New developments on Luxembourg tax substance
Alex Schmitt, Philipp Mössner and Janine Labusch
Bonn & Schmitt
Luxembourg
Alex Schmitt (Bio)
Philipp Mössner (Bio)
Janine Labusch (Bio)
Luxembourg remains very popular with investment funds, private equity investors, family offices and multinational enterprises, in particular large IT-companies, such as Skype and Amazon, to name just a few. Companies who are active in the financial sector appreciate the flexibility, competence, efficiency as well as the legal and political stability of Luxembourg. The possibility to obtain advance tax clearances, often required in complex company structures, is another major advantage for companies who locate their finance activities to Luxembourg by setting up a Luxembourg holding or financing entity within their group structure.
In order for such a Luxembourg entity to become subject to the Luxembourg tax jurisdiction, from a Luxembourg tax perspective, the entity must only show that its tax residence is located in Luxembourg, i.e. either its registered office or its place of central administration is situated in Luxembourg.
However, foreign tax authorities – where the Luxembourg entity has a nexus with the foreign jurisdiction – may still challenge a tax residence accepted by Luxembourg. In case of a conflict, double-tax treaties refer to the effective place of management. Therefore, whether a Luxembourg entity will in fact be subject to Luxembourg tax laws, and not (also) to foreign tax laws, depends on whether the Luxembourg entity has its effective place of management, e.g. board meetings, sufficient personnel and functions, in Luxembourg. Those substance requirements, easily established by multinational entities, may sometimes be more challenging in case of a Luxembourg holding or financing entity.
Legal clarity as to the tax substance requirements was recently strengthened as a consequence of two circular letters issued by the Luxembourg tax authorities (administration des contributions directes) on the tax treatment of legal entities engaged in intra-group financing transactions (the Letters). International groups who wish to obtain an advance tax clearance from the Luxembourg tax authorities on the tax treatment of their financing structure before executing an intra-group financing transaction through a Luxembourg entity are now given a clear guidance. Henceforth, the Luxembourg tax authorities will deliver a binding tax clearance, if the Luxembourg entity has, amongst others, a genuine presence in Luxembourg, which will be determined by the fulfilment of the following conditions:
Residency of managers or directors
The majority of the members of the board of managers or directors who have the authority to bind a Luxembourg entity must be either:
(i) Luxembourg residents; or
(ii) non-residents, who exercise a professional activity in Luxembourg which falls into one of the first four net-income categories pursuant to article 10 (1 to 4) L.I.R., and who are taxable in Luxembourg on at least 50% of the total net income from such activities.
In case a legal entity is a member of the board of directors, its registered office and its place of central administration must be located in Luxembourg.
Professional knowledge
The natural persons and legal entities mentioned in the item above must possess the professional knowledge required to exercise their functions.
Binding powers
The natural persons and legal entities must furthermore have at least the authority to bind the Luxembourg entity and ensure the proper execution of all transactions.
Personnel
The Luxembourg entity must have qualified personnel, either consisting of its own employees or outside personnel, capable of executing and recording the transactions. The Luxembourg entity shall be capable of supervising the work performed by said personnel.
Key decisions
Key decisions regarding the Luxembourg entity's management shall be taken in Luxembourg. Further, entities for which the Luxembourg corporate law requires the holding of general meetings of shareholders, in principal, shall hold at least one general meeting of shareholders at the place indicated in the Luxembourg entities' articles of incorporation per year.
Bank accounts
The Luxembourg entity must hold at least one bank account in its own name with a credit institution established in Luxembourg or a Luxembourg branch of a credit institution established outside of the country.
Tax declarations
At the time of submission of a request for an advance tax clearance with the Luxembourg tax authorities, the Luxembourg entity must have complied with all legal requirements regarding the filing of tax returns.
Tax residency
The Luxembourg entity must not be considered a tax resident of another state.
Equity
The Luxembourg entity's level of equity must be adequate with respect to the functions performed taking into account the assets managed and the risks assumed.
Although the requirement that managers or directors must be tax resident in Luxembourg for the purpose of effective management should, in our view, be subject to further discussions and perhaps corrected due to the fact that both items are not imperatively interrelated, the new rules contained in the Letters considerably contribute to legal clarity in the context of tax-substance requirements and will certainly help to facilitate the assessment process of Luxembourg tax substance requirements in the future.