
deductibility. Under this rule, tax deductions for net
interest expenses (i.e. 'exceeding borrowing cost') is
limited to 30% of the fiscal earnings before interest, tax,
depreciation and amortisation, or EBITDA (i.e. the taxpayer's
net revenue plus fiscal amortisations and depreciations
excluding exempt income and expenses in relation to such
income), or up to an amount of €3 million, whichever is
'Borrowing cost' is defined as interest expenses on all
forms of debt and other costs economically equivalent to
interest and expenses incurred in connection with raising
finance 'exceeding borrowing costs' means the excess of
deductible 'borrowing costs' (i.e. in relation to taxable
income) over taxable interest and equivalent revenues.
A qualifying taxpayer which is a member of a consolidated
group (for accounting purposes) can deduct its net interest
expenses if it can evidence that its equity ratio (over its
total assets) is equal to or higher than the corresponding
equity ratio of the group, subject to specific
Deductible net interest expenses which are not utilised in
the accounting period in which they are incurred can be
carried forward for up to five years.
Scope of interest limitation rules
In practice, taxpayers receiving income other than
interest (e.g. dividends), which does not qualify for the
Luxembourg participation exemption regime, and which is
financed by interest bearing debt, may be adversely impacted
as the net interest expense will be generated, and deductions
for such net interest may be limited.
A "grandfathering rule" applies in relation to loans
entered into before June 17 2016, provided they are not
amended after that date.
Subject to certain qualifying conditions, the interest
limitation rules do not apply to loans financing a long-term
EU infrastructure project.
Certain 'financial undertakings' subject to certain EU
regulations (e.g. undertakings for collective investments in
transferrable securities, or UCITS; alternative investments
funds managed by alternative investment managers; Luxembourg
securitisation vehicles subject to specific EU regulations)
are outside the scope of the rules, and the relevant net
interest excess should remain tax deductible.
Also, 'stand-alone entities' will be excluded (i.e.
entities which are not part of a consolidated group
accounting wise, and have no associated enterprise or PE).
Most notably, Luxembourg orphan securitisation companies
cannot benefit from this exclusion since they are considered
as having an associated enterprise or PE in a state other
Based on the Luxembourg 2019 budget draft bill, the
interest limitation rule may be calculated at the level of
tax consolidated groups. This option was not originally
implemented in the ATAD Law.
Exit taxation rules
Moving tax residence and/or the location of assets may
offer the possibility of avoiding taxation in the
jurisdiction where the economic value was generated.
Therefore, exit taxes aim to ensure that if such a move takes
place, any unrealised capital gain is taxed.
As such, Luxembourg introduced exit tax rules with effect
from January 1 2020.
The taxpayer will be subject to tax based on the fair
market value at the time of exit in case of:
1) A transfer of assets from a Luxembourg
enterprise is to a PE situated in another state; and
2) A transfer of assets of a Luxembourg PE
is to an enterprise (or a PE) or its head office situated in
In both of the above cases, Luxembourg loses its taxing
rights over the assets transferred.
3) A change of domicile, habitual abode,
registered office or central administration, except where the
assets remain effectively linked to a local PE and their
accounting value is maintained, and
4) The transfer of a local PE's activity to
another state, Luxembourg losing its taxing rights over the
In the case of transfers within the European Economic Area
(EEA), it should be possible to pay such tax by instalments
over five years, subject to meeting certain conditions.
The new rule does not apply to certain assets that will
return to Luxembourg in less than 12 months, provided
1) The assets are related to the financing
of securities; and
2) The assets are posted as collateral, and
such assets are transferred to satisfy prudential capital
requirements or in relation to liquidity management.
General anti-abuse rule
The new general anti-abuse rule (GAAR) provides that for
tax abuse to exist, there must be:
1) A use of forms and institutions of
2) Such use must have as main purpose, or
one of the main purposes, to avoid or reduce tax, that
defeats the object or purpose of the applicable tax law;
3) Is not genuine, having regard to all
relevant facts and circumstances. This is expressed in such
arrangements or series of arrangements not being put in place
for valid commercial reasons that reflect economic
The new GAAR further adds that in the case of abuse, taxes
should be collected as if the transaction has been
implemented in a normal, non-abusive manner, taking into
account all the relevant facts and circumstances.
From January 1 2019, the possibility to defer corporate
tax upon conversion of convertible debt into capital is no
longer available. Therefore, the conversion of debt into
capital will no longer be treated as tax neutral, and will
instead be considered as a sale of the loan and a subsequent
acquisition of shares.
Furthermore, the definition of a PE in Luxembourg domestic
law is updated. Aiming to resolve conflicts of interpretation
on the existence of a PE as a result of inconsistencies
between domestic law and double tax treaties, it is now
provided that the treaty definition should supersede the
domestic law definition to determine if the Luxembourg
taxpayer has a PE abroad.
Luxembourg may ask for certification from other
jurisdictions as to the existence of the PE in that other
jurisdiction to avoid double non-taxation.
Next steps for Luxembourg
Another EU Council Directive (2017/952) on May 29 2017
(the ATAD 2) amending the ATAD's hybrid mismatches with third
countries is expected to be transposed in the coming
Considering Luxembourg is the second largest fund hub in
the world (after the US), a principal securitisation
destination and a mainstream holding jurisdiction, the impact
of the ATAD Law, as well as further legislative steps which
are expected to amend this law, should be closely monitored
to assess their impact on existing structures and future
Simmons & Simmons Luxembourg
Pierre-Régis is a tax partner at Simmons &
Simmons Luxembourg. His primary focus is advising
asset managers and financial institutions which have
operations in or through Luxembourg. In this context,
he is dealing with regulated and non-regulated
structures for various types of investments (e.g.
private equity, real estate and infrastructure).
Pierre-Régis also provides tax advice with
respect to the reorganisation of international groups
and in the field of investments in intellectual
Pierre-Régis is a qualified lawyer in
France since 1998 and was first registered with the
Luxembourg Bar in 2011. Before joining Simmons &
Simmons Luxembourg office from its opening in 2015,
Pierre-Régis was the tax partner of a boutique
firm in Luxembourg and he previously worked for a Big
4, a reputed tax advisor firm and a magic circle firm
He is a member of the International Bar
Association and the Association of the Luxembourg
Simmons & Simmons Luxembourg
Alejandro is a supervising associate in the
Luxembourg tax team and has extensive experience in
corporate tax and international tax planning. His
expertise includes the tax treatment of financial
products issued by investment funds, asset managers
and financial institutions, and tax issues in real
Alejandro also advises international clients,
mainly private equity firms, real estate funds and
multinational companies, on Luxembourg and
international taxation in the context of cross-border
transactions and reorganisations (e.g. mergers and
acquisitions, corporate reorganisations, and
cross-border restructurings), securitisation and
project financing related matters. Alejandro also has
specific expertise in the field of exchange of
information (FATCA and CRS) as well as on indirect
Alejandro was admitted as Avocat au Barreau de
Paris in 2017 and as Abogado in
Colombia in 2013.
He is a member of the International Fiscal
Association and the Luxembourg Fiscal Studies