The Luxembourg tax authorities issued a circular on 8 January 2021 on the interest deduction limitation rules (“ILR”) as foreseen in Article 168bis of the Luxembourg income tax law (“LITL”).
The original circular was already amended several times (Circulaire du directeur des contributions L.I.R. n°168bis/1 du 2 juin 2021 and Circulaire du directeur des contributions L.I.R. n°168bis/1 du 28 juillet 2021) before being most recently replaced by the circular of 25 March 2022 (Circulaire du directeur des contributions L.I.R. n°168bis/1 du 25 mars 2022) (the “Circular”).
Precision of the concept of "subsequently modification" of the loan
As a reminder, exceeding borrowing costs related to debt instruments concluded before 17 June 2016 are excluded from the scope of the ILR (in accordance with the application of the grandfathering clause) except when a modification, qualified as “subsequent modification”, occurs after this date (extension of the loan maturity date, amendment to the principal amount of the loan after the Grandfathering Date).
In this regard, the tax authorities specify that a modification of the loan to compensate for the end of the “London Interbank Offered Rate” (the “LIBOR”) cannot constitute a “subsequent modification” bringing the loan within the scope of the ILR as soon as three cumulative conditions are met. The modification:
- Is strictly required to take into account the cessation of the LIBOR or its unrepresentativeness;
- Does not change the economic substance of the loan; and
- Does not include other changes, which could be qualified as “subsequent changes”.
Application of the interaction between the interest deduction limitation rules and the parent-subsidiary regime
The ILR provide for the limitation of the deduction of exceeding borrowing costs incurred in a financial year by a taxpayer up to the higher of 30% of its taxable EBITDA and EUR 3 million.
This provision is likely to interact with other provisions of the same law and in particular (a) Article 166 LITL providing for the tax exemption of income from qualifying participations within the meaning of the parent-subsidiary regime and (b) the amended regulation of 21 December 2002 implementing paragraph 9 of this provision.
This is particularly the case when operating expenses are directly economically related to the exempt income from a qualifying participation within the meaning of the parent-subsidiary regime and are also considered as borrowing costs within the meaning of the ILR. Indeed, as a reminder, expenses that are economically linked to exempt income are not deductible up to the amount of such income in a given tax year, but remain deductible for any amount in excess of tax exempt income (subject to the recapture rule). In the Circular, the tax authorities discuss the interaction between the rules of the parent-subsidiary regime and the ILR. The Circular provides for an allocation method of the exceeding borrowing costs as follows:
- On the one hand to interest expenses exceeding the interest income (fully deductible before the application of the ILR) and subject to the recapture rule, and
- On the other hand to other interests expenses related to the taxpayer’s activity which differs from the holding of participations.
The calculations recommended by the Circular could materially affect the tax position of a company that both (i) holds participations and (ii) grants loans to its subsidiaries. As this situation is regularly encountered in practice, taxpayers should closely monitor this aspect going forward.