In light of the global Base Erosion and Profit Shifting (BEPS) initiative and the European developments against tax evasion and aggressive tax planning, two European Directives were adopted in July 2014 and January 20151 by the European Council, amending the Parent-Subsidiary Directive (2011/96/EU). These two Directives, in a nutshell, aim to introduce anti-hybrid and general anti-abuse rules into EU domestic tax laws.
In an effort to be one of the first complying countries of these Directives, the Luxembourg finance Minister submitted a draft law ('the Bill')2 on 5 August 2015. This Bill would introduce the amendments to the Parent-Subsidiary Directive with effect from 1 January 2016. Achieving this would reinforce Luxembourg in its leader position as a trusted financial hub within the EU.
The Bill also proposes to implement the horizontal tax consolidation between Luxembourg-affiliated companies and to broaden the scope of deferral on exit tax payment.
The first amendment proposed by the Bill consists of an anti-hybrid rule. This rule states that profit distributions falling within the scope of the Parent-Subsidiary Directive may no longer be tax-exempt if such distributions are tax deductible from the EU distributing entity’s tax basis.
Under this new rule, dividends distributed by EU companies to a Luxembourg holding company will no longer benefit from the Luxembourg participation exemption3 if the dividends are tax deductible in the EU jurisdiction of the distributing entity.
This anti-hybrid rule will de facto eliminate the use of hybrid loan arrangements or so-called hybrid mismatches for investments made within the EU. However, it does not affect the debt qualification of certain debt instruments that are broadly used in Luxembourg, such as preferred equity certificates ('PECs') or convertibles preferred equity certificates ('CPECs').
This rule would apply to profits that are distributed after 31 December 2015.
General Anti-abuse rule (GAAR)
The second major amendment introduced by the Bill is a minimal anti-abuse rule. This rule denies, under several conditions, the benefit derived from the withholding tax exemption4 which applies to dividends paid by a Luxembourg company to another EU Company listed in Art.2 of the Parent-Subsidiary Directive. Such denial applies to an arrangement or a series of arrangements that are not “genuine” (in French, “non authentique”) and that have been put in place “for the main purpose or as one of the main purposes of obtaining a tax advantage that defeats the object of the Parent-Subsidiary Directive”. An arrangement is defined as not genuine if it is not implemented for valid commercial reasons that reflect economic reality. Same applies to dividends distributed by an EU company to a Luxembourg company, that is, the Luxembourg company will no longer benefit from the Luxembourg participation exemption.
Unfortunately, the Bill follows the term “non-authentique”, which was used in the Directive 2015/121/EU, instead of 'artificial'. The latter term, which is more self-explanatory, was used by the European Court in their ruling of several cases5. The Bill also lacks any further explanation and does not provide any example of arrangements that could be considered as abusive.
Further, it should be noted that the principle of a general anti-abuse rule was already embedded in the law6, but with a more narrow scope. Indeed, the current interpretation of the existing Luxembourg anti-abuse rule law is that a structure is considered abusive if it has been implemented for the sole purpose of obtaining a tax advantage. The rule proposed by the Bill makes instead a reference to a “main purpose”, which is general, and as such, it is given a broader scope.
Under the current regime7, two Luxembourg affiliated companies held by one parent company in another Member State are not entitled to file for tax consolidation. A similar regime has been challenged before the European Court of Justice8 on the grounds of freedom of establishment: the decision challenged the Dutch consolidation tax regime, which provided for the same restriction as Luxembourg regarding the fiscal unity of affiliated companies.
The Bill aims to extend the fiscal unity by making it available to resident companies that are held by a common parent company—to the extent the parent is a capital company that is resident in a Member State of the European Economic Area (EEA) and that is subject to a comparable tax regime to the one in Luxembourg (i.e., the horizontal fiscal unity). Luxembourg permanent establishments of companies that are resident in another Member State of the EEA will also be entitled to be part of a horizontal fiscal unity under the new rules.
Deferral on Exit Tax Payment
Under the current Luxembourg regime, companies transferring the place of effective management or the statutory seat within the EEA may opt for a payment deferral on the exit tax, which is due on latent capital gains existing at the time of the migration. But this is allowed to the extent that such unrealized gains are owned by the same taxpayer9.
The Bill widens the availability for exit tax payment deferral, making it available to any country that is not a Member State of the EEA, on condition that such country has concluded a DTT with Luxembourg in which it contains a clause inspired by Art. 26(1) of the OECD Model Convention.
In the event of a transfer of a permanent establishment, the State where the head office is located must meet the same conditions.
In summary, the Bill reflects the EU-wide changes to the Parent-Subsidiary Directive. As mentioned, Luxembourg is about to implement these changes so that it can meet the deadline imposed by the 2014 and 2015 EU Directives. It is worth noting, however, that the Bill should be considered a “raw material”, and therefore, it is likely that it will be significantly refined during the following parliamentary discussions, which will take place before year end.
1. Directives 2014/86/EU and 2015/121/EU
2. Projet de loi 6847/00
3. Article 166 of the Luxembourg Income Tax Law and § 9 Gewerbesteuergesetz
4. Article 147 of the Luxembourg Income Tax Law
5. See CJEU, C-196/04, Cadbury Schweppes plc, Cadbury Schweppes Overseas Ltd vs Commissioner of Inland Revenue
7. Luxembourg tax consolidation is governed by Article 164 of the Luxembourg Income Tax Law
8. CJEU, 12 June 2014 (SCA Group Holding C-400113)
9. The current regime on the taxation on latent capital gains is the result of the modifications introduced by the Law of 26 May 2014