On 9th March 2022, the Luxembourg Ministry of Finance introduced a new bill of law n°7974 before the Luxembourg Parliament, which amends the current interest deduction limitation rule (“IDLR”) by removing EU regulated securitization vehicles (“SVs”) from the exemption provided for financial undertakings.
Background and amendment required by the European Commission
The Luxembourg IDLR was introduced by the law dated 21 December 2018 implementing the EU Anti-Tax Avoidance Directive (Council Directive (EU) 2016/1164) (“ATAD I Directive” or “Directive”). Under this rule, the list of “financial undertakings” benefitting from an exemption also includes SVs governed by the Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitization and creating a specific framework for simple, transparent and standardized securitization (SVs covered by EU Regulation).
When implementing the Directive into its domestic law, Luxembourg (like Portugal) took the position to extend the list of “financial undertakings” falling under the scope of ATAD I Directive to SVs covered by EU Regulation, granting as such a derogation.
In practice, this means that interest expenses or costs economically equivalent incurred by SVs covered by EU Regulation can be deducted without limitation.
In May 2020, the European Commission sent a letter of formal notice to Luxembourg requesting an amendment of this rule. The European Commission argued that ATAD I Directive includes an exhaustive list of entities considered as “financial undertakings” for the purpose of the exemption. By including SVs covered by EU Regulation into the list of “financial undertakings”, the European Commission considered that Luxembourg rules went beyond the range of exemptions allowed by the Directive.
Since Luxembourg failed to amend its domestic legislation within the required deadline mentioned in the formal notice, in December 2021, the European Commission sent a reasoned opinion to Luxembourg for incorrect implementation of ATAD I Directive. Luxembourg was called again to amend its legislation to correctly transpose the IDLR set by the Directive to avoid the case to be brought before the Court of Justice of the European Union. It is therefore in this context that this new bill of law is introduced by the Luxembourg government.
Main implications of the bill of law
Once the bill of law will be adopted, Luxembourg SVs covered by EU Regulation will become fully subject to the IDLR. Therefore, exceeding borrowing costs incurred by Luxembourg SVs (covered by the EU Regulation or not) would be deductible only up to the higher of EUR 3 million or 30% of the undertaking’s EBITDA for each financial year (unless any other exception applies). The bill of law does not currently provide for a retroactive effect of the amendment. It is then questionable whether the European Commission will consider this amendment sufficient.
It is worth noting that the new bill of law amending the IDLR is proposed at the same moment as the new Luxembourg securitization law was adopted. Among the most relevant features, this recent legislation now allows SVs to be incorporated under the legal form of a partnership. As a tax transparent entity for corporate income tax, a partnership should be an alternative in the future to fall out of the material scope of the Luxembourg IDLR, subject to the application of the reverse hybrid rules.
Finally, it is also relevant to point out that while ATAD I Directive does not include SVs covered by EU Regulation as exempt vehicles, the recent draft ATAD III Directive includes such entities as entities carved out from the scope of the draft directive. Please refer to our article for further details regarding the draft ATAD III Directive.
The amended provision of the IDLR should become applicable as from 1st January 2023 if adopted. In consequence, an evaluation of your structure may be advised to assess any potential risks.
Our tax team remains available should you need any further information.
Article co-authored by Coralie Oberle.
Frédéric Feyten , Managing Partner | Avocat
Alejandro Dominguez, Counsel
Vicente Chapa Associate
Delphine Danhoui, Knowledge Lawyer