Luxembourg publishes draft bill to implement ATAD 1

With the European Commission further ramping up on the CCCTB initiative, BEPS peer reviews on its way and international trade in a turmoil, EU member states are now due to implement EU Directive 2016/1164 on anti-tax avoidance (ATAD 1) in their domestic tax laws before 1 January 2019. ATAD 1 is another step to further harmonization within the EU in the area of direct taxation. With new rules to apply already as early as from 1 January 2019, ATAD 1 providing for minimum rules and allowing opt in or opt out provisions, EU member states shall have to make tax policy choices with potential spillover effects on future EU legislative developments. There are likely to be significant differences between member states in the implementation of ATAD 1.

In Luxembourg a bill of law to implement ATAD 1 (Draft Bill) was published on 20 June 2018. Subject to parliamentary discussions, the Luxembourg government wishes to introduce measures in the area of (i) controlled foreign corporation (CFC), (ii) interest deduction limitation, (iii) anti-hybrid mismatches, (iv) general anti-abuse rule and (v) exit tax provisions. Also some other measures are announced with respect to the existing tax consequences of a conversion of loans in shares and application of the permanent establishment concept.

CFC rules

ATAD 1 allows member states to choose to include the income of the CFC pursuant to two different mechanisms. Luxembourg has decided to opt for the more flexible Model B. This means that where a CFC has been put in place in a non-genuine situation which is defined as an arrangement that has been put in place for the essential purpose of obtaining a tax advantage, Luxembourg corporate taxpayers will be taxed on the undistributed net income of a CFC, pro rata to their ownership or control of the CFC to the extent such income is related to significant functions carried out by the Luxembourg corporate taxpayer. A CFC is defined as a low-taxed (in)directly held entity of more than 50% - or a permanent establishment. Low-taxed means that the actual corporate tax paid on the profits of the CFC is lower than 50% of the corporate tax that would have been paid when determining the tax liability in accordance with Luxembourg tax law. A CFC however disqualifies in the event it has accounting profits of no more than (i) EUR 750,000 or (ii) 10% of operating costs.

Interest deduction limitation rules

Insofar interest (including amounts under alternative financing arrangements) expenses exceed interest income, the deductibility of the exceeding borrowing costs will be limited to 30% of the tax payer’s EBITDA. A de-minimis threshold of EUR 3,000,000 applies. A higher group ratio may be applied. Unused interest capacity exceeding EUR 3,000,000 can be carried forward for 5 years. Unused exceeding borrowing costs may be carried forward indefinitely. The limitation equally applies to related and unrelated party debt. The Draft Bill also carves out financial undertakings as defined in ATAD 1 as well as standalone companies (a taxpayer that is not part of a consolidated group for financial accounting purposes and has no associated enterprise or permanent establishment). A grandfathering applies to interest on loans entered into prior to 17 June 2016 subject to the terms of such loans not being modified.  

Hybrid mismatches

ATAD 1 includes rules to avoid mismatches between domestic legislations by hybrid instruments or entities allowing for double non-taxation in EU situations. The Draft Bill implements these rules. Where such a mismatch results in a double deduction Luxembourg denies the deduction insofar the deduction is also recognized in the source state. Where a mismatch results in a deduction without inclusion in the residence state, Luxembourg does not allow the claimed deduction.

General Anti-Abuse Rule (GAAR)

GAAR allows member states to ignore artificial (non-genuine) arrangements for calculating a direct tax liability. An artificial arrangement is defined as an arrangement or a series of arrangements which having been put in place for the main purpose or as one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part. In the Draft Bill the existing Luxembourg GAAR rule is aligned with the ATAD GAAR rule.

Exit tax

A cross border (i) transfer of a taxpayer’s residence, (ii) transfer of assets from a permanent establishment to its head office or (iii) transfer of assets between permanent establishments may give rise to exit tax meaning that such event triggers (deemed) capital gains taxation. ATAD 1 provides for a mechanism with respect to such exit tax rules. Exit tax rules already exist in Luxembourg, but its rules will on the one hand become more relaxed and at the same time also more tightened with the Draft Bill. For example the list of exit tax events qualifying for a tax deferral is expanded, but deferral will be limited to 5 years in case of transfers to an EU/EEA jurisdiction, whereas under the current rules an unlimited deferral applies. Under the Draft Bill the situations in which exit tax is due are extended to include the transfer of separate assets. In the event of an inbound migration of a tax residence to Luxembourg or the transfer of assets to Luxembourg will explicitly benefit from a step-up. The stepped up value to be recognized is similar to the value applied in the exiting member state, unless this does not reflect the fair market value. The new exit tax rules apply as from 1 January 2020. A grandfathering applies to exit tax payment deferrals granted for tax years ending before such date.

Additional measures

The Draft Bill also foresees to apply the tax treaty definition of permanent establishment instead of the domestic definition in order to avoid possible double non taxation situations. Also the tax neutral conversion of loans into shares will be abolished with capital gains becoming taxable upon conversion.

Next steps

The proposed implementation of ATAD 1 by the Luxembourg government is consistent with Luxembourg’s international tax policy. Notwithstanding it will impact all international investment structures with a Luxembourg presence. The Draft Bill is subject to parliamentary discussions and expected to be approved before 31 December 2018. The implementation of ATAD 2 to extend the anti-hybrid rules to non-EU situations and to a larger scope of hybrid mismatches (including e.g. imported mismatches) is expected next year.