On February 22 2019, Luxembourg's tax authority issued an administrative circular to clarify new rules surrounding permanent establishments (PEs).
The Luxembourg law, dated December 21 2018 and applicable from January 1 2019, includes measures that amend the domestic definition of a PE to apply where a double non-taxation situation can arise under a tax treaty.
The February circular confirms that if a relevant tax treaty contains a definition of a PE, that definition will prevail. However, if there is no definition, Luxembourg's domestic law will apply to determine whether a Luxembourg taxpayer has a PE in another country.
The following additional conditions must also be fulfilled for a Luxembourg taxpayer to have a PE:
- Independent activity: The taxpayer must bear the responsibility and risk for the activities, and not be acting within the scope of a dependent relationship;
- Participation in economic life: The relevant activity, when considered in isolation, constitutes an independent activity of an industrial or a commercial nature, and represents a "participation in the general economic life in the foreign state". Despite the contrary position expressed in some commentaries to the law due to an interpretation of this concept in Luxembourg case law, the requirement cannot exclude financing and intellectual property rights activities per se. This must be determined on a case-by-case basis, taking into account the type of assets, the size of the transaction and the organisational substance.
- Proof from the PE state: The Luxembourg tax authorities may require confirmation that the authorities of the state where the PE is located and carries out activities recognises the PE.
The latter point is dependent on the following situation:
- When the relevant treaty does not include a provision similar to Article 23(a)(4) of the 2000 OECD model treaty (i.e. providing that Luxembourg will not be required to grant an exemption for income when the other state's interpretation of the treaty results in an exemption or limited taxation), the taxpayer is always required to provide the confirmation; and
- When the treaty does contain a provision similar to Article 23(a)(4), the Luxembourg tax authorities may request the confirmation when the assessment of the relevant facts is not straightforward (e.g. when the PE's activities do not involve material infrastructure or human capital).
In both cases, the circular clarifies that the recognition of PE status may be demonstrated through any type of documentation issued by the competent authorities of the PE state, such as a tax assessment.
However, simply producing a document authorising the PE to carry out commercial activities in the country is insufficient. The absence of such proof will result in the denial of PE status.
The new statutory provision embraces the international tax efforts inspired by the BEPS project and addresses double non-taxation situations arising from the misinterpretation of a treaty that may potentially not be captured by the OECD multilateral instrument.
In practice, the determination of whether a PE exists essentially remains an analysis of the facts and circumstances, with a more sophisticated appreciation of the PE's activities.
However, the proof of recognition in the PE state seems to add a new element of formality to the analysis. How these new rules will be applied in practice may provide useful guidance in the future.