Luxembourg has transposed the EU's Anti-Tax Avoidance Directive (ATAD) into its domestic law, with the rules applying for financial years starting on or after January 1 2019. This article looks at the interest limitation rule.
Article 168bis in the Income Tax Law (ITL) reproduces the text of the ATAD provision on the interest limitation. Under this rule, any exceeding borrowing costs (EBC) are restricted to 30% of the taxpayer's tax-based earnings before interest, tax, depreciation and amortisation (EBITDA).
Luxembourg also has opted for the following relief options allowed by the ATAD (among others):
- EBC up to €3 million ($3.4 million) may be deducted in full;
- A full deduction of EBC is allowed if the taxpayer is a standalone entity for financial accounting purposes and does not have any associated enterprises or permanent establishment;
- Under a group-wide test, the EBC of taxpayers that have a ratio of equity to total assets that equals or exceeds the ratio of the taxpayer's consolidated group are fully deductible if certain conditions are fulfilled;
- EBC that cannot be deducted in a tax year may be carried forward indefinitely and unused interest capacity may be carried forward for up to five years; and
- Loans granted before June 17 2016 are grandfathered, i.e. such loans are excluded from the scope of the interest limitation rule provided they are not modified after that date.
Although the option had been excluded in the bill, the government is committed to add the option to calculate the EBC at the tax group level in a new draft law that would apply from early 2019.
In addition to the above anticipated change expected early 2019, it would be helpful if Luxembourg lawmakers would clarify the following:
- Grandfathering of loans: Additional guidance would be helpful on the type of modifications to loans that would prevent a taxpayer from benefiting from the grandfathering rule (e.g. change in the interest rate to meet the arm's-length principle); and
- Interaction with recapture rules: The interest limitation rule conflicts with Luxembourg's non-deductibility rules (known as recapture rules) that result in the immediate or deferred limitation of certain expenses economically linked with exempt income. When a Luxembourg company performs both holding and operational activities, the combined effect of the recapture rules and the new interest limitation rule could lead to taxation of all of the taxpayer's EBITDA instead of the 70% intended under the ATAD. It would be helpful if the government issued guidance to ensure that the objective of the ATAD is achieved.
Overall, Luxembourg has smoothly adapted to the new tax environment imposed by the OECD and EU Council and will continue to be an attractive and a competitive jurisdiction in which to do business.