On 22 July 2026, the Luxembourg Higher Administrative Court (Cour administrative) (the “Court”) (No. 53194C) clarified the framework to assess the arm’s length character of a debt restructuring as well as the rules applicable to the accounting of debt and related interest for tax purposes.
Facts
In 2010, a Luxembourg company (the “Company”) granted a fixed-interest loan (“IBLs”) at 12% to its 65%-owned French subsidiary (“FrenchCo”), financed through bonds (the “Bonds”) issued to its sole shareholder. Following the FrenchCo’s financial difficulties, the various lenders entered into a debt restructuring involving the FrenchCo’s minority shareholder (the “Minority Shareholder”). The restructuring, implemented in March 2018, included, inter alia, a partial waiver of accrued interest in 2017 and 2018, the conversion of part of the debt into equity, the granting of additional guarantees, the reduction of the interest rate at 6%, and the contribution by the Company of its shares in the FrenchCo in exchange for a minority participation in a subsidiary of the Minority Shareholder.
The Luxembourg tax authorities (the “LTA”) considered that the partial waiver of accrued interest under the IBLs resulted in a hidden capital contribution to the FrenchCo and also denied the deduction of part of the interest paid on the Bonds by recalculating the deductible interest on the basis of the depreciated market value of the Bonds rather than their nominal value. On 6 June 2025, the Tribunal upheld both adjustments (please see our previous Newsflash concerning the Tribunal decision).
Court’s decision
Interest waiver: undue advantage to a subsidiary or arm’s length restructuring?
The transaction under scrutiny for fiscal year 2017 was the waiver of interest for the period ranging from 16 October to 31 December 2017 while in first instance the analysis also covered the subsequent reduction in interest rate from 12% to 6%.
The Court recalled that the arm’s length principle requires verifying whether the conditions of an intra-group transaction correspond to those that would have been agreed and accepted between independent enterprises under comparable circumstances. Referring to paragraphs 9.27, 9.28, 1.122 and 5.37 of the 2017 OECD TP Guidelines, the Court held that the arm’s length character of a restructuring must reflect the economic circumstances at the time of the restructuring and the parties’ realistic options. Each concession, including an interest waiver, must be assessed against the arm’s length principle on an entity-by-entity basis, coordinated where the elements are economically linked.
Accordingly, the transfer pricing (“TP”) study, although supporting the arm’s length nature of the original 12% interest rate, could no longer serve as the relevant benchmark as it reflects the circumstances existing when the IBLs were granted in 2010, whereas the restructuring took place several years later in a significantly different economic environment.
The Court further observed that the Company had produced objective evidence demonstrating the FrenchCo’s severe financial difficulties, thereby supporting the conclusion that maintaining the original financing would increase the borrower’s risk of default or place it into insolvency with only a limited recovery rate. Accordingly, the Court considered that an independent lender may legitimately agree to waive part of its claim where such concession enables it to achieve a more favourable economic outcome than the other realistically available alternatives of maintaining the financing.
Finally, the Court refused to assess the waiver in isolation but considered the overall restructuring. First, the Company had also benefited from additional guarantees, converted part of the IBLs into equity and ultimately received a minority participation in another company of the Minority Shareholder. Secondly and contrary to the Tribunal, the Court considered the involvement of a third party, the Minority Shareholder, as further supporting the arm’s length character of the waiver.
Accordingly, the Court concluded that the partial waiver of interest complied with the arm’s length principle and could therefore not be requalified as a hidden capital contribution.
Deductibility of interest calculated on nominal value rather than depreciated market value
The second issue concerned the deductibility of the interest paid by the Company on Bonds issued to its shareholder. The LTA challenged the deduction of part of such interest on the basis that it should have been calculated by reference to the depreciated market value of the Bonds rather than their nominal value.
The Court rejected this approach. Referring to Article 23(4) of the Luxembourg Income Tax Law (“LITL”), read together with Article 23(3) LITL, it recalled that debts must, as a matter of principle, be valued at nominal value, unless a higher repayment obligation exists. Conversely, a debt cannot be valued below its nominal amount solely because its market value has decreased, unless there has been an actual debt release or it has become certain that the debt will never be repaid.
For the computation of the interest, the Court held that the accounting or market valuation of a debt is irrelevant and interest continue to accrue on the principal contractually owed by the debtor, irrespective of any accounting impairment or decrease in the market value of the debt. Accordingly, the LTA could not recalculate the deductible interest by reference to the depreciated market value of the Bonds, and the disallowed amount therefore remained deductible.
Key takeaways
- The arm’s length character of an intra-group debt restructuring must be assessed in light of the economic circumstances and the realistically available alternatives existing at the time of the restructuring, rather than solely by reference to the initially agreed terms.
- A TP study prepared for the original financing may no longer constitute the relevant benchmark where the economic circumstances have fundamentally changed. In such cases, taxpayers should ensure that the commercial rationale for the restructuring is supported by appropriate evidence.
- The participation of an unrelated third party in the negotiation and implementation of a restructuring may constitute strong evidence that the arrangements reflect market behaviour and may therefore reinforce the arm’s length nature of the transaction.
- For tax purposes, contractual interest continues to accrue on the nominal amount of a debt despite possible adjustments to the accounting value.
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