Luxembourg:
Guidelines of the Luxembourg tax authorities on the limitation of interest deductions
January 22, 2021
ELVINGER HOSS PRUSSEN, stock corporation
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On January 8, 2021, the Luxembourg tax authorities published the long-awaited administrative circular (“Circular”) Instructions on certain aspects of the interest deduction cap rule (“IDLR“) According to Article 168bis of the Luxembourg Tax Act (“LITL”)
As early as 2018, the Luxembourg law ATAD 11 implemented into national tax law (“ATAD1 law”) Introduced a new rule that limits the deductibility of excessive borrowing costs to taxpayers to 30% of their taxable EBITDA or EUR 3 million. The excess borrowing costs are defined as the deductible borrowing costs that are higher than the taxable interest income achieved by the taxpayer and other taxable, economically equivalent income.
The IDLR applies to Luxembourg companies and Luxembourg permanent establishments of non-resident companies that are subject to Luxembourg corporation tax in respect of fiscal years beginning on or after January 1, 2019.
For more background information, see our previous articles on this topic
The circular contains the interpretation of the Luxembourg tax authorities on the IDLR rules and the related concepts. Some of the points addressed in the circular are summarized below:
DEFINITION OF “TRAINING COSTS”
- The circular stipulates that only (i) operating costs that are exclusively caused by the taxpayer in accordance with Article 45 LITL and (ii) expenses that are incurred directly for the purpose of acquiring, securing or maintaining income in accordance with Article 105 of the LITL, can be qualified as “borrowing costs” within the meaning of the IDLR. For this reason, the circular advises that hidden dividend distributions cannot be considered as borrowing costs and that other rules that may limit the deductibility of borrowing costs (such as the Luxembourg anti-hybrid mismatch rules, anti-abuse rules, transfer pricing rules and participation) provide an exception ) should apply before the IDLR.
- The Circular recalls that “borrowing costs” encompass three categories of costs: (i) interest expenses on all types of debt, (ii) other costs that are economically equivalent to interest, and (iii) expenses related to financing, and includes some Explanations of the non-costs Full list of the loan costs contained in Article 168bis LITL, in particular:
- Deductions for impairment of bad debts do not result in borrowing costs in the hands of the creditor;
- For with-profits loans, the cost of borrowing includes fixed and variable compensation;
- Interest as well as issue and redemption premiums due by the issuer of financial instruments such as zero coupon bonds or convertible bonds are considered borrowing costs.
- For capitalized interest included in the cost of assets on the taxpayer’s balance sheet, the IDLR only applies to capitalized interest that is or is likely to be deducted.
- Interest calculated on the basis of a nominal amount under interest rate swaps or other derivatives / hedging instruments in connection with a company’s borrowing is also covered by the IDLR.
- Foreign exchange gains and losses related to interest on loans and finance-related instruments included in taxable income are treated as “borrowing costs” for the purposes of the IDLR. Conversely, exchange rate gains and losses on loan capital are not “borrowing costs”.
- Funding agreement guarantee fees include mortgage-related fees and other forms of funding transaction guarantees. However, fees and commissions charged by intermediaries such as notaries or experts involved in financing transactions are excluded when they are related to the purchase price of an asset.
SYMMETRIC APPROACH
In contrast to the term “exceeding borrowing costs”, Article 168bis LITL, despite its meaning in the context of the IDLR, does not contain a definition or example of the term “interest income” or “other economically equivalent taxable income”.
According to the circular, a symmetrical approach should be taken. If, for the purposes of the IDLR, costs should be viewed as interest or economically equivalent to interest, the corresponding income should accordingly be viewed as interest or economically equivalent to interest.
GRANDFATHERING RULE
The application of the grandfathering rule is another main aspect of the guidelines. Under the ATAD1 Act, borrowing costs for loans taken out before June 17, 2016 are excluded from the application of the IDLR, provided no subsequent changes are made to the loans.
According to the circular, the following changes apply as “later changes” in the sense of the grandfathering rule:
- Change in the term of the loan on or after June 17, 2016, if a change was not contractually provided for before June 17, 2016;
- Changing the interest rate or calculating the interest on or after June 17, 2016, if such a change was not contractually provided before June 17, 2016;
- Change in the amount borrowed on or after June 17, 2016;
- Change to one or more of the parties concerned on or after June 17, 2016, if such a change was not contractually provided before June 17, 2016.
Conversely, the following changes, among others, do not count as “later changes” in the sense of the grandfathering rule:
- Draw on an existing credit facility after June 17, 2016 in accordance with the terms contractually agreed before June 17, 2016;
- Transfer of the registered office or central administration of a company to Luxembourg that is involved in a loan concluded before June 17, 2016, provided that the terms of the loan are not changed.
In this context it should be noted that the IDLR only applies to the excessive borrowing costs that result from the “subsequent amendment”.
STAND ALONE ENTITIES
According to the ATAD 1 law, an independent institution is exempt from the IDLR. The ATAD 1 law defines an independent company as a taxpayer that is not part of a consolidated group for financial accounting purposes and has no affiliated companies or permanent establishments in a country other than Luxembourg.
The circular confirms that the term “associated companies” is not limited to the organizations in which the taxpayer is involved, but also includes all organizations and individuals recognized as associated companies under the Luxembourg CFC rules (see Article 164ter ( 2) LITL). It also states that the association should be analyzed from an economic point of view.
The circular also contains explanations on some other points such as the carryforward of the excess of borrowing costs and unused interest capacity, the specific exemption for long-term infrastructure projects and the calculation of EBITDA.
CONCLUSION
The guidelines in the circular are very much to be welcomed, although there are still some unanswered questions (in particular the qualification of capital gains from non-performing or non-performing debt, which is particularly important for debt security funds and securitization firms).
Footnotes
1 Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that have a direct impact on the functioning of the internal market
The content of this article is intended to provide general guidance on the subject. A professional should be obtained about your particular circumstances.
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