The bill that would implement the EU Anti-Tax Avoidance Directive I (ATAD) into Luxembourg law was published on June 20 2018. The bill contains provisions on controlled foreign companies (CFC), interest deduction limitations, exit taxation, hybrid mismatches within the EU and general anti-abuse rules (GAARs). It also would amend the domestic law definition of a permanent establishment (PE). This article will focus on the CFC, interest deduction limitation and PE measures.
Broadly, the CFC rules would ratably re-allocate undistributed income of a 50%-owned direct or indirect subsidiary or PE (in an EU member state) to the Luxembourg tax net where the actual corporate income tax (CIT) paid on the CFC's profits is lower than 50% of the CIT that would have been paid in Luxembourg.
The CFC income inclusion would be limited to income attributable to significant people functions (SPF) carried out in Luxembourg in relation to the assets owned and risks undertaken by the CFC. Interestingly, the CFC rules would apply only after the application of the existing transfer pricing (TP) rules; the interaction of the two rules is unclear and further guidance is expected.
Luxembourg's decision to limit the CFC income inclusion is positive as it demonstrates Luxembourg's full alignment with the OECD TP principles that already are largely reflected in domestic legislation without materially affecting the country's position as a prime holding jurisdiction.
Interest deduction limitation rules
Under the proposed rules, a taxpayer's borrowing costs always would be deductible to the extent of its taxable interest revenues and other economically equivalent taxable revenues. The deduction of any excess, defined as 'exceeding borrowing costs' (EBC), would be restricted to 30% of the taxpayer's tax-based earnings before interest, tax deductions, and amortisation (EBITDA). This would be computed by adding back to total net revenues the EBC, depreciation and amortisation, but excluding exempt income and economically related expenses.
The bill includes all of the reliefs available in the ATAD 1, except the possibility to compute the EBC and the EBITDA at the level of a tax-consolidated group. The interaction of the interest deduction restrictions with Luxembourg's 'recapture rules' (which temporarily allow the deduction of expenses financing a shareholding but require an add-back of those expenses when the shareholding is sold at a gain) must be clarified to ensure that the EBC deduction restriction does not exceed the 30% ratio described above. Loans issued before June 17 2016 would fall outside the scope of the interest deduction limitation rules provided they are not modified after that date. It is unclear whether any or only certain modifications to a grandfathered loan would bring the loan within the scope of the new rules.
The bill generally would recognise the existence of a PE only if the taxpayer's activity represented a participation in 'general economic life' in the other state. Under the bill, a taxpayer could be asked to provide a confirmation from the foreign tax authorities that a PE existed. This provision is intended to put an end to conflicts of interpretation with respect to the existence of a PE under the provisions of a tax treaty. The practicalities of the proposed new requirement would need to be further analysed.
The Luxembourg Parliament now must debate and vote on the proposed measures.