Luxembourg has introduced controlled foreign company (CFC) rules for the first time in national legislation as part of its transposition of the EU's Anti-Tax Avoidance Directive (ATAD 1).
The rules are in effect for Luxembourg taxpayers from their financial years commencing on or after January 1 2019.
From the two options provided by ATAD 1, under which member states can choose to impose the CFC charge, Luxembourg has elected option B, which will allow it to tax a CFC's undistributed income which has arisen from non-genuine arrangements that are put in place, essentially for the purpose of obtaining a tax advantage.
This is to be interpreted as a situation where Luxembourg resident companies have or retain "significant people functions" in managing assets of a CFC.
The rules refer to transfer pricing (TP) concepts, including those developed under the BEPS Action Plan, demonstrating Luxembourg's full alignment with the OECD TP principles that already are reflected in its domestic legislation.
Under the CFC rules, a Luxembourg taxpayer is required (as a general rule) to include in its taxable basis the net income of a foreign collective undertaking, or a foreign permanent establishment (PE) that qualifies as a CFC for the purposes of the application of the CFC rules. A foreign collective undertaking or PE qualifies as a CFC if:
- The Luxembourg taxpayer, alone or together with associated enterprises, directly or indirectly: (i) holds more than 50% of the voting rights, (ii) holds more than 50% of the capital, or (iii) is entitled to receive more than 50% of the profits of the foreign collective undertaking/PE;
- The actual corporate income tax (CIT) paid by the foreign collective undertaking/PE on its income is lower than the difference between the CIT that would have been paid on the same profits in Luxembourg, and the actual CIT paid in the CFC country; and
- The income of the foreign CFC is not taxable or is tax exempt in Luxembourg.
Municipal business tax is excluded from the scope of the application of the CFC rules, so it is disregarded for purposes of the "subject to tax" test performed to assess whether a foreign entity/PE qualifies as a CFC.
Similarly, a net CFC income inclusion at the level of a Luxembourg taxpayer is subject only to CIT, and not to the municipal business tax.
The net CFC income is to be included in the taxable basis of a Luxembourg taxpayer in the financial year during which the relevant financial year of the foreign CFC ends, proportionally to the ownership percentage (deemed to be) held by the Luxembourg taxpayer in the CFC.
The net income inclusion is also limited to the revenue generated by the assets and risks located in the CFC, but controlled by the significant people functions located at the Luxembourg taxpayer, and is determined based on the arm's-length principle.
A tax credit is provided for foreign tax paid by the CFC on the portion of the net CFC income included in the taxable basis of the Luxembourg taxpayer.