On 8 January 2021, the Luxembourg direct tax authorities issued the Circular n°168bis/1 which clarifies the provisions of article 168 bis of the Luxembourg income tax law on the Luxembourg interest deduction limitation rule. This provision is applicable since 1 January 2019 and was introduced by the law dated 21 December 2018 implementing the Anti-Tax Avoidance Directive. Under the interest deduction limitation rule, exceeding borrowing costs shall be deductible from the taxable basis of a Luxembourg taxpayer only up to the higher of EUR 3 million (safe harbor rule) or 30% of the taxpayer’s earnings before interest, taxes, depreciation and amortization (“EBITDA”). The long-awaited Circular provides some clarifications regarding the application of the interest deduction limitation rule.
Borrowing costs and exceeding borrowing costs
The Circular clarifies the non-exhaustive lists of borrowing costs. As a matter of principle, the substance over form principle should be applied to determine whether an expense can be treated as an interest expense or a payment economically equivalent to an interest. Among others, the Circular specifies that amounts due on instruments available in the framework of Islamic finance (e.g., Sukuk) should be treated as borrowing costs when they can be assimilated from a tax standpoint to a traditional financial instrument. Regarding the foreign exchange gains and losses incurred on borrowings and instruments related to financing, the Circular specifies that only foreign gains and losses incurred on the remuneration portion of the instrument (and not the principal) are subject to the interest deduction limitation rule. Other notable clarifications by the Circular are the interaction with the recapture rule and the confirmation that an impairment on a loan shall not be considered as a borrowing cost.
The Circular also recalls that only deductible borrowing costs (considering any other tax rules such as the anti-hybrid rule) should be considered for the determination of the exceeding borrowing costs.
The Circular, like the methodology adopted in the 2019 tax returns forms to determine the exceeding borrowing costs of a taxpayer, confirms that a symmetrical approach should be adopted to assess whether an income should be treated as an interest income or other equivalent income of the taxpayer.
Computation of the deductible threshold per year
The Circular specifies that the deduction cap corresponding to the higher of EUR 3 million or 30% of the taxpayer’s EBITDA applies to each financial year. This means that a financial year of less than 12 months should be treated as a full financial year and should not affect neither the EUR 3 million nor the 30% EBITDA threshold.
Report of exceeding borrowing costs and unused interest capacity
Exceeding borrowing costs may be carried forward without time limitation while unused interest capacity can be carried forward for a maximum of five years. The Circular also specifies that in the context of tax neutral transformations, the carry forward of the exceeding borrowing costs and the unused interest capacity is continued in the hand of the transformed entity.
Loans concluded before 17 June 2016 are out of the scope of the interest deduction limitation rule. However, the grandfathering rule does not apply to so-called “subsequent amendments” made to these loans after 17 June 2016. The Circular provides for a non-exhaustive list of amendments which should be considered as subsequent amendments where such amendments were not contractually foreseen prior to 17 June 2016. Are covered any amendment to (i) the maturity date of the debt instrument, (ii) the interest rate or the computation’s methodology of the interest rate, (iii) the borrowed amount and (iv) the parties to the debt instrument. The Circular clarifies that a reorganization such as a merger, demerger or an in-bound migration does not affect the application of the grandfathering clause provided the initial terms of the loan are not amended. In the case where a loan concluded before 17 June 2016 is modified after this date, the grandfathering provision will only apply to the borrowing costs incurred from the initial terms of the loan.
In conclusion, the Circular provides some useful confirmations even if some of them where already anticipated. It will be important that taxpayers that have already prepared their 2019 tax returns assess their situation in light of the clarifications provided by the Circular.