The Luxembourg Higher Administrative Court (Cour Administrative) in a judgment rendered on 14 January 2021 (No. 44763C) confirms that the partial disposal of a business undertaking by an individual to third-parties should qualify as a transfer for consideration of part of a business undertaking and as a result be considered as an extraordinary income benefiting from a preferential tax rate rather than as ordinary income. This judgement thus solves the long standing uncertainty as to whether the partial disposal of a business undertaking by an individual should benefit from the same preferential tax regime as the complete disposal of a business undertaking.
In the matter at hand, the Luxembourg direct tax authorities challenged the tax return filed by two married physiotherapists in respect of a partial transfer of their practice. The disposal consisted in selling a portion of the business (fonds de commerce) to two different third-parties. The sale agreement covering the transfer of the business provided that the disposal price was determined in accordance with the value of the patient group and the practice’s equipment.
Upon filing of their tax returns, the married couple reported the sale price of the transaction as a disposal gain (bénéfice de cession) in order to benefit from the preferential tax rate that applies in case of the realization of extraordinary income. When assessing the tax returns, the Luxembourg direct tax authorities refused the qualification of the sale proceeds as bénéfice de cession on the ground that the transaction does not constitute a sale of part of a business’ units and the couple still carries out their physiotherapist activity in said practice. Consequently, the application of the preferential tax regime (the “half-rate rule”) was denied and the proceeds were taxed in the same manner as ordinary income in the taxpayers’ hands. Upon receipt of the disputed tax assessment, the married couple filed a claim before the competent tax office. In the absence of an answer from the Director of the Luxembourg direct tax authorities, an appeal was lodged by the taxpayers before the Lower Administrative Court (Tribunal administratif). Not succeeding in their argument in the first-instance judgement, the Luxembourg direct tax authorities appealed the adverse decision before the Higher Administrative Court.
Analysis performed by the Luxembourg Higher Administrative Court
In its judgment dated 14 January 2021, the Luxembourg Higher Administrative Court first assessed whether the qualification of the partial disposal of a physiotherapy practice should fall within one of the business transfer scenarios foreseen under Article 15 of the Luxembourg Income Tax Law (“LITL”). To that end, the Luxembourg Higher Administrative Court specified that “a fonds de commerce should be defined as a range of elements contributing to the constitution of an economic unit whose purpose has a commercial nature being composed of tangible and intangible assets”. In this regard, the Luxembourg Higher Administrative Court noted that the transfer was not limited to the patient group as stated by the Luxembourg direct tax authorities but on an identified portion of the whole practice. Additionally, the Luxembourg Higher Administrative Court highlighted that the sale agreement contractually foresaw that the married couple would pursue their activities within the practice and the two purchasing third-parties would become shareholders of the practice upon the partial transfer.
Considering all the above, the Luxembourg Higher Administrative Court confirmed the position taken by the judges in the first instance: the disputed transfer must be analysed as a transfer for consideration of part of a business undertaking within the meaning of Article 15 al. 1 - n°3 LITL.
Furthermore, the Higher Administrative Court confirmed the approach taken by the Lower Administrative Court with regards to the determination of the tax rate applicable to the income arising from the transfer for consideration of part of a business undertaking. As the sale proceeds fall within the scope of bénéfice de cession, said bénéfice de cession should be treated as taxable extraordinary income. As a result, the preferential tax rate which corresponds to half of the overall marginal tax rate of the taxpayer applies to the adjusted taxable income.