This newsletter addresses the few points we would like to highlight with respect to the new corporate tax measures of the Luxembourg income tax law (“LITL”) enacted in Luxembourg for years 2015 and 2016. For a complete overview of the amendments, please refer to PwC Luxembourg newsletter.

We will focus on two specific measures, which are especially relevant for companies having a presence in Luxembourg:

  1. the new Luxembourg domestic participation exemption regime (art. 147 and 166 LITL), and
  2. the transitional rules in relation to the abolishment of the Luxembourg IP regime (art. 50bis LITL)

1. The new Luxembourg participation exemption regime (“the new PEX”) 

Two new conditions have been introduced, applicable to distributions occurring after December 31, 2015, both resulting from the transposition of the EU Parent Subsidiary Directive (“PSD”) as adopted in July 2014 and January 2015:

  1. Condition to counteract the use of “hybrid instruments”
  2. Common minimum anti-avoidance rule

Focusing on the second new condition consisting in the introduction of General Anti-Abuse Rule (“GAAR”), it is worth noting that the text of the law currently foresees its application only in the context of the EU PSD. 

In a nutshell, the new GAARs introduced in article 147 LITL foresee the denying of the withholding tax exemption on dividend distributions by a Luxembourg entity to an entity resident in another EU member state so long as the set-up of the holding structure was mainly driven by tax saving motives defeating the object or purpose of the Directive. 

In the case of Switzerland, although we cannot exclude that the Luxembourg authorities would extend the application of the new GAARs to cases falling in the scope of the Swiss-EU Saving tax agreement, it should in principle not affect cases involving Swiss-Luxembourg structures seeking application of the SwissLuxembourg double tax treaty (“DTT”).

The aforementioned new GAARs have also been introduced in article 166 LITL providing for the Luxembourg PEX on income derived from participations. However, as it is the case with respect to the withholding tax exemption under article 147 LITL, the PEX could still apply provided the subsidiary would qualify as a “fully taxable entity” for Luxembourg tax purposes (i.e., falling into one of the other conditions in article 166 to be a “qualifying entity”, disconnected from the EU PSD).

As a brief recap, an entity would be considered as “fully taxable” from a Luxembourg tax perspective if it meets two cumulative conditions: (1) the company is subject to an effective tax rate equal to at least half of the corporate income tax rate (i.e., currently, it would mean a minimum corporate income tax rate of 10.5%), (2) 

applied on a taxable basis similar to the one it would have if it was a Luxembourg resident company.

The situation involving Swiss subsidiaries of Luxembourg entities should therefore remain basically unchanged. However, a case-by-case analysis is highly recommended particularly for Swiss subsidiaries of Luxembourg holding companies availing the Holding tax status. 

The dividend distribution by a Swiss Holding company to its Luxembourg parent may still however be tax exempt in Luxembourg by application of the DTT (art. 23, §1, c). 

The main issue will therefore concern capital gains realized upon disposal of the Swiss Holding, which could be taxable in Luxembourg (as not covered by the DTT). 

Further guidance from the Luxembourg tax authorities are expected on how they will approach the application of those new conditions in practice.

Also, it should be kept in mind that in the context of all the changes to be implemented in the coming years (e.g., as a consequence of the OECD BEPS project), it is expected that the Luxembourg corporate income tax rate may be decreased which could in some instances allow for some Swiss companies to qualify for the “fully taxable” condition (in case the minimum effective tax rate was the only condition not met).

2. The transitional rules in relation to the abolishment of the Luxembourg IP regime (art. 50bis LITL)

The Luxembourg authorities have decided to repeal the IP regime provided under article 50bis LITL. As a reminder, said regime provided for an advantageous tax treatment of income (including capital gains) derived from qualifying IPs (80% tax exemption). A similar exemption was also provided for net wealth tax purposes.

According to the Budget law as approved last December, the IP regime will be repealed effectively as from July 1st, 2016 (corporate income tax and municipal business tax purposes; January 1st, 2017 for net wealth tax purposes) and a 5-year transitional period will apply to Luxembourg companies owning IP assets and currently benefitting from the IP regime. Specific conditions will have to be met for those companies which did not already benefit from the regime prior to December 31st, 2015, and which would acquire qualifying IP between January 1st and June 30, 2016.

It may be expected that Luxembourg authorities will replace the abolished IP regime by a new one, more in sync’ with the “nexus approach” recommended by the EU Code of Conduct Group and the OECD (BEPS).

Companies with holding and IP companies in Luxembourg are advised to address the above developments.