On 8 January 2021, the Luxembourg tax authorities issued a circular (Circulaire du directeur des contributions L.I.R. n°168bis/1 du 8 janvier 2021) (the “Circular”) on the interest deduction limitation rules (“ILR”) as foreseen in Article 168bis of the Luxembourg income tax law (“LITL”).
The ILR has been introduced in the LITL by the law dated 21 December 2018 (as amended), implementing into Luxembourg law the Council Directive EU 2016/1164/EU of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market (commonly known as the ATAD Directive). The ILR entered into force on 1 January 2019.
The ILR limits the deductibility of exceeding borrowing costs to the highest of (a) 30% of the taxpayer’s fiscal EBITDA (Earnings before Interest, Tax, Depreciation and Amortisation) and (b) EUR 3 million. Standalone entities as well as taxpayers who can demonstrate that their equity ratio is equal to or lower than the ratio of the consolidated group they belong to, can, subject to certain conditions, nonetheless fully deduct their borrowing costs under the ILR.
The ILR defines “exceeding borrowing costs” as corresponding to the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest revenues and other economically equivalent taxable revenues that the taxpayer receives.
CLARIFICATIONS PROVIDED BY THE CIRCULAR
Although the ILR contains a broad definition of the borrowing costs, no precise definition of “taxable interest revenues and other economically equivalent taxable revenues” is provided. The Circular now officially confirms the approach defended by the tax doctrine, which consists in applying a symmetrical approach between the definitions of interest expenses and interest income, thus alleviating the uncertainty left by legislation. It is interesting to note that the Luxembourg tax authorities themselves, in the 2019 tax forms, already applied this position.
Another confirmation provided by the Circular relates to the grandfathering clause. The ILR indeed excludes form the scope of the ILR, exceeding borrowing costs that are linked to loans concluded before 17 June 2016 (the “Grandfathering Date”) to the extent that their terms are not subsequently modified. With respect to the “subsequently modified” criteria, the Luxembourg tax authorities provide a non-exhaustive list of situations deemed to create a subsequent modification, such as: (i) an extension of the loan maturity date, when such an extension was not already provided for in the loan concluded before the Grandfathering Date, the subsequent modification of the interest rate when such a modification was not already included in the loan concluded before the Grandfathering Date, (ii) an amendment to the principal amount of the loan after the Grandfathering Date and (iii) the change of parties to the loan agreement, when such a change was not already provided for in the loan concluded before the Grandfathering Date. In the context of the last point, the tax authorities confirm that in their view, a change of parties due to a restructuring such as a merger or demerger should not jeopardize the grandfathering of the loan. Likewise, the tax authorities confirm that an increase of the loan amount under a facility should not challenge the grandfathering, provided that the increase does not increase the maximum amount of the facility granted prior to the Grandfathering Date. Last but not least, the tax authorities also confirm that the grandfathering clause should apply to taxpayers moving their tax residency to Luxembourg in case they were party to a loan agreement concluded before the Grandfathering Date.
Finally, the Circular provides two additional clarifications, the first one concerning long-term public infrastructure projects and the second one concerning “standalone entities” that are out of scope of the ILR. For the long term public infrastructure projects, the tax authorities provide a non-exhaustive list of examples of what could qualify as long-term public infrastructure projects, such as universities, public libraries and public swimming pools, a significant emphasis being put on the public interest aspect of those projects. For the standalone entities, the tax authorities confirm that an economic approach should be applied when assessing whether parties are related or not.