Two limited liability Luxembourg companies ("Lux Co 1" and "Lux Co 2") were created, on the same day, by the ultimate investors based in the UK and Monaco. Lux Co 1 owned Lux Co 2.
A few months later, Lux Co 2 created five Danish entities ("Danish Cos"), which subsequently purchased ("Purchase") French real estate or special purpose French vehicles owning French real estate ("French Assets").
Subsequently, Danish Cos sold the French Assets ("Sale"), resulting in an aggregate capital gain of €70 million ("Capital Gain"). Before the actual Purchase and Sale took place, Lux Co 2 had signed a protocol documenting the principle of the disposal of the French Assets.
The FTA took the position that, for the purposes of the AOL procedure, Lux Co 2, rather than Danish Cos, should be viewed as having realized the Capital Gain, i.e. Lux Co 2 should be treated as if having effected directly the Purchase and Sale of the French Assets, the intermediation of Danish Cos (totally controlled by Lux Co 2 and without economic substance) being enacted with the sole motivation of avoiding French tax on the Capital Gain.
The AoL Committee ruled in favor of the FTA, on the basis of the following arguments:
Under the then-applicable Danish/French double tax treaty, the French real estate capital gains were not taxable in either jurisdiction; the situation was the same under the Luxembourg/French double tax treaty, before the treatment was changed from January 1, 2008 (where such capital gain became taxable in France).
Lux Co 2 implemented all the necessary steps for the Purchase and Sale of the French Assets even before the Danish Cos were created; notably the relevant market counterparties dealt only with Lux Co 1 and Lux Co 2, and all the transfers of the related cash flows took place in Luxembourg.
The Danish Cos were created only because of the above change in the Luxembourg/French double tax treaty; in other words, the incorporation of the Danish Cos had no other purpose than to avoid (by using the Danish/French double tax treaty) the French tax that would have been due if the Capital Gain were realized by Lux Co 2.
The AoL procedure should be applicable given that the avoidance of the taxation of the Capital Gain is against the objectives of the Danish/French double tax treaty, where such nontaxation derives from the purely tax-motivated incorporation of the Danish entities.
The AoL Committee also decided that Lux Co 2 had the principal initiative to set up the structure challenged under the AoL procedure and, accordingly, should be liable to the 80 percent penalty. NB: The AOL procedure provides for 80 percent and 40 percent penalties, the latter being applicable when the relevant taxpayer is neither the principal initiator nor the principal beneficiary of the relevant transaction.