LUXEMBOURG Law and Practice Contributed by: Romain Tiffon and Marie Bentley, ATOZ Tax Advisers
consolidation can only be offset against the positive income generated during the consolidation by the entity that originally incurred those losses. After the consolidation ends, any losses generated during the consolidation period remain usable exclusively by the integrating parent company. Under Luxembourg’s worldwide taxation principle, tax losses incurred abroad by a domestic company are generally deductible in Luxembourg. However, this does not apply when the losses relate to a foreign permanent establishment located in a treaty country (subject to Court of Justice of the European Union case law) or to foreign immovable property. 2.5 Deduction of Interest As a matter of principle, expenses, including interest, are only deductible when they are related to the busi - ness activity of the corporate taxpayer. In addition, Luxembourg tax law provides for specific limits on the deduction of interest. Transfer Pricing Principles Luxembourg’s transfer pricing framework is anchored in Article 56 of the LITL, which empowers the tax authorities to adjust a company’s taxable income when transactions between associated enterprises diverge from arm’s length conditions. This may lead to an upward adjustment where a Luxembourg entity confers an undue advantage on a related party – for example, by paying interest at a rate above arm’s length – or, conversely, to a downward adjustment where the Luxembourg entity is the beneficiary of such an advantage. Separately, Article 164 (3) of the LITL provides that hidden dividend distributions – meaning benefits granted to a shareholder that would not have been provided absent the shareholding relationship, such as interest charged at a rate above arm’s length – are not deductible for tax purposes. These rules govern - ing hidden distributions operate alongside the trans - fer pricing framework and may, in certain cases, take precedence over arm’s length adjustments. Limitation to the Deduction of Interest Subject to conditions, a corporate taxpayer may deduct its exceeding borrowing costs only up to the
higher of 30% of its earnings before interest, tax and amortisation or EUR3 million. Various exemptions to this limitation to the deduction of interest may apply. Limitation for Entities Located in Non-Cooperative Jurisdictions As from 1 March 2021, Luxembourg corporate tax - payers may no longer deduct interest or royalty payments where the beneficial owner is a collective undertaking established in a jurisdiction included on the EU list of non-cooperative tax jurisdictions. How - ever, such payments remain deductible if the taxpayer can demonstrate that the underlying arrangement was implemented for valid economic reasons which reflect economic reality. Thin Capitalisation Rules In the absence of statutory thin capitalisation rules under Luxembourg tax law, the principles set out in Chapter X of the OECD Transfer Pricing Guidelines on financial transactions, released on 11 February 2020, serve as the primary reference point. Consequently, a Luxembourg company’s debt‑to‑equity ratio must, in practice, be supported by a debt capacity analysis carried out as part of a transfer pricing assessment. Where the level of indebtedness is considered exces - sive, related interest payments may be recharacter - ised as hidden profit distributions, resulting in the denial of the tax deduction and potentially triggering Luxembourg dividend withholding tax. Historically, the commonly used 85%/15% debt‑to‑equity ratio has not been systematically challenged, although the Luxembourg tax authorities have, in certain cases, requested formal debt capacity analyses. More recently, however, the Administrative Court has clarified that this 85/15 practice does not have any legally binding force. 2.6 Consolidated Tax Grouping Fiscal consolidation is permitted for CIT and MBT purposes, but not for NWT. Luxembourg law allows groups to elect either vertical or horizontal tax con - solidation, with the consolidated group being bound by the regime for a minimum period of five years. A company may not simultaneously belong to more than one tax‑consolidated group.
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