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Middle East investors investing in Luxembourg and EU real assets: The new tax norm

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New regulations and tax reporting requirements have been adopted across EU countries

Marcell Koves and Victor Sanlorien of Deloitte discuss why Middle East investors that invest in Luxembourg and EU real assets must navigate the new tax norm when considering outbound investments.

Middle East investors that invest in EU real assets, such as real estate and infrastructure, must navigate the new tax norm when considering outbound investments and, in particular, how to organise their investment structures. 

New regulations and tax reporting requirements have been adopted across EU countries, inspired by the OECD and its work regarding the BEPS project. Investors should tread carefully around local EU compliance obligations, beneficial ownership (BO) rules, and, especially, substance requirements.

Navigating the new norm

Business purposes and economic substance

As part of the BEPS project, the OECD developed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The MLI swiftly implements a series of tax treaty measures to update international tax rules. To date, 95 countries have signed the MLI, while others have expressed their intention to do so. 

In the EU, the majority of member states apply the MLI provisions and the remaining states are in the process of implementing them. In the Middle East, the MLI is already in force in Egypt, Israel, Oman, Qatar, Saudi Arabia, and the United Arab Emirates and has been signed by Bahrain, Kuwait, and Turkey. Lebanon has expressed its intent to sign it.

One of the key aspects of the MLI is the introduction of anti-abuse provisions, such as the principal purpose test (PPT). The PPT allows tax authorities to disallow the application of treaty benefits (such as withholding tax relief or exemption) if it is reasonable to conclude that obtaining these benefits was one of the principal purposes of any transaction that resulted directly or indirectly in that benefit. 

Thus, to pass the PPT, it is critically important to be able to demonstrate the business purposes and economic substance behind an arrangement or transaction in relation to which treaty benefits are applied. 

BO concept

In addition, there have also been substantial developments across the EU regarding the BO concept and the substance requirements for holding companies.

These mainly follow the interpretation of the Court of Justice of the European Union (CJEU) in five cases (the so-called Danish cases). These are T Danmark (C-116/16) and Y Denmark ApS (C-117/16) regarding the interpretation of the parent-subsidiary directive, and the N Luxembourg 1 (C-115/16), X Denmark A/S (C-118/16), C Denmark I (C-119/16), and Z Denmark ApS (C-299/16) cases regarding the interpretation of the interest-royalty directive.

For example, the Spanish Central Economic Administrative Court (CEAC) denied the application of the domestic withholding tax (WHT) exemption on dividend payments made by a Spanish company to its Luxembourg parent, which was held by a Qatari investor (see the Spanish Central Tax Court Decision of October 8 2019). 

The Spanish tax authorities had determined that the Luxembourg holding company had no employees, its registered address was the official address of its third service provider, and it had no third-party financing or relevant expenses with its sole shareholder. The CEAC found that the Luxembourg holding company had insufficient substance and was not the BO of the income received, finding that the Qatari shareholder was the BO instead. It also denied the application of the Luxembourg–Spain tax treaty on the same grounds. Although this decision is not yet final and could be appealed, it is a clear example of the issues targeted by EU local tax authorities. 

In another case, the Italian Supreme Court issued a decision (see the Italian Supreme Court, July 10 2020 decision No. 14756) in favour of the taxpayer in a situation where the Italian tax authorities (ITA) tried to deny the application of the Italian interest WHT exemption because the Luxembourg shareholder had insufficient substance and was not the BO. 

However, the court found that the mere fact that a Luxembourg shareholder was a holding company and performed financial and treasury activities did not mean that it was a conduit company. Also, the Luxembourg holding company held various investments and provided several loans to other EU subsidiaries. Hence, the court held that substance should be understood as proportionate to the activities performed, and the fact that the holding company was an EU investment vehicle supported the BO position as well.

Brace for impact…

Tax authorities and regulators across the EU appear to be moving at speed in a common direction, triggering some real game-changing shifts. An increase in tax audits is expected across the EU, given the budget constraints in various countries resulting from the COVID-19 pandemic.

Indeed, the use of new technologies and innovative tools, as well as the tax transparency and exchange of information mechanisms within the EU, provide local tax authorities an improved toolbox to do so (e.g., big data tools to analyse tax residency matters, automated risk assessment with respect to transfer pricing policies). 

EU countries such as Italy, Spain, France, Belgium, and Germany have initiated several tax audits against foreign holding companies investing in their country. Investors from the Middle East have not been exempt from this trend. 

Key takeaways

Each investment and structure should be weighed on its own merits. However, a clear trend seems to be that non-genuine arrangements and structures may be targeted by EU member states. An arrangement or series of arrangements may be disregarded by the tax authorities where one of the main purposes is obtaining a tax advantage. 

There is a clear and increased focus on commercial rationale and economic substance. The criteria set out in the Danish cases have been followed by certain tax authorities and domestic courts across the EU.

Given the evolving tax landscape and possible increased scrutiny due to budgetary constraints in the context of COVID-19, investors should: 

  • Review their existing EU investments to ensure they are aligned with the best practices;

  • Properly document the genuine business reasons for undertaking these investments; and

  • Consider and model the impact of potential challenges to their existing and future cross-border investments.

However, during these complex times, one must see the silver lining as well. Investors must consider the expected post-pandemic economic boom and the unique opportunities that the Next Generation EU Fund will bring to the real estate and infrastructure sectors.

Certainly, the EU is, and will be, one of the most popular regions to invest in these asset classes. Therefore, it is essential to consider the issues discussed above to enjoy the benefits of tomorrow.


Marcell Koves

Director, Deloitte



Victor Sanlorien

Senior consultant, Deloitte



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