Local developmentsi Entity selection and business operationsEntity forms
Corporate law provides a wide range of legal forms of companies and partnerships. Historically, Luxembourg entrepreneurs have used commercial partnerships to carry out their activities. However, in the past decade this trend has shifted towards a more frequent use of corporate vehicles in this context. Inversely, in the funds area, the new common and special limited partnerships (CLPs and SLPs) have gained substantial recognition in the market.Limited liability companies
Luxembourg-resident companies are fully subject to corporate income tax (CIT), municipal business tax (MBT) and net wealth tax (NWT). Depending on the need of the shareholders, they may generally adopt a corporate form such as a public limited company, a limited liability company or a corporate partnership limited by shares.
A limited liability company is subject to CIT, MBT and NWT if it is considered under Luxembourg law as a Luxembourg resident. Under Luxembourg law, a company is considered as a Luxembourg resident if its registered office (i.e., statutory office as determined by the articles of incorporation of the company) or its central administration (i.e., the place of effective management of the company) is located in Luxembourg. From a pure Luxembourg tax law standpoint, one of these two criteria is sufficient to consider a company as a Luxembourg resident and, generally, no additional mandatory substance requirements should be fulfilled for the company to be considered as a Luxembourg resident (except for companies engaged in intra-group financing activities). In an international context, however, the absence of sufficient economic substance in Luxembourg or maintaining closer links with another foreign jurisdiction may result in foreign tax authorities challenging the Luxembourg tax residence of the company. Therefore, in an international context, Luxembourg companies should have a minimum level of economic substance in Luxembourg.Limited partnerships
There are mainly two types of limited partnerships under Luxembourg law: the CLP and the SLP. The specificity of CLPs and SLPs is that they are transparent for Luxembourg tax purposes. The main difference between them is that a SLP, unlike a CLP, is not vested with legal personality. Both limited partnerships regimes have proven to be widely accepted and used by all persons wishing to have an onshore European domiciled partnership with similar features to Anglo-Saxon types of partnership structures.
Owing to their tax transparency, they are not subject to CIT or NWT. However, a CLP or SLP may be subject to Luxembourg MBT if it carries out a genuine business activity in Luxembourg pursuant to Article 14(1) of the Luxembourg income tax law (ITL) or if it is tainted by business on the basis of the Geprägetheorie according to Article 14(4) of the ITL – namely where the general partner is a Luxembourg limited liability company that owns at least 5 per cent of the interests in the CLP or SPL. As regards this business activity, Circular letter L.I.R. No. 14/4, dated 9 January 2015, provides that CLPs and SLPs that qualify as alternative investment funds within the meaning of the Alternative Investment Fund Management law of 12 July 2013 are deemed not to be conducting a business activity.
The qualification of a CLP or SLP being subject to MBT would, besides tax liability, also result in the (material) consequence of non-resident limited partners being considered to each operate a permanent establishment (PE) in Luxembourg, as their interest in the CLP or SLP would generally be attributable to the PE in Luxembourg (unless under a double tax treaty where different provisions would apply). In principle, because of the non-MBT exposure of a properly structured CLP or SLP, independent professionals tend to structure their activity through such transparent entities. With regard to withholding tax (WHT), any 'distributions' by the partnership are, as a rule, made free of WHT in Luxembourg. Distributions are performed for corporate reasons only, but are disregarded from a tax perspective, as any income and loss derived at the level of the partnership is directly attributable to the partners.
Given its tax transparency, CLPs or SLPs may not benefit from double tax treaties but their partners may generally claim treaty benefits from the source state.Investment vehicles
Under Luxembourg law, a full range of different vehicles are available to structure investments. As a general rule, those investment vehicles benefit from an advantageous tax regime. They consist of the following important investment vehicles:
- tailor-made investment funds, (i.e., undertakings for collective investment (UCIs), a special investment fund (SIFs) or a reserved alternative investment fund (RAIFs) opting for the SIF-like regime), which can take different corporate forms;
- companies investing in risk capital (SICARs), and RAIFs opting for the SICAR-like regime, which can take different corporate forms;
- common funds;
- securitisation undertakings;
- pension funds; and
- family wealth management companies (which are often structured together with a limited liability company and financed mainly with loans to benefit from the final 20 per cent WHT on interest distributions to Luxembourg-resident individuals; see the subsection on 'Withholding taxes').
The investment vehicles mentioned under points (a) and (e) and are thus only subject to a subscription tax without being subject to WHT on distributions to investors. It must be analysed on a case-by-case basis whether double tax treaties are applicable to these vehicles.
SICARs, such as mentioned in point (b), are fully subject to taxation but exempt from taxation on income arising from assets held in risk capital. As the purpose of a SICAR is limited to investments in risk capital, all of its income should thus be exempt from taxation. If SICARs opt for an opaque entity form, double tax treaties should, in principle, be applicable to them.Domestic income taxCIT and MBT
The taxable profit as determined for CIT purposes is applicable, with minor adjustments, for MBT purposes. MBT rates vary depending on the municipality in which the company's registered office or undertaking is located.
In 2019, CIT is levied at an effective maximum rate of 18 per cent (19.26 per cent, including the 7 per cent surcharge for the employment fund) for corporate income above €30,000. An intermediary rate of €3,750 plus 33 per cent of net income exceeding €25,000 is also available for corporate income between €25,000 and €30,000. Finally, a lower rate of 15 per cent for corporate income below €25,000 may also be applicable. MBT is levied at a variable rate according to the municipality in which the company is located (6.75 per cent for Luxembourg City in 2019). The maximum aggregate CIT and MBT rate consequently amounts to 26.01 per cent in 2019 for companies located in Luxembourg City.NWT
Luxembourg imposes NWT on Luxembourg-resident companies at the rate of 0.5 per cent (or 0.05 per cent for the upper tranche of net worth exceeding €500 million) applied on net assets as determined for NWT purposes. Net worth is referred to as the unitary value, as determined in principle on 1 January of each year. The unitary value is calculated as the difference between assets estimated at their fair market value and liabilities regarding third parties. In that respect, third-party liabilities in relation to exempt assets are not deductible when computing the unitary value.
Further, Luxembourg-resident companies are subject, as of 1 January 2016, to a minimum NWT. This is set at €4,815 for Luxembourg companies whose financial assets, receivable against related companies, transferable securities and cash deposits, cumulatively exceed 90 per cent of their total balance sheet and €350,000. All other companies that do not meet the aforementioned conditions are subject to a minimum NWT on the basis of their total balance sheet at year end, according to a progressive tax scale varying from €535 to €32,100 respectively for a total balance sheet from €350,000 to at least €30,000,001.WHT
Dividends paid by a Luxembourg company to its shareholders are, as a rule, subject to WHT at a rate of 15 per cent.
An arm's-length interest paid by a Luxembourg company is generally not subject to WHT. However, a payment of interest or similar income made by a paying agent established in Luxembourg (or under certain circumstances in the European Union or the European Economic Area (EEA)) to or for the benefit of an individual owner who is a resident of Luxembourg, will be subject to a WHT of 20 per cent. This WHT will be in full discharge of income tax if the beneficial owner is an individual acting in the course of the management of his or her private wealth. Responsibility for WHT is assumed by the Luxembourg paying agent.
Liquidation proceeds (deriving from a complete or partial liquidation) paid by a Luxembourg company are not subject to WHT.
Royalties paid by a Luxembourg company are generally not subject to WHT.
Fees paid to directors or statutory auditors are subject to a WHT levied at the rate of 20 per cent on the gross amount paid (25 per cent if the withholding cost is borne by the payer). WHT is the final tax for non-resident beneficiaries if their Luxembourg-sourced professional income is limited to directors' fees not exceeding €100,000 per fiscal year.International tax – double taxation elimination method
Luxembourg has an extensive double tax treaty network and has signed, as at the time of writing, double tax treaties with 83 countries, and is in negotiation to sign a double tax treaty with 15 more countries.
In the absence of a double tax treaty, resident taxpayers are generally subject to Luxembourg income tax on their worldwide income, but unilateral credit relief is generally available.
Under treaties concluded by Luxembourg, double taxation is generally avoided by way of an exemption method with a progressivity clause that permits the inclusion of foreign income into the Luxembourg tax base to determine the global tax rate. As an exception, Luxembourg generally relies on the credit method regarding dividends, interest and royalties. Some double tax treaties concluded by Luxembourg provide tax-sparing clauses, which should also apply to Luxembourg PEs of US-resident companies.Capitalisation requirements
According to the general practice adopted by the Luxembourg tax authorities (LTA), the debt-to-equity ratio applicable to a fully taxable Luxembourg limited liability company is 15 for equity to 85 for all liabilities combined (shareholder and third-party debt, represented or not by an instrument). It is understood that these liabilities finance the acquisition of participations and bear a market interest rate. (See 'Transfer pricing consideration' subsection for the equity at risk requirements in relation to an intra-group financing transaction.)ii Common ownership – group structures and intercompany transactionsOwnership structure of related parties – fiscal unity
Under certain conditions, Luxembourg-resident companies of the same group are allowed to consolidate their taxable profits and losses for CIT and MBT purposes.
The main conditions of the fiscal unity regime may be summarised as follows:
- the consolidating parent company must be either a fully taxable resident company or a Luxembourg PE of a non-resident company liable to a tax corresponding to Luxembourg CIT;
- the consolidated subsidiaries must be either fully taxable resident companies or Luxembourg PEs of non-resident companies liable to a tax corresponding to Luxembourg CIT;
- the consolidating parent company must hold, either directly or indirectly, a participation of at least 95 per cent in the share capital of the consolidated subsidiaries. Participation of at least 75 per cent may also qualify for fiscal unity, but is subject to the approval of the Ministry of Finance and of at least three-quarters of the minority shareholders. Indirect participation of at least 95 per cent may further be held through non-resident companies liable to a tax corresponding to the Luxembourg CIT. The participation condition must be uninterruptedly satisfied as of the beginning of the first accounting period for which the fiscal unity is requested; and
- the regime is granted upon written application filed jointly by the consolidating parent and the consolidated subsidiaries for at least five years. The application must be filed before the end of the first accounting period for which fiscal unity is requested.
Since 2016, horizontal fiscal unity has been permitted between qualifying companies that are held by a common parent company established in an EEA Member State and subject to a tax corresponding to CIT. This is fiscal unity between two or more Luxembourg-resident companies owned by the same non-resident parent, provided that the parent company is resident in a state of the European Economic Area.Intercompany transactionsParticipation exemption regime and other exemptions applicable to dividends, liquidations proceeds and capital gainsDividends and liquidation proceeds
To qualify for the participation exemption on dividends and liquidation proceeds, the following conditions must be met (Article 166 ITL):
- the parent company must be either:
- a Luxembourg-resident fully taxable company;
- a Luxembourg PE of a company covered by Article 2 of the amended EU Parent-Subsidiary Directive (PSD);
- a Luxembourg PE of a company resident in a country having a tax treaty with Luxembourg; or
- a Luxembourg PE of a company that is resident in a Member State of the European Economic Area, other than an EU Member State;
- the parent must hold a direct participation in the share capital of an eligible entity (the eligible entity), namely:
- a Luxembourg-resident fully taxable company;
- a company covered by Article 2 of the PSD; or
- a non-resident company liable to a tax corresponding to Luxembourg CIT; or
- at the time the income is made available, the parent company must have held or must commit itself to hold a participation in the eligible entity for an uninterrupted period of at least 12 months, a participation of at least 10 per cent or an acquisition price of at least €1.2 million. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
If the conditions for the participation exemption are not satisfied, dividends are as a rule taxable at the ordinary rate. As an exception, a 50 per cent exemption is available for dividends derived from a participation in one of the following entities:
- a Luxembourg-resident fully taxable company limited by share capital;
- a company limited by share capital resident in a state with which Luxembourg has concluded a double tax treaty and liable to a tax corresponding to Luxembourg CIT; or
- a company resident in an EU Member State and covered by Article 2 of the amended PSD.
Capital gains realised on the transfer of participations are exempt under the following conditions (Article 166(9)(1) ITL and Grand-Ducal Decree of 21 December 2001):
- the parent and the entity in which the participation is held must satisfy the same conditions as those applicable for the exemption of dividends (see the subsection on 'Dividends and liquidation proceeds'); and
- the parent must have held or commit itself to hold a direct participation in the share capital of the eligible entity for an uninterrupted period of at least 12 months, a participation of at least 10 per cent or an acquisition price of at least €6 million. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
If the above-mentioned conditions are not met, capital gains are as a rule taxable at the ordinary rate.
However, the participation exemption regime contains some rules intended to avoid a double benefit – namely the exemption of capital gains realised by a Luxembourg company upon disposal of its participation would not apply to the extent of the algebraic sum of related expenses and value adjustments that have decreased the tax result of the current or preceding years. Nevertheless, losses in relation to exempt income under the participation exemption remain deductible once they become final.Outbound dividend distribution
Dividends paid by a Luxembourg company to its shareholders are as a rule subject to a 15 per cent WHT, unless a reduced rate or an exemption applies under an applicable double tax treaty, or because of the participation exemption regime.
Under Article 147 of the ITL, dividend payments made by a fully taxable Luxembourg company may be exempt from WHT provided that, at the time the income is made available:
- the distributing entity is a Luxembourg-resident fully taxable company;
- the recipient is either:
- a Luxembourg-resident fully taxable company;
- a company covered by Article 2 of PSD or a Luxembourg PE thereof;
- Luxembourg, a municipality, a syndicate of municipalities or local corporate bodies governed by public law;
- a company liable to a tax corresponding to Luxembourg CIT, and a resident of a country with which Luxembourg has a double tax treaty or a Luxembourg PE thereof;
- a company resident in an EEA Member State other than an EU Member State, and liable to a tax corresponding to the Luxembourg CIT or a Luxembourg PE thereof; or
- a Swiss-resident company that is effectively subject to CIT in Switzerland without benefiting from an exemption; or
- at the time the income is made available, the recipient holds or commits itself to hold directly for an uninterrupted period of at least 12 months a participation of at least 10 per cent or an acquisition price of at least €1.2 million in the share capital of the distributing entity. Holding a participation through a tax-transparent entity is deemed to be a direct participation in the proportion of the net assets held in this entity.
Such an application of the national participation exemption could be envisaged in the case of dividends distributed by a Luxembourg-resident company to its eligible shareholder in the form of a US real estate investment trust.NWT
The participation of a Luxembourg company in another company will be considered as an exempt asset for NWT tax purposes to the extent the conditions of the Luxembourg participation exemption regime, as described above, are met (except that the Luxembourg company must merely hold the qualifying participation at the end of the previous accounting year).Transfer pricing considerations
As a general rule, Luxembourg does not levy any WHT on arm's-length interest payments. However, companies engaged in intra-group financing activities need to evidence that their remuneration complies with the arm's-length principle. According to the OECD's arm's-length principle, activities that are carried out between affiliated companies must comply with market conditions, namely conditions that would apply between independent companies.
To provide practical guidance to companies engaged in intra-group financing activities and following the implementation of the new Article 56 bis of the ITL, the LTA issued a circular letter, dated 27 December 2016, which follows the OECD guidelines in transfer pricing matters.Scope
Transfer pricing considerations, inter alia, apply to all companies that are engaged in intra-group financing transactions.Determination of the arm's-length price
The comparability analysis is the main element for the application of the arm's-length principle: the arm's-length principle is based on a comparison of the conditions of a controlled transaction with the conditions that would have been made had the parties been independent had they undertaken a comparable transaction under comparable circumstances.Equity at risk
Companies engaged in intra-group financing activities must have the financial capacity – or equity at risk – to assume the risks related thereto. The amount of equity at risk must hence be determined by an appropriate transfer pricing analysis on a case-per-case basis. No specific methodology is foreseen but equity at risk needs to be determined on the basis of a credit risk analysis, which includes a market analysis, a balance sheet analysis as well as all the other elements that are relevant for the determination of the risks linked to a financing activity.Economic substance
To be able to control the aforementioned risks, an intra-group financing company must have a genuine presence in Luxembourg, which requires a minimum of economic substance in Luxembourg, as follows:
- the majority of the members of the board of managers, directors or managers having power to bind the company must be (1) Luxembourg residents or (2) non-residents who pursue a professional activity (i.e., a business or agricultural, forestry, independent or salaried activity) in Luxembourg and who are taxable in Luxembourg for at least 50 per cent of their professional revenue. If a company is part of the management board, it must have its statutory seat and central administration in Luxembourg;
- the company must have qualified personnel able to control the transactions performed. The company may, however, outsource functions that do not have a significant impact on the control of the risks;
- key decisions regarding the management of the company must be taken in Luxembourg. Companies that are required by corporate law to hold shareholder meetings must hold at least one annual meeting at the place indicated in the articles of incorporation; and
- the company must not be considered as a tax resident of another state.
On 1 January 2018, a new intellectual property box regime (the IP Box Regime) following the modified nexus approach (as proposed by the Base Erosion and Profit Sharing (BEPS)Action 5) entered into force. Eligible IP assets are mainly limited to patents, software protected by copyright under national or international provisions in force, and utility models. IP assets of a commercial nature are excluded. Taxpayers that carry out an economic activity in Luxembourg, including certain PEs, are entitled to the IP Box Regime (80 per cent exemption from CIT and MBT) according to a nexus approach on the net income from the eligible IP asset. Eligible IP assets are 100 per cent exempt from NWT.
Investment tax credits are available to Luxembourg companies and Luxembourg PEs of non-resident companies for their qualifying investments physically used in a country of the European Economic Area. As a general rule, qualifying investments include, among others, tangible depreciable assets other than buildings and livestock, and mineral and fossil deposits. As such, tax credits can be available to Luxembourg companies for certain assets financing, for example, planes or software that has been acquired (as opposed to self-developed), and can be extended inter alia to the shipping industry under specific rules.iv Indirect taxesGeneral considerations
In 2019, the standard value added tax (VAT) rate in Luxembourg is 17 per cent. Reduced rates of 3 per cent, 8 per cent and 14 per cent apply to supplies of goods and services that are specified in three appendices to the Luxembourg VAT Law. These appendices cover the specific scope of the application of the reduced rates and must be interpreted in a strict sense. The Finance Bill envisages the introduction of a reduced VAT rate of 3 per cent for e-books and e-press, as well as certain hygienic products, of 8 per cent for certain phytosanitary products and an increase in excise duties on petrol.
All supplies of goods and services carried out (or deemed to have been carried out) in Luxembourg for consideration, and by a person carrying out an economic activity, fall within the scope of the Luxembourg VAT Law. While located in Luxembourg, certain supplies of goods and services may benefit from a VAT exemption. The most frequently used VAT exemptions relate to: the supply and letting of real property, except where taxation is opted for; financial transactions; insurance and reinsurance, and connected services; and the management of regulated UCIs, SICARs, SIFs, alternative investment funds, pension funds and Luxembourg securitisation undertakings.VAT group
Persons that are closely bound by financial, economic and organisational links (cumulative conditions) can constitute a VAT group. A VAT group does not provide for any limitation as regards the status of the person (i.e., VAT taxable or not), or the nature or type of activity (e.g., VAT exempt or taxable supply of services or goods). However, persons may only be members of one VAT group and the members of a VAT group must be established within the same EU Member State (no cross-border VAT groups). Members of a VAT group are considered as a single entity for VAT purposes, with the result that supplies and services provided among members of a VAT group (i.e., internal transactions) are outside the scope of VAT.