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October 11, 2024
2024-1865

Luxembourg provides details on tax exemption for rental allowances; strategy to attract young talent

  • New guidance provides additional details concerning the tax-exempt rental allowance that employers in Luxembourg can grant their employees for renting their primary residence.
  • Under specific conditions and limits, the rental allowance is eligible for a 25% tax exemption.
  • The tax exemption is automatic, with no requirement for prior approval or subsequent notification to the tax authorities.
 

Executive summary

Circular L.I.R. No. 115/14 (Circular), issued on 27 September 2024, provides details on the tax-exempt rental allowance for a primary residence (prime locative). Effective from 1 June 2024, employees can receive a partial tax exemption on rental allowances paid by their employer for primary residence rent, subject to specific criteria being met. This initiative aims to alleviate the high rental costs in Luxembourg, which can deter job seekers from accepting employment offers. The policy is intended to ease the transition of young professionals into the workforce and expand the range of compensation benefits employers can offer to attract and retain talent.

Detailed discussion

Mechanism

Employees can benefit from a 25% tax exemption on rental allowances with a maximum qualifying allowance of €1,000 per month for full-time occupancy.

The exemption must be prorated if the employee's income is partially exempt due to the application of international tax agreements, based on the proportion of days worked in Luxembourg (and subject to tax in Luxembourg) to those worked abroad during the month for which the allowance is paid.

For incomplete pay periods or part-time employment, the maximum monthly allowance eligible for tax exemption is adjusted according to the actual hours worked compared to a full-time schedule.

Conditions

The exemption is conditional on the satisfaction of specific requirements at the time the rental allowance is provided.

Employee and housing conditions

The tax exemption is reserved for rental allowances given by an employer to an employee under an employment contract, earning income from employment as defined by the Income Tax Law.

Eligibility for this tax exemption is contingent upon the employee's age. To qualify, employees must be younger than 30 years old as of 1 January of the tax year at issue. The exemption is linked to age, not employment duration, and is unaffected by changes in employers as long as all conditions are met.

To benefit from the tax exemption, the rental allowance must cover the lease of the employee's primary residence, irrespective of its location, evidenced by a lease agreement naming the employee as the lessee. It does not apply to secondary homes or properties owned or occupied rent-free by the employee.

For joint tenancies, the rent considered for each tenant is the total rent divided by the number of tenants, unless the contract specifies individual rent shares.

The rent amount under consideration excludes additional costs, such as utilities, agency fees, insurance, etc.

Remuneration conditions

The employee's gross annual salary, including all compensation except the rental allowance, may not surpass 30 times the minimum monthly social wage for qualified workers (€92,553.30 as of 1 June 2024). Although employers are permitted to provide allowances to subsidize (a portion of) the housing costs to employees whose annual remuneration exceeds this threshold, these allowances are not eligible for the partial tax exemption.

For the purposes of determining if the above condition is met, the gross annual salary encompasses all taxable and nontaxable compensation received by the employee in cash or in kind, except the rental allowance itself.

Employers are obligated to ensure that the total annual gross remuneration paid or projected for the year remains within the prescribed limit.

The Circular offers additional guidance for specific scenarios:

  • Employers within a fiscal unity group, as defined by the Luxembourg Corporate Income Tax Law, must combine the total compensation an employee has received or is expected to receive from all entities in the group during employment.
  • If an employee has not been employed for the entire year or has been employed part-time, the employer must adjust the salary received during the employee's tenure to reflect what it would have been for a full year of full-time work.

It is the employer's responsibility to regularize the tax withheld by no later than the final salary payment of the tax year if the employee's remuneration for the year exceeds the annual limit that qualifies him or her for the exemption.

Limitation

The monthly rental allowance is capped at two levels. It is limited to the lower of:

  • The actual rent paid by the employee (excluding any additional rental costs), as evidenced by documentation submitted to the employer
  • A maximum of €1,000 for full-time work throughout the month, with this entire sum being taxable in Luxembourg

This restriction only pertains to the part of the rental allowance that qualifies for the tax exemption. Although employers may provide a rental allowance that surpasses this threshold, any amount above the limit will be taxed as a benefit in-kind.

If the employee works less than a full month or on a part-time basis, the maximum monthly rental allowance is prorated. The proration is based on the ratio of the actual hours paid during the month to the hours that would have been paid had the employee worked full-time for the entire month.

The maximum allowance must also be adjusted if the employee receives income that is exempt from tax due to a Double Taxation Treaty or another international agreement.

The rental allowance must be paid to the employee monthly; eligibility for the tax exemption depends on prompt payment. Specifically, the exemption is not applicable to any rental allowance paid more than one month after the rent's due date. Consequently, rental allowances provided by the employer for rent due before the employee's start date, or lump-sum payments meant to cover several months of rent already paid, do not qualify for the tax exemption.

Other considerations

The Circular provides further details on the following matters:

  • Social security contributions paid on the tax-exempt segment of the rental allowance cannot be claimed as tax deductible by the employee.
  • Rental allowances disbursed to employees who are also shareholders of the employing company can still be eligible for the partial tax exemption, as long as all the requisite conditions are met.

Procedure and documentation

The tax exemption for rental allowances neither necessitates prior authorization from tax authorities, nor requires notification after the tax year has concluded. Nonetheless, the rental allowance must be clearly itemized on the pay statement, detailing both the total gross amount and the exempt portion.

Due to the employer's responsibility to withhold taxes correctly from salaries, maintaining accurate documentation to substantiate the exemption is crucial, especially in the case of a tax audit. Consequently, employees are required to provide their employer with the necessary evidence to confirm that all conditions for the tax exemption are fulfilled. Typically, this includes a copy of the lease agreement.

Impact

The initiative represents a significant enhancement to Luxembourg's tax landscape, designed to draw in young professionals by acknowledging the challenging housing market. The rental allowance offers tax reductions, leading to increased take-home pay — an essential factor for young individuals embarking on their careers. This advantage is expected to increase the attractiveness of employers to up-and-coming talent, with the benefits anticipated to outweigh any additional administrative responsibilities and costs.

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Contact Information

For additional information concerning this Alert, please contact:

Ernst & Young Tax Advisory Services Sàrl, Luxembourg City

Ernst & Young LLP (United States), Luxembourg Tax Desk, New York

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor