The new rules will deny the tax deductibility of interest and royalties due or paid to certain entities in countries or territories such as the Cayman Islands (recently added to the list), unless it can be proven that the transaction to which the interest or royalties relate is carried out for valid commercial reasons reflecting economic reality.
Luxembourg taxpayers potentially impacted by the bill
Companies (organisme à caractère collectif) subject to corporate tax and municipal business tax in Luxembourg, such as the S.A., the Sàrl and Luxembourg permanent establishments, are expected to be the main entities impacted by the bill.
Definition of interest and royalties
In short, the bill covers interest due or paid on debt of any kind (loans, bonds, etc.), whether variable or not, secured or not, possibly also premiums and rights attached thereto. Royalties refer to remuneration for the use or right to use certain intellectual property rights (patents and copyright in particular).
According to the initial comments on the bill, these terms are intended to have the same scope and definition as in Article 2 of the Interest and Royalties Directive and Articles 11 and 12 of the OECD Model Tax Convention.
Interest and royalties due or paid
Given that the purpose of the bill is to deny the deduction of certain business expenses, it is specified in the legislative history that no distinction should be made between expenses paid or payable.
Conditions relating to the beneficiary of the interest or royalties
The measures apply to beneficiaries that meet the following three cumulative conditions:
- The beneficiary must be a company (organisme à caractère collectif) and the beneficial owner of the interest or royalties. If the recipient is not the beneficial owner, only the beneficial owner shall be considered.
- The beneficiary must be a related enterprise. In that respect, the legislative history refers to the definition of related enterprise found in the Luxembourg transfer pricing rules, which in turn reflects the link of association expressed in Article 9(1) of the OECD Model Tax Convention (Associated Enterprises).
- The beneficiary must be established in a country or territory included on a list corresponding to the European Union list of non-cooperative jurisdictions for tax purposes. This list must be submitted annually by the government to the parliament for approval along with the draft budget bill; the first list will therefore be effective as from 1 January 2021. Special rules will apply to additions and removals of countries or territories to or from the list.
Valid commercial reasons reflecting economic reality
By way of exception, the tax deductibility of interest and royalties may not be denied for purposes of the new rules if evidence is provided that the transaction to which the interest or royalties due or paid relate is carried out for valid commercial reasons reflecting economic reality.
According to the legislative history, this safe harbour may apply if, having regard to all relevant facts and circumstances, the reasons cited for the transaction can be regarded as genuine and as demonstrating a sufficient economic advantage over and above any possible tax benefit obtained.
Entry into force
The bill is expected to enter into force and apply as from 1 January 2021, for interest and royalties due or paid on or after 1 January 2021.
The bill must now pass through the legislative process and is thus still subject to amendment.