On 31 May, 2022, the Luxembourg tax authorities (“LTA”) issued a new circular (the “Circular”) on defensive measures against non-cooperative jurisdictions. This Circular replaces a previous circular (dated 2018) on the same subject and follows the introduction, in 2021, of Article 168 (5) of the Luxembourg income tax law (the “LITL”).
As a reminder, the latter provision disallows, under certain conditions, the tax deduction of interest and royalty expenses, in case the recipient of the corresponding payments is an associated enterprise established in a jurisdiction or territory appearing on the EU blacklist. The EU blacklist currently includes American Samoa, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands and Vanuatu. A more general description of these defensive measures can be found in our newsflash issued on 1 April 2021.
The Circular sets out the background of the defensive measures as well as the criteria according to which blacklisted jurisdictions are identified at EU level. It further provides useful clarifications relating to the scope of Article 168 (5) of the LITL to the relevant version of the blacklist in case of updates during the course of a given year, as well as to certain consequences of and exceptions to the applicable rules. Finally, the Director of the LTA describes certain administrative measures, taken against non-cooperative jurisdictions.
Clarifications on the scope of Article 168 (5)
Article 168 (5) of the LITL applies to any corporate entity (“organisme à caractère collectif”) that is subject to Luxembourg Corporate Income Tax (“CIT”). This means that both Luxembourg tax resident corporate entities and non-resident corporate entities taxed on Luxembourg sourced income (based on Article 156 LITL), as well as permanent establishments of non-Luxembourg resident corporate entities fall within the scope of the defensive measures.
The Circular further explains that Article 168 (5) of the LITL applies to interest and royalty expenses as soon as they are accrued, notwithstanding their actual date of payment. Any kind of interest or arrears on any kind of liabilities, with or without collateral or a participation clause, including bonds, are targeted. Royalties are defined as remuneration of any kind paid for the use or licensing of the intellectual property of a literary, artistic or scientific work (including films, patents, trademarks, drawings, templates, blueprints, etc.)
Finally, it should be noted that interest or penalties for late payment are out of scope.
Relevant version of the EU blacklist
The Circular clarifies that Article 168 (5) LITL in principle only applies with respect to one single version of the EU blacklist per fiscal year. The relevant version of the EU blacklist is the last available version as at 1 January of each year. For the 2021 fiscal year, the relevant version of the EU blacklist is the one dated 26 February 2021, i.e. the last published version as at 1 March 2021, when Article 168 (5) of the LITL entered into force.
An exception applies however to jurisdictions which are removed from the EU blacklist during the course of the fiscal year (without being added back to the EU blacklist before the end of the year). In such circumstances, the defensive measures immediately cease to apply with respect to payments made to associated enterprises in the concerned jurisdiction and a pro rata determination of the portion of expenses falling within the scope of Article 168 (5) of the LITL would need to be carried out.
Tax consequences if the conditions of Article 168 (5) are met and exceptions
Interest and royalties falling within the scope of the defensive measures should not be deductible for tax purposes. The Circular specifies that, in case interest expenses are not deductible based on Article 168 (5) of the LITL, they should not be taken into account as “borrowing costs” for the purpose of determining deductible exceeding borrowing costs based on the interest limitation rules of Article 168bis of the LITL.
By way of exception, interest and royalties in scope of the measures should remain deductible, if the taxpayer evidences that such expenses are incurred in the context of a transaction that is entered into for valid business reasons that reflect the economic reality. The taxpayer needs to provide relevant evidence that the exception can apply, upon request of the LTA. The Circular specifies that an application for a tax ruling may be sought in case the taxpayer wishes the LTA to bindingly confirm the application of the exception provided for by Article 168 (5) of the LITL to a specific fact pattern.
Defensive administrative measures
The previous circular already provided for certain defensive measures, which the LTA decided to maintain, in addition to the application of Article 168 (5) of the LITL. As part of these measures, the LTA notably requires taxpayers to tick a specific box in their tax return if they carry out transactions with related parties in a blacklisted country. The applicable version of the blacklist for this purpose is the one in force at the end of the accounting period concerned by the tax return.
These administrative measures, which are taken in order to allow for an increased scrutiny by the LTA, are state to have a broader scope than the one of Article 168 (5) LITL and are thus not limited to transactions generating interest or royalties payments. In this context, the LTA will be able to request additional information within the framework of the examination of the tax return.