OUR INSIGHTS AT A GLANCE
- On July 28, 2021, the Luxembourg tax authorities issued a circular to provide guidance on the interpretation of the rules on limiting interest deductions under Article 168bis of the Luxembourg Income Tax Act (through which the EU Directive on Combating Tax Avoidance Practices) (“ATAD 1“) has been implemented in Luxembourg law). The circular extends and replaces the previous circular of January 8, 2021 (see https://www.atoz.lu/media/insights-march-2021) and of June 2, 2021.
- The rules on the limitation of interest deduction limit the tax deductibility of interest for Luxembourg corporation taxpayers and Luxembourg permanent establishments of foreign taxpayers, unless they are considered to be financial companies or independent legal entities. The limit applies to exceeding borrowing costs (ie the amount by which borrowing costs exceed interest income in a given year) and corresponds to the higher of EUR 3 million or 30% of taxable EBITDA per fiscal year.
- Exceeding borrowing costs remain fully deductible if the equity ratio of the Luxembourg taxpayer is (largely) the same as or higher than the corresponding group ratio (“Group escape clause“).
On July 28, 2021, the Luxembourg tax authorities issued Circular No. 168bis / 1 (the “Circular”) to provide guidance on the interpretation of the Interest Limitation Rules (“IDLR”) under Article 168bis of the Luxembourg Income Tax Law (” LITL “) (through which the Council Directive (EU) 2016/1164 of July 12, 2016 laying down rules against tax avoidance practices (” ATAD 1 “) was implemented in Luxembourg law).
The circular replaces the circular of June 2, 2021, which previously expanded and replaced the circular of January 8, 2021 to provide clarifications regarding the Group Escape Clause pursuant to Article 168bis §6 of the Luxembourg Income Tax Act.
While the circular from the 2nd group escape clause in the case of a tax group, which is only briefly outlined below. The IDLR have been in effect since January 1, 2019 and are to be interpreted for all tax years from 2019 onwards in accordance with the circular (the circular only serves to clarify the interpretation of the existing legal provisions).
The IDLR limits the tax deductibility of interest for Luxembourg corporation taxpayers and Luxembourg permanent establishments of foreign taxpayers, unless they are considered to be financial companies or independent legal entities. The limit applies to exceeding borrowing costs (ie the amount by which borrowing costs exceed interest income in a given year) and corresponds to the higher of EUR 3 million or 30% of taxable EBITDA per fiscal year.
In a fiscal unity, the IDLR apply as standard to the entire group of tax-integrated Luxembourg companies. Upon request, the IDLR can also be applied at the level of every member of the tax group.
The IDLR provisions in Luxembourg tax law contain a number of definitions that are central to the practical application of the restrictions on taxpayers. Their interpretation has been the subject of many discussions in recent years.
According to the Group Escape Clause, excess borrowing costs remain fully deductible upon request if the equity ratio of the Luxembourg taxpayer is (largely) the same as or higher than the corresponding group ratio (a tolerance of two percentage points below the corresponding amount). Group relationship is permitted).
This article gives an overview of the most important aspects of the circular.
Conditions to be met
The Group Escape Clause goes beyond the mere comparison of equity with total assets and requires the fulfillment of a number of conditions.
The Luxembourg taxpayer applying for the Group Escape Clause must be a member of a consolidated group for financial accounting purposes (by virtue of a legal obligation or on a voluntary basis). A tax group is not required in this context. However, in the case of a tax unity with the application of the interest limitation rules at the level of the tax group (ie not at the level of each integrated company), each of the Luxembourg integrated companies must be consolidated for accounting purposes. In this case, the application for use of the Group Escape Clause must be submitted by the integrating company.
If there are several consolidated financial statements, only that of the highest consolidation group serves as the basis for the Group Escape Clause. The same applies in the case of voluntary consolidation (here the company is to be considered which would have been the last consolidating company according to the applicable legal provisions).
For financial accounting purposes, the consolidated financial statements are to be prepared using the full consolidation method (line by line). Other methods such as proportionate consolidation and the equity method exclude the taxpayer from applying the Group Escape Clause.
The consolidated financial statements are based on a recognized accounting standard of an EU member state, according to IFRS (either in the one published by the IASB or adapted to EU law) or another equivalent accounting standard (e.g. Japan, USA, People’s Republic of China, Canada or the Republic of Korea ).
The consolidated financial statements must be audited by a licensed auditor according to Luxembourg or equivalent standards of the highest consolidating unit as part of an audit or a contract audit, provided that the applicable audit standards in the jurisdiction of the ultimate parent company or under The Luxembourg audit standards are complied with.
The statutory financial statements of the Luxembourg taxpayer applying for the Group Escape Clause benefit need not necessarily be drawn up according to the same accounting standard as that of the ultimate consolidating company. However, in order to have the same basis of comparison, a separate version based on the same accounting standards is required.
Adjustments to the consolidated financial statements
In order to be able to compare the different account rates, certain adjustments are necessary.
All assets and liabilities are to be valued in the individual financial statements and in the consolidated financial statements using the same methods. The circular requires that the individual financial statements of the Luxembourg taxpayer be adjusted if a different accounting standard is used for the consolidated financial statements. In other words, this should not require an audit of the individual accounts of the Luxembourg taxpayer against the accounting standards of the consolidated accounts.
If the consolidated financial statements include companies that are only consolidated proportionately or using the equity method, these companies must be excluded from the consolidated financial statements by making appropriate adjustments before comparing equity with total assets.
In a tax group, the adjustments are to be applied accordingly, in particular with regard to a coherent valuation method for assets and liabilities. In addition, all intra-group transactions between board members must be eliminated.
The above modifications are associated with some practical problems and can be tedious depending on the size of the group and the availability of all relevant information.
The benefit of the Group Escape Clause is subject to certain documentation requirements that must be attached to the Luxembourg tax return of the respective taxpayer. This documentation should include:
- Documentation on all conditions relating to the application of the group escape clause (including the type of integration, the auditing company, confirmation that the taxpayer is fully integrated in the consolidated financial statements, etc.);
- A detailed calculation of the equity ratio at the level of the consolidated group and at the level of the respective taxpayer (including information on any adjustments made and information on the equity and assets used for the calculation).
These rules apply mutatis mutandis to a tax group. When applying the IDLR at the level of the tax group, the integrating company must submit all relevant information and details together with its tax returns.
The Luxembourg tax authorities can request additional information.
The term “equity”
The circular does not contain an explicit definition of the term equity capital (fonds propres), which is used in Article 168bis §6 LITL for the purposes of the Group Escape Clause, and uses the French word “capitaux propres” interchangeably.
Without clarification, the term “equity” therefore tends to refer to the meaning of equity from a balance sheet point of view in the broadest sense, ie including any equity accounts such as retained earnings and reserves. Since the basis of comparison is the annual financial statements, the tax qualification of an instrument should be irrelevant.
Luxembourg taxpayers who may fall within the scope of the Group Escape Clause must carefully review their financial accounts and compile all relevant information with their tax returns.
The number of requirements and conditions to be met sets the bar quite high and underlines that the Group Escape Clause is clearly to be seen as an exception to the IDLR regulation.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.