On 20 June 2018, the Luxembourg Government filed the bill of law n°7318 (“Draft Law”) implementing the so-called Anti-Tax Avoidance Directive (“ATAD 1”).
ATAD 1 is mainly focused on base erosion and profit shifting (BEPS) regarding groups of companies engaged in cross-border transactions, but investment funds may also be impacted.
Pursuant to the Draft Law, the new tax rules apply to (i) corporate taxpayers in Luxembourg excluding transparent entities and (ii) Luxembourg permanent establishments of foreign corporate taxpayers. The rules will come into force in two phases:
1 January 2019
1. Interest limitation rule
The rule aims to discourage excessive interest payments by limiting the deductibility of exceeding borrowing costs up to 30% of the taxpayer's EBITDA.
Several exceptions should enable to avoid negative tax consequences in a number of situations.
2. CFC rule
If a control test and an effective taxation test are passed, the stake of the Luxembourg taxpayer in a foreign entity or a foreign permanent establishment will qualify as a Controlled Foreign Company (“CFC”).
ATAD 1 enables the EU Member States to decide between 2 options in presence of a CFC:
option A: tax adjustments are automatic,
option B: tax adjustments further require that the essential purpose of the CFC is to obtain a tax advantage.
The Draft Law applies option B and also opts for 2 derogations so that the impact of the CFC rules should be limited.
3. Hybrid mismatch rule
The rule deals with hybrid mismatches (i.e. hybrid instruments or entities allowing for double non-taxation) between EU Member States.
Hybrid mismatches with third countries are included in ATAD 2 and the latter will be implemented in 2019 with effect on 01/01/2020.
The current anti-abuse rule will be slightly amended in line with the ATAD 1 definition of the General Anti-Abuse Rule (“GAAR”) allowing Luxembourg income tax authorities to ignore non-genuine arrangements for tax purposes.
1 January 2020
1. Exit taxation rules
The current exit taxation rules will be amended in line with the ATAD 1 provisions.
It is to be noted that the current rules allow, under certain conditions, an unlimited deferral of the tax due upon migration, while the new rules will limit such tax deferral to a maximum of 5 years.
2. Hybrid mismatches with third countries
To be implemented by ATAD 2 (cf. point 3. above).
As a conclusion, the Draft Law will introduce new rules into domestic income tax law which may impact international structures and activities in Luxembourg.
ATAD 1: Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market.
ATAD 2: Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries.
EBITDA: earnings before interest, tax, depreciation and amortisation.