On 30 March 2020, Luxembourg introduced draft law No 7547 providing for the non-deductibility of interest and royalty payments to related entities resident in non-cooperative jurisdictions.
The draft law is Luxembourg’s response to the guidance issued by the EU Council on 5 December 2019 inviting member states to take action as of 1 January 2021 against countries listed on the EU list of non-cooperative countries and territories for tax purposes. Under this guidance, member states should apply at least one of following four specific legislative measures: non-deductibility of costs; controlled foreign company (CFC) rules; withholding tax measures; or limitation of the participation exemption on profit distribution vis-à-vis the non-cooperative jurisdictions.
Among these alternative measures, Luxembourg has chosen to implement the non-deductibility of interest and royalty payments to non-cooperative jurisdictions with effect as from 1 January 2021 when the following conditions are cumulatively met:
- The recipient of the interest or royalties is an undertaking under the meaning of article 159 of Luxembourg Income Tax Law (generally being entities that are tax opaque). If the recipient is not the beneficial owner, the beneficial owner should be taken into account.
- The recipient is a related entity under article 56 of Luxembourg Income Tax Law. Two entities are related entities when one of them participates directly or indirectly in the management, control or capital of the other; or where the same persons participate directly or indirectly in the management, control or capital of both collective undertakings.
- The recipient is established in a country or territory included in the list of non-cooperative countries and territories for tax purposes.
However, where the Luxembourg taxpayer requesting the tax deduction provides evidence that the transaction to which the interest or royalties payments relate to, is used for valid commercial reasons that reflect economic reality, then such interest and royalty payments will be tax deductible.
The above provision shall be applicable to interest or royalties paid or due as from 1 January 2021 to non-cooperative jurisdictions. Non cooperative will be the jurisdictions included in the Luxembourg list of non-cooperative jurisdictions as issued upon proposal of the Luxembourg Government. The Luxembourg list is expected to rely on the EU list of non-cooperative countries and territories for tax purposes and will be updated annually.
As of 27 February 2020, the EU list of non-cooperative countries and territories for tax purposes comprises American Samoa, Cayman Islands, Fiji, Guam, Oman, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu, and Seychelles.
These measure will also be reinforced by the mandatory disclosure rules under DAC 6 (our recent blog on this can be accessed here, under which such payments will be subject to mandatory reporting to the Luxembourg tax authorities.
In the meantime, Circular No 64 dated 7 May 2018 remains applicable in Luxembourg. Under this Circular, the Luxembourg tax authorities apply more scrutiny in transactions involving a non-cooperative jurisdiction including reinforced monitoring of intragroup transactions between Luxembourg entities and associated enterprises resident in non-cooperative jurisdictions and enforcing of the tax audits to Luxembourg entities with structures involving non-cooperative jurisdictions. Luxembourg entities should also indicate in their corporate income tax returns whether they carried out any intra-group transactions with such associated enterprises and should hold available relevant data to be provided to the Luxembourg tax authorities upon request.