Luxembourg
Keith O'Donnell & Samantha Nonnenkamp
ATOZ Tax Advisers - Taxand
Luxembourg
Different investment vehicles have different tax benefits, explain Keith O'Donnell & Samantha Nonnenkamp of ATOZ Tax Advisers - Taxand
Over the last year, Luxembourg has made a number of important changes in the field of company taxation, all enhancing the tax system for business particularly for holding companies. These changes include chiefly:
- the extension of exemptions from dividend withholding tax;
- the extension of its recently introduced intellectual property (IP) exemption regime; and finally
- the long-awaited abolition of the 0.5% capital contribution duty.
Over the last few months, Luxembourg has amended some of its double tax treaties (DTT) quickly to make them OECD-compliant as regards exchange of information and transparency requirements. As a result Luxembourg has been removed from the so-called grey-list of the OECD report on the jurisdictions surveyed by the OECD Global Forum in implementing the internationally agreed tax standards.
Unregulated vehicles
Two types of unregulated holding company are available in Luxembourg: the Soparfi, the standard Luxembourg unregulated fully taxable holding company, available to any type of investor and the private wealth management company (Société de Gestion de Patrimoine Familial or SPF), a vehicle dedicated to private investors and subject to a specific tax regime.
Occasionally, certain other Luxembourg vehicles such as SICARs, SICAVs or Specialised Investment Funds (SIFs) are used in a context analogous to that of a holding company, but subject to some regulatory constraints.
The Soparfi
The Soparfi is a fully taxable Luxembourg resident company that takes advantage of the participation exemption in Luxembourg and that benefits from DTTs signed by Luxembourg, as well as the provisions of the parent-subsidiary and interest and royalties directives, and may benefit since 2008 from the partial IP exemption regime.
No more capital duty
The 0.5% capital duty that was due upon incorporation and capital increases of companies has been abolished effective from January 1 2009.
New fixed registration duty
A fixed registration duty of €75 ($107) has been introduced in 2009 and covers several transactions pertaining to Luxembourg companies: incorporation, transfer of seat from a foreign country to Luxembourg and amendment of the bylaws.
Proportional registration duties
Contributions of Luxembourg real estate in exchange for shares are now subject to a 0.6% registration duty + a 0.5% transcription tax. Contributions remunerated by means other than shares are subject to a 6% registration duty + a 1% transcription tax (4% for Luxembourg town);
However, transfers made in the context of a corporate restructuring (that is, contributions of all assets and liabilities, contributions of one or more branches of activities, as well as contributions of all assets and liabilities of the 100% held subsidiary) are exempt from proportional duties. The transfers have however to be mainly remunerated (that is, with more than 50%) with securities that represent the share capital of the companies involved.
Partial exemption for intellectual property
Since 2008, an 80% exemption applies, under certain conditions, to the net income and capital gains that derive from software copyrights, patents, trade marks, domain names, designs and models. In 2009, the IP tax regime has been extended and now also provides for an exemption of these IP rights for net worth tax (NWT) purposes. NWT is a tax which is levied annually at a rate of 0.5% on the adjusted net asset value of a corporation on January 1 each year.
Corporate income taxes
A Soparfi is subject to corporate income tax (CIT) and municipal business tax (MBT), both taxes being computed on an almost identical base. For convenience, these two taxes are referred to as corporate income taxes hereafter.
The effective tax rate applicable to profits is 28.59% for Luxembourg City.
Provided the conditions for the participation exemption described below are met, dividends or liquidation proceeds received by a Soparfi as well as capital gains realised upon the sale of shares in its subsidiary are exempt.
Net worth tax
Net worth tax is levied annually at a rate of 0.5% on the adjusted net asset value of a corporation on January 1 each year. Broadly, the net asset value is calculated as assets less liabilities and corresponds to the net equity.
The NWT due may be reduced by a tax credit through the creation of a special 5-year reserve, provided certain conditions are met.
Certain assets are exempt from NWT, notably substantial shareholdings (participation regime) and IP rights that qualify for the IP exemption regime, that is, software copyrights, patents, trade marks, domain names, designs and models.
Amended participation exemption regime
Provided certain conditions are met, the participation exemption regime allows for the following exemptions:
- Dividend exemption
Dividends received by the Soparfi are exempt from corporate income taxes to the extent the Soparfi holds during a minimum period of 12 months at least 10% of the shares of a qualifying subsidiary or the acquisition price of the shares in the subsidiary is at least €1.2 million ($1.7 million). Qualifying subsidiaries are fully taxable Luxembourg companies, EU undertakings within the meaning of article 2 of the EU Parent-Subsidiary Directive or non-resident capital companies which are liable to a tax corresponding to Luxembourg CIT (Luxembourg tax authorities generally consider that the foreign tax must be assessed at a minimum tax rate of 10.5% on a basis comparable to the Luxembourg taxable basis. The subsidiary may be held through a transparent entity as defined by article 175(1) of the Income Tax Law (ITL).
In case a dividend is exempt, the amount of expenses in direct economic connection in that year (for example, interest expenses that are in relation to the financing of the shareholding) will not be deductible, up to the amount of dividends received. There are rules relating to write-downs linked to exempt dividends.
Liquidation proceeds received are exempt under the same conditions.
- Capital gains exemption
Capital gains realised by the Soparfi on the sale of shares are exempt from corporate income taxes under the same conditions as dividends except that the minimum shareholding is either 10% or the shareholding has an acquisition price of €6 million ($8.6 million).
Notwithstanding what is mentioned above, the capital gains realised upon disposal of a participation are subject to a recapture rule, according to which capital gains will remain subject to tax up to the sum of all related expenses that were deducted for tax purposes in the year of disposal or in previous financial years (for example, interest expenses on loans contracted to purchase the shares and/or write-downs of the participation).
- Withholding tax exemption
Dividends distributed by a Soparfi are in principle subject to a withholding tax at a rate of 15%, unless a reduced rate under the provisions of a DTT applies. A withholding tax exemption, the scope of which has recently been extended, applies under certain conditions, mainly to distributions made to fully taxable Luxembourg resident companies, EU undertakings within the scope of article 2 of the Parent-Subsidiary Directive, fully taxable corporations or cooperatives resident in an EEA member state and fully taxable undertakings that are resident in a country with which Luxembourg has concluded a DTT.
The last category has been added from 2009. A CIT is considered as similar to the Luxembourg CIT if it is mandatory (that is, not optional) and if the effective tax rate is at least half of the Luxembourg CIT rate (that is, 10.5% as from 2009) and applied on a taxable basis that is determined following rules which are similar to the ones applicable in Luxembourg
At the date the dividends are placed at the disposal of the beneficiary company, the latter must hold or commit to hold, for a continuous period of at least 12 months, a direct shareholding of at least 10% in the capital of its subsidiary, or a shareholding that was acquired for at least €1.2 million ($1.7 million).
The beneficiary may hold its participation through a transparent entity and still qualify for the exemption.
- Net worth tax
A shareholding is exempt from NWT at the level of the shareholder provided that the conditions for benefiting from the dividend exemption are met except that there is no requirement regarding the holding period.
The SPF
The SPF was launched by the Law of 11 May 2007 to replace the 1929 Holding regime for private wealth management. The purpose of this vehicle has however to be limited to passive investments (acquisition, holding, management and disposal of financial assets excluding any type of commercial activity) and the investor type is also restricted to private investors (individuals managing their private wealth or private wealth entities acting for one or several individuals, or intermediaries acting on behalf either of the above). Thus, it is not a vehicle that can always be used as an alternative to the Soparfi.
The SPF is exempt from CIT, MBT and NWT. It is also exempt from Luxembourg withholding tax on distributions.
Income from financial assets is therefore exempt at the level of the SPF but will be taxed subsequently once the income is distributed to the private investor:
- interest paid by the SPF on its debts towards individuals may be subject either to the final 10% withholding tax for individuals resident in Luxembourg or subject to withholding tax under the provisions of the so called Savings Directive mainly for EU resident individuals,
- dividends paid to Luxembourg shareholders (individuals) will be fully taxed in their hands.
Gains realised by non-residents upon the sale of a participation in a SPF, either upon sale or upon liquidation of the company will not be subject to tax in Luxembourg.
The SPF is excluded from the exemption regime for a given financial year if 5% or more of the total dividend income it receives during that year derives from participations in non-resident non-listed companies that are not subject to an income tax similar to Luxembourg CIT (that is, subject to an effective rate of less than half the rate of the Luxembourg CIT of 21%, that is, 10.5%).
The SPF is subject to subscription tax at a rate of 0.25% applicable on its share capital, including any share premium. The minimum tax is €100 ($143) and the maximum tax is €125,000 ($178,000) a year. Subscription tax also applies to the part of the debt (if any) that is more than an equity to debt ratio of 1 to 8.
Given its tax regime, the SPF is unable to benefit from the DTTs concluded by Luxembourg.
SPF or Soparfi? What is the best in which situation?
The decision to use an SPF instead of a Soparfi should be taken after a careful review of the complete structure and an analysis of the plans/expectations of the investors in terms of profit repatriation.
Using an SPF instead of a Soparfi can make sense in situations where most of the income received by the entity would otherwise be fully taxable in Luxembourg (because of the nature of the income or because the conditions of the participation exemption would not be fulfilled). It also makes sense to use an SPF when profit repatriation would otherwise have been subject to withholding taxes in Luxembourg, would a Soparfi have been used (even though, in this case, the withholding tax cost could be reduced using debt funding rather than capital funding). The SPF does, however, not benefit from the DTTs and thus suffers, if any, withholding taxes at the internal rate (that is, the highest rate) in the countries in which the SPF invests. This is a big disadvantage of the SPF towards the Soparfi. Finally, the SPF is not always an alternative since the scope of permitted investments is limited.
The use of a Soparfi, on the other hand, is efficient when the main or complete portion of its profits can be exempt under the participation exemption regime. The recent improvements made to the Soparfi regime and the participation exemption regime have even increased the attractiveness of the Soparfi.
These are however only general guidelines. In any case, before making a choice for one or the other investment structure (SPF or Soparfi), a careful review of, for example, the investments envisaged (nature and size), the investor profile, the expectations in terms of returns and the timing of profit repatriation should be performed to estimate the cost of one or the other structure upon implementation and in the medium and/or longer term.
Luxembourg regulated investment vehicles
Regulated vehicles like "Part 1" (that is, Undertakings for Collective Investments in Transferable Securities within the meaning of the EU Directive) and "Part 2" funds, the SICAR or the Specialised Investment Fund (SIF) can be used as an alternative to invest using a Luxembourg vehicle. These vehicles are generally used for bigger and/or longer term investments since their implementation costs are higher because they are subject to the approval process by the supervisory authority of the financial sector. These vehicles can only be used in specific investment situations as they are subject to prudential rules relating to the nature of their investments. They are generally subject to diversification rules or other restrictions, for example, investments only in capital risk for the SICAR and investments made by so-called sophisticated investors in the SIF. Thus, they are not always an alternative to unregulated vehicles. They benefit from an exemption of tax on their income (Part 1 & 2 Funds, SIF) and are taxed on their net asset value (NAV) but at a low rate (0.05% for Part 1 and 2 Funds and 0.01% for SIFs) or are tax exempt on most of their income (SICARS are exempt on their income from movable property, that is, dividend, interest and capital gains). The only downside of investment funds and SIFs is that they do not qualify for the Parent-Subsidiary Directive (no application of the zero withholding tax rate in the countries in which they invest) and do benefit only from some of the DTTs concluded by Luxembourg. Thus, so far, they often suffered higher withholding taxes in the countries they invested in than other fully taxable vehicles such as the Soparfi.
SIFs and other investment funds in corporate form (SICAVs/SICAFs) could however become more attractive in future following some recent jurisprudence at EU level; the European Court of Justice ruled that a member state law which discriminated between payments to national and foreign (EU) investment funds went against the freedom of establishment.
The ECJ considered that this conclusion was not jeopardised by the fact that:
- The Luxembourg SICAV had a legal form unknown in local, in this case Finnish, law. Thus the SICAV was still to be considered as "comparable" to the Finnish investment funds that were exempt from Finnish WHT;
- The Luxembourg SICAV did not qualify for the Parent-Subsidiary Directive;
- The Luxembourg SICAV was exempt from income tax under its home state law.
The case is a major step towards the elimination of discriminatory dividend withholding tax on distributions to entities which do not qualify for the Parent-Subsidiary Directive, such as Luxembourg SICAVs. The case means that dividends from any EU country which are distributed to Luxembourg SICAVs will be exempt from withholding tax in the foreign country, to the extent the foreign country's legislation exempts from withholding tax dividends distributed to similar local entities. In case the foreign country does not grant a full exemption but a reduced WHT rate, the Luxembourg SICAV will have to be granted the same favourable treatment. Member states can refuse to grant the lower rate in case of wholly artificial arrangements (anti-abuse provision under the conditions set in the Cadbury Schweppes case law) however this test is strictly applied.
Relaxing banking secrecy
Soparfis benefit from the DTTs concluded by Luxembourg. Luxembourg has concluded many DTTs (there are 53 in force) and is working towards expanding its DTT network. The most recent DTTs include those with Hong Kong, India, the UAE, Azerbaijan and Qatar (recently ratified by Luxembourg), Albania, Bahrain, Georgia and Monaco (recently signed) and Kyrgyzstan and Armenia (recently initialled). Finally, negotiations have started with Liechtenstein.
Luxembourg has renegotiated some of its DTTs to have their exchange of information and transparency provisions in line with article 26.5 of the OECD Model Tax Convention (MTC). This followed the announcement made by the Luxembourg government on March 13 this year regarding its commitment to comply with OECD standards on international tax cooperation. On July 8 2009, after the signing of a protocol with Norway, Luxembourg, as the first of the so called grey-listed countries, has been removed from the OECD grey list.
In the weeks after, Luxembourg kept renegotiating and negotiating OECD-compliant DTTs with Belgium and more recently with Monaco. The same should happen soon to the DTT with Germany. The Luxembourg government has committed that all DTTs to be concluded in future will be in line with article 26.5 of the OECD MTC.
Some changes are expected to Luxembourg law to allow the various parties involved to exchange information in accordance with article 26.5 while respecting the general principle of professional secrecy.
These measures can be seen as a chance for Luxembourg to find new DTT partners in future. Indeed some countries were reluctant to conclude treaties which are not fully in line with the OECD expectations in this area, since they consider that it will have a negative impact on their image or reputation. Showing that Luxembourg is fully complying with the OECD requirements as regards transparency could lead to an expansion of the Luxembourg DTT network and thus might attract new foreign investments to Luxembourg.
Keith O'Donnell (keith.odonnell@atoz.lu)
Samantha Nonnenkamp (samantha.nonnenkamp@atoz.lu)