Luxembourg Lower Court Delivers Judgment on the Scope of Hidden Dividend Distributions

In its judgment handed down on 25 September 2020, the Lower Administrative Court (Tribunal Administratif) considered the scope of hidden dividend distributions under Luxembourg law.

In the case at hand, the taxpayer (a company) had booked in its 2013 and 2014 financial accounts provisions for bonuses to be paid to its managing director (who was also the shareholder) and to the managing director’s wife (who was an employee of the company), that the company had not yet paid out. The Luxembourg tax administration took the view that these bonuses were excessive compared to market practice and sought to requalify the deemed excessive part of the provisions as hidden dividend distributions and subject them to 15% withholding tax.

At issue was therefore (i) whether the wife, who was not a shareholder, could fall within the scope of “interested person” for the purposes of the definition of dividend distribution and (ii) whether accounting provisions could fall within the meaning of hidden dividend distributions.

The Lower Administrative Court confirmed a number of interesting points. First, Article 164(3) of the Luxembourg income tax law defines hidden dividend distributions as an advantage conferred directly or indirectly by the company to a shareholder, group company or interested person that a third party would not have received. As regards the meaning of “interested person” the Court held that no direct relationship between the company and that person is required but that the advantage must be motivated by a shareholder interest - thus a person with sufficiently close links with a shareholder (such as a spouse) may receive a hidden dividend distribution.

However, the Lower Administrative Court also held that, in the absence of effective payment to the intended recipient, the provisioning of bonuses could not be lawfully qualified as a hidden dividend distribution since it did not give rise to an effective distribution, i.e.: an impoverishment of the Company to the benefit of a third party. The Court acknowledged that while the provisions had diminished the company’s profits, it took the view that only effective payment of the bonuses could give rise to a hidden dividend distribution. Implicit in the Court’s reasoning is that the shareholder and his spouse had not in fact received an advantage from the company.