February 17, 2021
Luxembourg implements defensive measures related to EU-listed non-cooperative jurisdictions
With the law of 10 February 2021 (the Law), Luxembourg has introduced defensive measures towards countries listed on the European Union (EU) list of non-cooperative jurisdictions for tax purposes (the EU List). The Law disallows, under certain circumstances, the deduction of interest and royalties owed by Luxembourg corporate taxpayers to associated enterprises that are corporations established in a jurisdiction that is on Annex I of the EU List.
The new provisions apply as from 1 March 2021.
This Alert summarizes the provisions of the Law.
Background on the EU List
The EU published its list of non-cooperative jurisdictions for the first time on 5 December 2017, comprising in Annex I at that time 17 jurisdictions deemed to have failed to meet the tax transparency, fair taxation and implementation of anti-base erosion and profit shifting (BEPS) criteria established by the European Commission. Since the release of the EU List, there have been multiple changes to its composition based on recommendations made by the Code of Conduct Group for Business Taxation. Annex I to the EU List was updated for the last time on 6 October 2020 by the Council of the EU and currently includes 12 jurisdictions (American Samoa, Anguilla, Barbados, Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, the US Virgin Islands and Vanuatu). While no amendment was adopted during the informal video conference of the ECOFIN (i.e., the Economic and Financial Affairs Council of the EU, comprising the Ministers of Finance of the EU Member States) of 16 February 2021, the EU List is still expected to be updated in February 2021.
On 5 December 2019, the ECOFIN endorsed a report on the progress achieved by the Code of Conduct Group for Business Taxation, which included in particular a detailed state of play on the EU List. It also included guidance on further coordination of national defensive measures in the tax area towards non-cooperative jurisdictions. The guidance invited all Member States to apply legislative defensive measures in taxation related to the listed jurisdictions as of 1 January 2021, aiming to encourage those jurisdictions' compliance with the Code of Conduct screening criteria on fair taxation and transparency.
Non-deductibility of interest and royalties
The Law denies, under certain conditions, the deduction by corporate taxpayers of interest or royalties owed.
The Law provides for a specific definition of the concepts of "interest" and "royalties" for the application of the said measure. These definitions are to a large extent aligned with EU legislation, viz. Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States (the Interest and Royalty Directive), and with the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention.
The term "interest" thus refers to interest and arrears due in relation to receivables of any nature, whether secured by mortgage and whether carrying a right to participate in the debtor's profits, and in particular interest and arrears from bonds or debentures, including premiums and prizes attaching to such securities. Penalty charges for late payment are not regarded as interest for the purpose of this provision.
The term "royalties" as used in the new provision means consideration of any kind owed for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, and for information concerning industrial, commercial or scientific experience.
The new rule applies to interest or royalties that are owed, irrespective of whether they are paid or remain outstanding. This also means that interest or royalties that have accrued before the entry into force of the Law, i.e., before 1 March 2021, will remain deductible upon actual payment.
Owed to related enterprises in an EU-listed jurisdiction
The deduction of interest or royalties (as explained above) owed is denied, when the beneficiary of the interest or royalties meets the following conditions cumulatively. Where the beneficiary is not the beneficial owner of the interest/royalty, the criteria need to be assessed in relation to the beneficial owner:
Application of the safe-harbor rule
Even if the aforementioned conditions are all met, the provision will not apply if the taxpayer proves that the transaction that gives rise to the interest or royalties owed "is used for valid economic reasons which reflect economic reality."
The provision thus recalls the wording of the General Anti-Abuse Rule (GAAR) as codified in paragraph 6 of the Luxembourg Tax Adaptation Law and according to which arrangements that have been put in place for the main purpose or one of the main purposes of obtaining a tax advantage should be ignored if they are not genuine, i.e., if they are not put in place for valid commercial reasons which reflect economic reality.
According to the parliamentary documents relating to the Law, it would not be sufficient to state economic reasons, but such reasons need to be considered "real" and representing an economic advantage that exceeds a potential tax benefit resulting from the operation. No more details are provided as regards what kind of proof is expected or accepted to sustain that the transaction is effectively justified by valid commercial reasons.
As a result, even if the interest and royalties are owed to a related enterprise established in a jurisdiction or territory that is on Annex I of the EU List, the amounts owed remain deductible (subject to restrictions as provided by other provisions of the Income Tax Law) if they are incurred in the context of a transaction entered into for valid economic reasons which reflect the economic reality.
Evolution of the EU List
Given that the EU List is constantly evolving, the Law also clarifies which version of the EU List a taxpayer should refer to in order to determine if interest or royalties owed are caught by the new rule.
As of 1 March 2021, the new rule applies with respect to those jurisdictions listed in the latest version of Annex 1 of the EU List as published in the Official Journal of the EU (OJEU) at that date. Given that a revision of the EU List is due in February 2021 and assuming Annex I will be amended, such amended version will apply as of 1 Match 2021, provided the EU List has been published in the OJEU prior to that date. Otherwise, Annex I of the EU List in its version as published on 7 October 2020 will apply (please see above for the countries and territories listed in Annex I at that date).
Effective 1 January of each subsequent calendar year, the rule will apply with respect to those countries and territories that are included in Annex I of the EU List in its latest version as published in the OJEU before that date.
Removals from Annex I of the EU List are taken into consideration regarding interest or royalties owed as from the date of publication in the OJEU of the EU List enacting the removal of a country or territory from the EU List. If consequently a given country is taken off Annex I during a given year, the non-deductibility will cease to apply in respect of this country from the date of publication in the OJEU of the revised Annex I that enacted the withdrawal of the country in question.
It should be noted that the parliamentary documents relating to the Law highlight that the reporting requirements, as per Circular L.G. — A n 64, in relation to transactions of Luxembourg companies with related enterprises located in jurisdictions that are included in Annex I of the EU List will continue to apply.1
For additional information with respect to this Alert, please contact the following:
Ernst & Young Tax Advisory Services Sarl, Luxembourg City
Bart Van Droogenbroek, Tax Leader | firstname.lastname@example.org
Marc Schmitz, Tax Policy & Controversy Leader | email@example.com
Olivier Bertrand, Private Equity Tax Leader | firstname.lastname@example.org
Dietmar Klos, Real Estate Sector Leader | email@example.com
Fernando Longares, TMT & Life Science Tax Leader | firstname.lastname@example.org
Christian Schlesser, Commercial and Public Sector Tax Leader | email@example.com
Jacques Linon, Banking & Insurance Tax Leader | firstname.lastname@example.org
Vincent Rémy, Wealth & Asset Management Tax Leader | email@example.com
Nicolas Gillet, Transfer Pricing Leader | firstname.lastname@example.org
Elmar Schwickerath, Global Compliance and Reporting Leader | email@example.com
Ernst & Young LLP (United States), Luxembourg Tax Desk, New York
Xavier Picha | firstname.lastname@example.org
Ernst & Young LLP (United States), Luxembourg Tax Desk, Chicago
Alexandre J. Pouchard | email@example.com
Andres Ramirez-Gaston | firstname.lastname@example.org
1 See EY Global Tax Alert, Luxembourg: Reporting implications of revised EU List of non-cooperative jurisdictions for tax purposes, 27 February 2020.