Luxembourg: Luxembourg Tribunal Held That The Use Of Corporate Tax Losses Amounts To Abuse Of Law: What Went Wrong?

01 INTRODUCTION

On 30 March 2023, the Luxembourg Administrative Tribunal (Tribunal Administratif, the "Tribunal", which is the first instance jurisdiction) held its decision (the "Decision") in a case that concerns the use of corporate tax losses by a Luxembourg company ("LuxCo").¹

LuxCo incurred its tax losses when it was a holding company and intended to use these losses, following several years of being dormant, to offset a capital gain realised upon disposal of a Luxembourg real estate property. The Luxembourg tax authorities ("LTA") challenged the use of the tax losses based on the abuse of law provision provided in § 6 of the Tax Adaptation Law (Steueranpassungsgesetz, or "StAnpG"). The Tribunal followed the decision of the LTA and rejected the use of the tax losses.

The case further concerns the payment of (excessive) charges to a UK resident company for a mandate to find a buyer for the Luxembourg real estate property. As it seems that the UK company had some links to the shareholder of LuxCo, it is rather likely that the high level of fees paid by LuxCo entails an advantage that should be classified as a hidden dividend distribution. Therefore, this aspect of the Decision seems to be uncontroversial and will not be further analysed.

At the time this article was drafted, an appeal against the Decision had been filed with the Luxembourg Administrative Court (Cour Administrative, which is the second instance jurisdiction). As the use of corporate tax losses is a fundamental feature of the Luxembourg (corporate) tax system, the decision of the Administrative Court will be of utmost importance to restore legal certainty.

The question arises whether the LTA and the Tribunal were right when concluding that the use of tax losses by LuxCo was an abuse of law. This question is analysed in detail in this article.

02 FACT PATTERN OF THE CASE

LuxCo was incorporated on 14 January 2000 in the legal form of a public limited company (société anonyme, S.A.) for the purpose of holding participations. LuxCo was never part of a fiscal unity and, crucially, has had a stable shareholder base since 2001 (i.e. the shares of LuxCo have been owned by a Luxembourg resident individual since 2001).

The object of LuxCo was defined very broadly in the company's bylaws which state that "the company may carry out all commercial, industrial or financial transactions, as well as all transfers of real or personal property. The company's object is also to carry out all operations relating directly or indirectly to the acquisition of participations in any form whatsoever, in any company, as well as the administration, management, control and development of these participations. In particular, it may use its funds for the creation, management, development and liquidation of a portfolio consisting of all securities and patents of any origin, participate in the creation, development and control of any company, acquire by way of contribution, subscription, underwriting or purchase option and in any other way, all securities and patents, realise them by way of sale, transfer, exchange or otherwise, have these businesses and patents developed, and grant to the companies in which it is interested all assistance, loans, advances or guarantees". However, in practice LuxCo mainly performed holding activities until 2008.

From 2009 until 2013, LuxCo ceased its previous activity as a holding company and did not dispose of any corporate assets of significant economic value (i.e. LuxCo was a dormant company during that period).

On 12 May 2014, LuxCo acquired an immovable property situated in Luxembourg that was resold on 31 October 2014, i.e. less than six months later. LuxCo realised a significant capital gain (circa 80% of the acquisition costs) on its investment which was included as income in the company's 2014 corporate tax return. However, LuxCo's taxable income was offset by tax losses carried forward from the time LuxCo performed holding activities.

In 2014, LuxCo indicated a change of its activity from the "holding of shares" to the "management/trade of real estate" in its financial statements and its corporate tax returns.

The LTA denied the deductibility of LuxCo's tax losses, arguing that the conditions of the abuse of law provision were met.

Following the real estate transaction in 2014, LuxCo did not perform any further activities. This has been explained by the representants of the company with the uncertainty created by the LTA through the challenge of the tax loss carry-forward.

03 DECISION OF THE TRIBUNAL

The Tribunal had to decide whether LuxCo could use its tax loss carry-forward to offset the 2014 taxable income or whether the use of these tax losses was an abuse of law, as claimed by the LTA.

The abuse of law concept applies if four conditions are cumulatively met. The Tribunal analysed these conditions as follows:

The Tribunal agreed with the LTA that the first condition is satisfied since the purchase of a property by a company constitutes the use of forms and institutions of private law within the meaning of § 6 StAnpG.

The Tribunal further pointed out that LuxCo was undisputedly out of business from 2009 to 2013 and did not have any assets of significant economic value at its disposal during that period.

According to the Tribunal, the use of tax losses allowed LuxCo to substantially reduce the tax burden in relation to the capital gain through a deduction of the operating losses carried forward from previous years.

Here, the Tribunal reiterated that LuxCo ceased all activity between 2009 and 2013, and that the company was "reactivated" in 2014 when acquiring and selling a Luxembourg real estate property within a period of less than six months.

The Tribunal stated that LuxCo indicated the "acquisition of participations" as the company's object in its corporate tax returns filed for the fiscal years 2000 to 2013. In 2014, when LuxCo acquired and sold the Luxembourg real estate asset, LuxCo declared "real estate management" as business purpose in its corporate tax return. Likewise, in the 2014 financial statements of LuxCo, it was stated that "the company's main object is the trading of real estate".

The Tribunal emphasised that it was not the initial intention of LuxCo to invest into real estate as no real estate investment had been made since its incorporation in 2000 until 2014. Given the facts and circumstances of the case, it was considered that LuxCo was established for performing holding activities, not for investing into real estate.

According to the Tribunal, it is settled case law that the application of the abuse of law requires an analysis of all the transactions carried out, and the individuals or legal entities involved, regardless of the question of which person is at the origin of the (potential) abuse of law.

The Tribunal considered that:

On this basis, the Tribunal concluded that there is sufficient evidence that the legal and tax personality of LuxCo was used solely to benefit from its tax loss carry-forward and to reduce the tax that would have otherwise been incurred on such a transaction.

The Tribunal further reminded that LuxCo is ultimately owned and controlled by a Luxembourg resident individual who is the actual beneficiary of LuxCo who derives a tax advantage from carrying out this very profitable real estate transaction through LuxCo (that has sufficient tax losses to offset the capital gains). The Tribunal highlighted that the speculative capital gain, had it been realised directly by the shareholder, would have resulted in a tax liability.

According to LuxCo, its shareholder intended to limit the "significant risks with regard to the work to be carried out and the uncertainty as to the possibility of finding a buyer at the desired price" by "reactivating" a dormant company to carry out the real estate investment.

However, the Tribunal found that these arguments were not sufficient to reverse the finding of the LTA's Director that the disputed transactions carried out by LuxCo constitute an abuse of law and that they are not motivated by considerations other than fiscal ones.

On this basis, the Tribunal concluded that all the conditions of the abuse of law provision (as applicable in fiscal year 2014) were met. Consequently, LuxCo's tax loss carry-forward was not available to compensate the capital gain realised upon disposal of the Luxembourg real estate property.

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Footnote

1. Administrative Tribunal, Decision No. 45984 of 30.3.2023.

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.