These words echo with intensity in today’s complex and global tax environment, where a multitude of international tax rules are evolving at an unprecedented rate. This is particularly true in the context of the G20/OECD-driven global initiative aimed at combatting base erosion and profit shifting (BEPS), which focuses on transparency and consistency among rules and the presence of economic substance.
This is also the case in the EU framework. The draft EU Anti-tax Avoidance Directive issued by the EU Commission on January 28 2016 reflects some of the actions in the BEPS Project. If the proposed EU directive is adopted as currently worded, it could potentially create issues of double or multiple taxation and significant inconsistencies in EU law, notably with respect to the freedom of establishment. The directive and the proposals relating to the common consolidated corporate tax base (CCCTB), as well as the recent state aid investigations launched by the EU Commission, may be seen as a ‘Trojan horse’ being used to challenge the fiscal autonomy of EU member states.
In this context, it is imperative to set a new strategy for Luxembourg’s tax policy. At the end of February 2016, the Luxembourg government announced outlines for the 2017 tax reform; further details will be released during the annual State of the Nation speech of the Luxembourg Prime Minister on April 26 2016. The measures already announced include those to strengthen the purchasing power of individuals and to progressively reduce the corporate income tax (CIT) rate. Additional tax reform strategies that the Luxembourg government should consider are discussed below.
Reduction of CIT rate
The announced reduction of the CIT rate, from the existing (cumulative) rate of 29.22% (the rate in Luxembourg City, taking into account the employment fund contribution and the municipal tax) to 27.08% in 2017 and to 26.01% in 2018 is a welcome measure. However, these proposed reductions may not be sufficient, particularly in view of the proposed EU Anti-tax Avoidance Directive.
The EU proposal provides for a standard tax rate - nominal or effective - of a member state for purposes of the application of measures relating to controlled foreign companies (CFCs) and a ‘switch-over’ clause. The measures proposed in the directive could potentially lead to competition between certain member states to reduce their CIT rates. Ireland already has a rate of 12.5% and the UK has a rate of 20% (soon expected to be reduced to 17%). A strategic positioning of the Luxembourg CIT rate between these two countries could be one of Luxembourg’s targets in its tax reform.
Tax simplification
If the reduction in the Luxembourg CIT rate was combined with a simplification of the taxes companies are liable to pay – as well as an emphasis on one of the fundamental principles of the legal system they have to comply with, namely legal certainty (predictability, reliability, readability) – this would result in a more attractive corporate taxation reform.
This simplification could be applied to one of the key features of the Luxembourg corporate tax system: the parent-subsidiary regime. The conditions to benefit from this regime have not fundamentally changed since its modification a quarter of a century ago, whereas a significant evolution has taken place at the level of both the investor and the investment (in terms of type of activity and geographic area). To take into account this evolution, the relevant legislation should be updated.
The recent codification of certain measures, such as allowing the use of functional currencies other than the Euro for tax purposes and the formalization of the advance tax agreement procedure, seems to be fully in line with the government’s position on transparency and the reliability of the domestic tax environment. The advance tax agreement procedure, which applies to the field of corporate and personal taxation, should be extended to VAT. The tax administration might also consider issuing circulars on the anti-abuse measures recently introduced into Luxembourg domestic law and other administrative positions.
The net wealth tax could also benefit from simplification. It should be noted that in Luxembourg, only companies are liable to this tax, and that the Grand Duchy is the only EU member state that still levies a net wealth tax on companies.
The net wealth tax, which is based on somewhat outdated provisions, is proving particularly unsuitable within today’s framework of international tax transparency. As one example, 31 jurisdictions, including Luxembourg, have signed an international agreement under which they commit to automatically exchange data on large international corporations that are obliged to submit reports with regards to their activities on a country-by-country (CbC) basis (‘country-by-country reporting’ (CbCR)). The first exchange of this data will apply for 2016, and should occur in 2017-2018. However, for purposes of the CbC reports that should be prepared by the corporations targeted by this measure, the net wealth tax is not considered to be a reportable tax, which means that the CbC reports will only partially describe the fiscal burden actually incurred by Luxembourgish member companies of affected groups. Furthermore, the net wealth tax is doubly burdensome for foreign investors, who generally cannot credit it against the taxes paid in their state of residence.
Even if Luxembourg decides not to abolish this capital tax, it should be updated to adapt it to the realities of the new global tax environment.
Modernising the net wealth tax also could serve to further encourage a better capitalisation of Luxembourgish companies, and thus respond to the risk of a systemic crisis. Furthermore, it would be appropriate to ensure tax neutrality with respect to companies that would continue to use third-party or internal indebtedness. The use of appropriate tax measures at this level could motivate investors to recapitalise their Luxembourg subsidiaries, or even attract the headquarters of international companies.
Incentives for innovation, talent and investment funds
Promoting innovation and creativity has been central to the Luxembourg economy. ‘Fintech’, ‘biotech’ and ‘space mining’ are recent illustrations of industries that have contributed to this success. In this context, it is essential to consider assistance for contractors and ground-breaking project developers, such as tax credits for R&D, to ensure the attractiveness of the Grand Duchy. ‘Fruitful ground’, particularly in terms of fiscal incentives, is required to stimulate the blooming of projects providing a high added value to the country.
The development of these projects also requires highly qualified human resources. Luxembourg has been a hub for attracting talent for many years. Qualified resources are coveted and highly sought-after on an international level, including by the most prestigious universities and the most elaborate R&D centres. The Luxembourg direct tax administration’s ‘impatriates’ circular compensates employees for the physical costs of transferring to Luxembourg to a certain extent, but does not take into account their particular activities (notably frequent travel).
A proactive approach which promotes access to tax treaties for alternative investment funds, in line with the relevant OECD discussions, also should be on the agenda for Luxembourg. This approach would help to ensure tax neutrality for investment funds and their investors and would further enhance Luxembourg’s attractiveness for investment funds, as well as for new functions that are not yet present in the country.
While Luxembourg has endorsed the BEPS initiative, the country has not introduced unilateral measures ahead of the international consensus within the context of the BEPS framework. Considering that taxpayers are looking for legal certainty, it would be inappropriate to anticipate the application of international measures that still warrant some refinement before being made applicable. These measures should be adopted only after discussions between countries at an international and/or an EU level are completed, and the results of the relevant impact studies have been carefully assessed.
In the current climate, even if it requires bold choices that call on Luxembourg’s resources, reform and legal certainty must be brought into step with each other to create a modern tax system that supports competitiveness and growth.
Raymond Krawczykowski (rkrawczykowski@deloitte.lu)
Bernard David (bdavid@deloitte.lu)
Deloitte Luxembourg
Tel: +352 451 454 904
Website: www.deloitte.lu
