LUXEMBOURG Law and Practice Contributed by: Oliver R Hoor and Fanny Addouda, ATOZ Tax Advisers
case regarding the qualification of an interest- free loan. Administrative Court No 48125C, 23 November 2023 and Administrative Tribunal No 44902, 23 September 2022 – Interest-Free Loan (IFL) On 23 November 2023, the Luxembourg Admin - istrative Court held a decision in a case concern - ing an IFL which was granted by a Luxembourg company to its wholly-owned Luxembourg sub - sidiary. The case involved a company resident in the Cayman Islands (CayCo) that invested via a Luxembourg investment platform into (distressed) debt owed by third parties. CayCo financed its Luxembourg subsidiary (LuxParent - Co) by a mixture of equity and a profit-partici - pating loan (PPL). LuxParentCo used the funds received to finance its Luxembourg subsidiary ( “LuxSubsidiary” , the taxpayer) by a mixture of equity and (mainly) an IFL. LuxSubsidiary (the borrower) invested the funds received from Lux - ParentCo (the lender) mainly into distressed debt instruments. In its corporate tax return, in accordance with Article 56 of the LITL, LuxSubsidiary performed a downward adjustment in relation to the IFL in order to account for deemed interest expenses that would have been due at arm’s length. Lux - ParentCo recognised deemed interest income in its corporate tax return (corresponding to the amount of the deemed interest expenses reflect - ed in the corporate tax return of LuxSubsidiary). The upward adjustment was also performed in accordance with Article 56 of the LITL. Both the LTA and the Administrative Tribu - nal denied the downward adjustment on the grounds that the IFL was to be considered as an equity instrument. The equity qualification by the tax authorities and the Tribunal was mainly
based on the fact that the IFL included a lim - ited recourse clause providing for no or limited risk in case of default. One additional element was that the loan was only formalised several months after the cash had been made available, so, according to the Administrative Tribunal, the intention of the parties was to make a hidden capital contribution. The Administrative Court overturned the judg - ment of the Tribunal and recalled that the clas - sification of a financing instrument follows the economic approach (so-called wirtschaftliche Betrachtungsweise ). This approach involves, for tax purposes, the economic reality prevailing over the legal form (also referred to as the “sub- stance over form” principle). The Administrative Court performed an overall analysis of the trans - action and an analysis of all relevant features of the IFL. Since most of the relevant features of the IFL were debt features, the Administrative Court classified the loan as a debt instrument. As the subject matter of the case was the classification of the IFL as debt or equity and the Administra - tive Court is limited by the grounds on which it has been involved, it could not itself review the downward (and upward) adjustment in principle (ie, notional interest) and the arm’s length nature of the notional interest rate declared by the bor - rower. However, the Administrative Court stated that it is led to hold that it was wrong to rechar - acterise the IFL as equity and to refuse to admit the amount put forward as notional interest. Hence, the Administrative Court re-established long-standing principles with respect to the classification of financial instruments as debt or equity (ie, economic approach, substance over form).
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