OUR INSIGHTS AT A GLANCE

  • On 30 March 2020, a draft law was presented to Parliament which amends the Luxembourg corporate income tax law so as to deny, in Luxembourg, the deduction of certain expenses directed to entities established in blacklisted jurisdictions
  • The measure to be introduced by the draft law will apply as from 1 January 2021. It provides that interest and royalties paid or due by Luxembourg corporate taxpayers will no longer be tax deductible in Luxembourg if the beneficial owner of the interest or royalty is a collective undertaking (within the meaning of article 159 of the Luxembourg corporate income tax law ("ITL")) established in a non-cooperative jurisdiction for tax purposes
  • The analysis of the impact of this new measure on structures with entities located in non-cooperative jurisdictions still depends on evolving factors, including a potential amendment of the list of non-cooperative jurisdictions before the new measure enters into force
  • Awaiting these clarifications, Luxembourg taxpayers with investments into and from non-cooperative jurisdictions such as the Cayman Islands should seek advice from their tax adviser in order to analyse the potential impact of the new provisions on their investments, shareholders or lenders/bondholders and take action, if necessary

On 30 March 2020, a draft law amending the Luxembourg corporate income tax law so as to deny, in Luxembourg, the deduction of interest and royalty expenses directed to entities in non-cooperative jurisdictions was presented to Parliament.

The draft law amends one of the corporate income tax law provisions (article 168 ITL), meaning that the new measure only deals with the tax deductibility at the level of Luxembourg corporate taxpayers and will not apply to individuals.

Background

On 18 February 2020, the EU Council updated the EU list of non-cooperative tax jurisdictions by adding the Cayman Islands, Palau, Panama and Seychelles.

As of 27 February 2020 (date of the latest update of the list), the list included the 12 following jurisdictions: American Samoa, the Cayman Islands, Fiji, Guam, Oman, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, the US Virgin Islands and Vanuatu.

The EU Council regularly reviews and updates the list, taking into consideration the evolving deadlines for jurisdictions to deliver on their commitments and the evolution of the listing criteria that the EU uses to establish such list.

In parallel, the Council produced a guidance on further coordination of national defensive measures in the tax area towards non-cooperative jurisdictions in December 2019 and invited EU Member States to apply one of the following legislative defensive measures in taxation vis-à-vis the listed jurisdictions as of 1 January 2021, with the aim of encouraging those jurisdictions' compliance with the Code of Conduct screening criteria on fair taxation and transparency:

  • non-deductibility of costs
  • CFC rules
  • withholding tax measures
  • limitation of the participation exemption on profit distributions

The Luxembourg Government decided to introduce the first of these measures, i.e. the non-deductibility of costs.

Presentation of the new measure

As from 1 January 2021, interest and royalties paid or due will no longer be tax deductible, if the following cumulative conditions are met:

  • the beneficiary of the interest or royalty is a collective undertaking within the meaning of article 159 ITL (which means that tax transparent partnerships are out of scope); if the beneficiary is not the beneficial owner, then the beneficial owner has to be taken into account
  • the beneficiary of the interest or royalty is an associated enterprise within the meaning of article 56 ITL and
  • the collective undertaking which is the beneficiary of the interest or royalty is established in a country or territory which is on the list of non-cooperative countries and territories

Interest and royalties will remain tax deductible to the extent that the taxpayer can demonstrate that the operation to which the interest or royalties relate has been put in place for valid economic reasons which reflect economic reality.

Interest is defined as follows: «Interest paid or due relating to debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and, in particular, interest from bonds or debentures, including premiums and prizes attaching to such securities. Penalties for late payments shall not be regarded as interest payments.»

Royalty is defined as follows: «Remuneration of any kind paid or due as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.»

These 2 definitions are largely inspired by the definitions included in the EU Interest and Royalty Directive and in the OECD Model Tax Convention.

Timing for application

The new measure will apply to interest and royalties paid or due as from 1 January 2021.

The list of non-cooperative jurisdictions to be taken into account and applied as from 1 January 2021 will be proposed by the Government later on and will be annexed to the above provision. It will reflect the situation as of the date of the proposal based on the latest EU list available at that time.

The commentary to the draft law states that the Luxembourg Government intends to present the list at the time the 2021 budget will be presented to Parliament (which generally occurs each year in October). In this respect, please note that the next update of the EU list is also supposed to take place in October 2020.

Updates of the blacklist

Once a year, the Government will propose an update of the list which will correspond to the latest EU list available in the Official Journal of the EU at the time of the update proposal.

  • The countries which will be added will be taken into account for interest and royalties paid or due as from 1 January of the following year (i.e. there will be no retroactive nor immediate effect but only an impact as from the following calendar year)
  • The countries which have been removed will no longer be taken into account for interest and royalties paid or due as of the date of the publication of the relevant EU list in the Official Journal (i.e. the removal will apply immediately)

The draft law and the related commentary provide some examples on the effect of adding or removing a specific country from the list.

Implications

Since the EU blacklist evolves over time and some jurisdictions (such as the Cayman Islands) may have already adopted measures which could be assessed as sufficient from an EU point of view, it is possible that such jurisdictions will no longer be on the list to be presented by the Luxembourg Government and to be taken into account as from 2021.

Therefore, the analysis of the impact of this new measure on structures with entities located in non-cooperative jurisdictions still depends on evolving factors which remain to be clarified. Awaiting these clarifications, Luxembourg taxpayers with investments into and from non-cooperative jurisdictions such as the Cayman Islands should seek advice from their tax adviser in order to analyse the potential impact of the new provisions on their investments, shareholders or lenders/bondholders and take action, if necessary.

Originally published April 2020

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.