Besides the anti-tax avoidance rules of ATAD, the ATAD Draft Law covers certain other tax measures considered as required to avoid aggressive and harmful tax planning by an inadequate use of tax measures currently available for Luxembourg taxpayers.
 

As such, this article will cover the following items:

ATAD measures

• Controlled foreign companies rules;
• Interest deduction limitation rules;
• Hybrid mismatches rules;
• General anti-abuse rule; and
• Exit taxation (including new valuation rules regarding transferred assets).

Miscellaneous measures

The main tax outcomes of the above measures, which will generally be applicable as of 1 January 2019 (except for the exit tax provisions which should be applicable as from 1 January 2020), are summarised below.

• Reinforcement of the permanent establishment concept in a double tax treaty context; and
• Abolition of the tax neutral conversion of a debt into equity.

ATAD measures

Controlled foreign companies rules

Control foreign company ("CFC") is a brand new concept in Luxembourg, which aims to attribute net income to a Luxembourg taxpayer when its subsidiary or permanent establishment meeting certain threshold requirements in terms of accounting profits is located in a low- or no-tax jurisdiction, and this even if this income is not distributed. 
This rule should, however, only apply: (i) when specific control and effective tax rate tests are met; and (ii) to the extent that this net income relates to significant functions carried out by the Luxembourg taxpayer. 
Based on the various criteria that needs to be complied with in order for the CFC rules to apply, the impacts for Luxembourg, even though this needs to be analysed on a case-by-case basis, may only be limited.

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Interest deduction limitation rules

The interest deduction limitation rules ("IDLR") limit the deductibility of interest payments and aim as such the avoidance of an excessive erosion of the tax base of a taxpayer by means of excessive interest payments. In this context, "exceeding borrowing costs" shall be deductible from the taxable basis of a taxpayer in the tax period in which they are incurred only up to the higher of (i) 30% of such taxpayer's earnings before interest, tax, depreciation and amortisation ("EBITDA") or (ii) EUR 3 million.
Certain exceptions exist however as regards the IDLR.
Further, available options under ATAD have been taken over such as a carry forward of (i) exceeding borrowing costs without time limitation and (ii) unused interest deduction capacity for a maximum of five years.

Even if some important uncertainties remain under the IDLR at this stage – comprehensible considering the complexity of this new concept for Luxembourg, two important announcements have been made by the Luxembourg Minister of Finance during the today's vote of the ATAD Draft Law, which are more than welcome considering their (potential) positive effects. First, the Luxembourg government will in 2019 amend the ATAD Draft Law to allow Luxembourg taxpayers in a tax unity to apply the IDLR on a consolidated basis. Second, they will have a deeper analysis of the IDLR and their impacts on Luxembourg securitisation vehicles to assess the need for any further amendment of the ATAD Draft Law to assure, to the extent possible, the attractiveness of the Luxembourg market place as regards securitisation transactions.

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Hybrid mismatches rule

This rule will tackle the tax advantages under hybrid mismatches resulting from a different classification by two different Member States of a legal instrument or entity which leads either to a double deduction in both Member States or a deduction in one Member State without a corresponding inclusion in the other Member State. 

In cases of such mismatches, the deduction will only be permitted in the country of source as regards double deductions, respectively will be forbidden in case of a deduction without inclusion.

Some uncertainties remain at this stage as regards the hybrid mismatches. However, they should not be considered, in our view, as key.
 

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General Anti-Abuse Rule

Our existing Luxembourg general anti-abuse rule ("GAAR") will be amended (but not replaced) to come closer to the wording of the GAAR included in the ATAD. Most of the amendments reflect in our view however components already developed by recent Luxembourg case law regarding the interpretation of our current GAAR.

Whilst certain amendments to the current GAAR will be made, the key element to consider will also in the future be whether there are commercial reasons that are real and reflect economic reality, and as such represent an adequate economic advantage beyond the tax advantage gained.

The burden of proof will remain unchanged and as such, existing case law in this area will provide helpful legal security. Thus, the Luxembourg tax authorities need first to prove the existence of an abuse and its constituting elements, and demonstrate the likelihood of an absence of sufficient valid commercial reasons that could justify the transaction. Afterwards, the burden of proof is shifted, and the taxpayer needs to prove the presence of sufficient valid commercial reasons.

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Exit taxation rules

The concept, well known in Luxembourg, was reshaped not long ago. The new rules under ATAD, applicable as from 2020 (without retroactive effect), will now only provide for the mere possibility to spread the tax payment at exit over a period of maximum five years. Hence, it will not be possible to postpone the exit tax payment indefinitely anymore. Further, it will be limited to the only cases of migration to another EU Member State or an EEA State with which Luxembourg has concluded an agreement on the exchange information in the field of taxation. The choice to include this limitation, which goes beyond the minimum imposed by ATAD, may be unwelcome. However, we can understand the desire of the Luxembourg legislator to deal differently with exit tax payments for administrative and cash management purposes. Further, whilst this limitation will have a certain negative impact, its consequences for Luxembourg financial actors should be limited as, in our experience, the need to rely on exit tax deferral is rather exceptional.

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Miscellaneous measures

Reinforcement of the permanent establishment concept in a double tax treaty context

The provision defining a permanent establishment under Luxembourg domestic law will be amended by the inclusion of an additional paragraph. It will reinforce the definition of the permanent establishment concept when the latter is established in a country with which Luxembourg has a double tax treaty ("DTT") in place to avoid double non-taxation situations resulting from a different interpretation of the notion of permanent establishment between the involved countries.

A permanent establishment is to be construed solely on the basis of the criteria mentioned by the relevant DTT, and except if provided otherwise therein, a permanent establishment will only be considered to exist if its activity, considered by itself, forms an independent activity and represents a participation in the general economic life in that other country.

Depending on the scenarios, a taxpayer either may be requested on demand or must provide a confirmation that the other country recognises the existence of its permanent establishment.

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Abolition of the tax neutral conversion of a debt into equity

Article 22bis (2) (1) LITL, which allows currently the tax neutrality upon a conversion of a debt into shares, will be abolished as of 1 January 2019. Indeed, this provision, as currently drafted, may result in situations of deduction without corresponding inclusion. As a consequence, these conversions will henceforth be considered from a tax perspective as a disposal of the convertible loan at fair market value followed by the acquisition of shares at fair market value. Any latent capital gains that might occur during this conversion may no longer rolled-over into the shares received in exchange, but will be considered from a tax perspective as being realised and will thus have to be taxed accordingly at the time of conversion

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Authored by Gérard Neiens, Jean-Philippe Monmousseau, and Pierre-Luc Wolff

Hogan Lovells (Luxembourg) LLP is registered with the Luxembourg bar.