In December 2025, the European Commission issued a letter of formal notice to Luxembourg concerning the failure to abolish a discriminatory tax regime applicable to dividends derived from public investments. The contested regime allows for an exemption of the Luxembourg 15% withholding tax on dividends distributed by Luxembourg resident companies to the Luxembourg State and its public entities, whereas dividends paid to other Member States of the European Union and the European Economic Area, as well as to their public entities, remain subject to such withholding tax. According to the European commission this difference in treatment constitutes a discrimination that is contrary to the principle of free movement of capital enshrined in Article 63 of the Treaty on the Functioning of the European Union ("TFEU") and Article 40 of the Agreement on the European Economic Area ("EEA Agreement").
The discriminatory regime at issue
As a general principle, pursuant to the combined provisions of Articles 146 and 148 of the amended law of 4 December 1967 on income tax (hereinafter, the "L.I.R."), dividends distributed by Luxembourg companies are subject to Luxembourg withholding tax at a rate of 15% of gross income without deduction.
However, Article 147, (2), letter c) of the L.I.R. provides for an exemption from such withholding tax where dividends are allocated to the State, municipalities, municipal syndicates or undertakings of domestic public law entities. This exemption enables Luxembourg public entities to receive the full amount of dividends without any tax deduction.
Conversely, dividends paid to other EU/EEA Member States and their public entities remain subject to the 15% withholding tax without access to the domestic withholding tax exemption. This difference in treatment based on residence is contrary to the principle of free movement of capital.
The European Commission has therefore initiated infringement proceedings. Luxembourg has two months to respond to the letter of formal notice. In the absence of compliance, the Commission shall issue a reasoned opinion and may subsequently refer the matter to the CJEU, which may confirm the infringement and impose financial penalties.
Potential solutions and their implications
The European Commission requires the abolition of the discriminatory regime. The following correctives might be envisaged:
Option 1: extension of the exemption to EU/EEA public entities
This option entails a legislative amendment to Article 147, (2), letter c) of the L.I.R. to extend the withholding tax exemption to dividends paid to EU/EEA Member States and their public entities.
While this option appears to be the preferred approach of the European Commission, whose objective is to extend the benefit of the withholding tax exemption regime to European public entities and Member States this will affect the tax revenues for the Luxembourg State.
Option 2: repeal of the domestic exemption
This option consists of the outright repeal of Article 147, (2), letter c) of the L.I.R., thereby subjecting all dividends paid to public entities, whether Luxembourg or foreign, to the 15% withholding tax. Whilst this solution appears to be the most straightforward in theory, the practical reality may prove otherwise. The fundamental question concerns the budgetary impact: although this option formally satisfies the European Commission's requirement to eliminate the discrimination, it would in substance merely reduce the net dividend income received by the Luxembourg State and as such does not at first glance appear to be a suitable option for the Luxembourg government's objectives
By way of illustration, according to the budget adopted for the 2025 fiscal year, the Luxembourg State anticipates receiving a total amount of EUR 393 million in dividend income through its various shareholdings in local undertakings (Spuerkeess, BNP Paribas, Post Group, Cargolux, etc.). Hence, if this road is followed the State would be deprived of approximately EUR 59 million by virtue of the withholding tax.
The Luxembourg government will therefore have to strike a balance between avoiding an infringement procedure and the least costly option for the budget.
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