Luxembourg: Tax exemption under participation regime, beneficial ownership and withholding tax refunds (court decisions)
Luxembourg high court clarifies certain important tax concepts
Luxembourg high court clarifies certain important tax concepts
The Luxembourg supreme court with jurisdiction over direct tax matters (Cour administrative) released a series of judgments that clarify certain tax concepts regarding:
- The minimum requirements for a tax exemption of dividends, liquidation proceeds, and capital gains under the participation regime.
- “Mandatorily redeemable preferred shares” (MRPS) issued by a Luxembourg public limited company to its sole shareholder qualified as equity for direct tax purposes and preferred dividends paid on these MRPS did not constitute a tax-deductible expense for income and business tax, and the shares released as MRPS were not deductible as a debt for wealth tax purposes at the level of the issuing company.
- The beneficial ownership requirements for a successful claim for refunds of dividend withholding tax in Luxembourg.
Case concerning “account 115” and the participation exemption regime
Luxembourg holding companies benefit from a flexible participation exemption regime—a full tax exemption of dividends, liquidation proceeds, and capital gains, if on the date that the income is received, the qualifying Luxembourg parent company has held, during an uninterrupted period of at least 12 months, a direct participation of at least 10% or with an acquisition price of at least €1.2 million (€6 million for capital gains) in the share capital of the qualifying subsidiary. Under substantially similar conditions (except for the absence of minimum holding period), the qualifying subsidiary will be fully exempt from wealth tax at the level of the Luxembourg parent company. Likewise, shareholders benefit from a full exemption from dividend withholding tax, provided that they meet the minimum holding requirements of 10% or €1.2 million, among other requirements.
In a final judgment released 31 March 2022, the court denied the withholding tax exemption for a Luxembourg shareholder who held 4.5% in the share capital and made a contribution (in cash and kind) into the “account 115” of less than €1.2 million of a Luxembourg subsidiary. The Luxembourg shareholder considered that the €1.2 million threshold was nevertheless reached on an aggregate basis by taking into account both the acquisition price for the 4.5% stake and the contribution to account 115. However, the court held that the capital contributions to the subsidiary (account 115) without issuance of additional shares to the shareholder are not to be taken into consideration for the minimum holding requirements of the participation and withholding tax exemption. According to the court, the capital contributions into account 115 do not represent a holding in the share capital of the subsidiary and do not form part of the acquisition price.
The reasoning of the court can be reconstructed along the following lines:
- Taking into account the primacy of EU law and interpretations of the Parent-Subsidiary Directive by the Court of Justice of the European Union (CJEU), the concept of a “participation in the capital” within the meaning of the dividend withholding tax exemption refers to the holding of shares in the capital of the distributing subsidiary.
- While the EU Directive stipulates a participation dans le capital, Luxembourg tax law explicitly foresees a participation dans le capital social of the subsidiary. According to Luxembourg accounting principles, the subscribed capital (capital social) together with share premium, capital contributions into the account 115 and other premiums form the capital (capitaux propres) of a company. Against this background, the court found that only holding shares (as representative titles of the subscribed capital or capital social) establish a direct legal relationship with the subsidiary within the meaning of the Luxembourg company law, that confers shareholder rights to the parent company.
- Unlike the issuance of shares, capital contributions into the account 115 do not require the intervention of a notary and are thus not published in the trade register. The court therefore concluded that the account 115 is not to be considered for the determination of the minimum holding of at least 10% in the capital of the subsidiary.
In addition, the court held that capital contributions without the issuance of shares (account 115) do not form part of the acquisition price. As an alternative to the 10% shareholding (as prescribed by EU law), the Luxembourg tax law foresees a domestic exemption from dividend withholding tax for investors that hold a direct participation with an acquisition price of at least €1.2 million in the share capital of the subsidiary. Luxembourg tax law defines “acquisition price” as the total expenses incurred by a taxpayer to acquire an asset and to bring it into an operational state. The court confirmed that expenses that are ancillary to the acquisition of the shareholding are to be included in the acquisition price. However, the court explained that an expense can only be considered as part of the acquisition price, if: (1) it results in an increase in the number of the shares, (2) it results in an increase of the nominal value of the shares, or (3) it is a direct ancillary cost to such an increase.
In the case at hand, the capital contributions into the account 115 increased neither the number nor the nominal value of shares held by the minority shareholder, as a result of which there was an insufficient link between the account 115 and the share capital.
The court also incidentally mentioned that the articles of association of the subsidiary did not provide that capital contributions into the account 115 would be allocated exclusively to the contributing shareholder.
MRPS—debt or equity for tax purposes?
The court, in another decision released 31 March 2022, held that “mandatorily redeemable preferred shares” (MRPS) issued by a Luxembourg public limited company to its sole shareholder qualified as equity for direct tax purposes. Consequently, the preferred dividends paid on these MRPS did not constitute a tax-deductible expense for income and business tax, and the shares released as MRPS were not deductible as a debt for wealth tax purposes at the level of the issuing company.
The case concerned the tax years 2015 and 2016 and the circumstances of the case were specific to this taxpayer.
The court confirmed that the tax classification of financial instruments as equity or debt is to be based on a substance-over-form approach. The court concluded that some terms and conditions of the MRPS were indicative of a debt treatment (e.g., terms of 10 years, mandatory redemption) but given the overall circumstances of the restructuring, the court qualified the MRPS as equity for tax purposes.
Notably, the court considered the fact that the subscriber of the MRPS was at the same time the sole shareholder of the company. The court also observed that the shares treated as MRPS were issued by the company after its transformation from a private limited into a public limited company with a capital increase (by transferring funds from the account 115) and reclassification of the share capital into ordinary shares, alphabet shares, and MRPS. All steps were carried out on the same day.
To avoid a hybrid mismatch, the court also emphasized the need for a matching qualification of the financial instrument at the level of both the subscribing and the issuing company. Moreover, the court considered that the issuing company did not substantiate the preferred cumulative fixed dividend of 6.8% with a transfer pricing study, and the shares representing MRPS were booked under the section "capital and reserves" in the balance sheet of the issuing company. Finally, the MRPS holder was not allowed, under regulatory requirements in its state of residence, to provide debt financing to the Luxembourg company. Thus, the desired requalification of the MRPS into a debt instrument could not be based on commercial reasons but should be considered as purely tax-driven.
This case is a valuable reminder of the substance-over-form approach applicable in Luxembourg. Neither the Luxembourg tax authorities nor taxpayers are bound by the pure legal form of a transaction. The economic substance also must prevail over the legal form and all facts and circumstances of the specific case need to be considered. The substance-over-form approach is also recognized for accounting purposes, and MRPS can be recorded as a debt instrument in the commercial balance sheet. Apparently, this treatment was not done in the case at hand.
Furthermore, the court held that French open-ended real estate investment companies (société de placement à prépondérance immobilière à capital variable sous forme d'une société par actions simplifiée, SPPICAV SAS) do not qualify for the participation exemption regime in Luxembourg, since a French SPPICAV can benefit from a subjective exemption from French corporate income tax. In the present case, the participation in the SPPICAV was subject to wealth tax at the level of the Luxembourg parent company.
Beneficial ownership and withholding tax refund claims
In another case, the court clarified the beneficial ownership requirements for a successful claim for refunds of dividend withholding tax in Luxembourg.
To obtain a refund of the dividend withholding tax from the Luxembourg direct tax authority, the court established the following conditions:
- The claimants must prove that they are the beneficial owners of the dividends.
- They must prove that they directly held the participation (as legal or economic owners):
- In the qualifying subsidiary pursuant to article 147 (2) of the Luxembourg income tax law,
- During an uninterrupted period of at least 12 months, including the date on which the dividends were made available
- The participation represents at least 10% or an acquisition price of at least €1.2 million in the share capital of the qualifying subsidiary.
Based on the OECD Commentary to the Model Tax Convention and the “Danish cases” decided by the CJEU, the Luxembourg court held that the beneficial owner (a term that is not defined in Luxembourg tax law) must be the person who actually receives the economic benefit of the dividend income—and not the person who merely formally collects the dividend income without being able to actually use and enjoy it. Therefore, only the person with the authority to dispose of the dividends and to freely determine its allocation can be considered to receive income from capital.
While the court admitted that minor errors in the tax vouchers would not lead to the denial of any probative value, it rejected the tax vouchers. The court pointed out that the tax vouchers did not establish that the dividends were actually paid to the claimant and did not provide information on the actual holding period. Furthermore, for one of the tax years under dispute, a payment confirmation from a bank was missing.
Moreover, the court dismissed the banking documentation with “daily position review per client” and “clearing statements for client” because the court held that these documents did not clearly prove that the claimant benefitted economically from the dividends. The court also identified inconsistencies that raised doubts about the accuracy of the documentation. Finally, the court rejected the claim that it was impossible for the taxpayer to bring evidence of the complete chain of payments and proof of payment from each intermediary in the chain from the issuing company to the claimant.
With regard to the second condition to establish beneficial ownership, the court clarified that, in principle, a participation is considered to be held by the beneficial owner of the dividends if that party is the legal owner of the participation. Only if essential shareholder rights and risks are transferred by the legal owner to a third party that thus may claim shareholder status, the economic owner of the participation replaces the legal owner as direct holder of the participation. The holding rights of usufruct over shares, for example, would not be sufficient to claim shareholder status.
Although the substance of the claimant was not under scrutiny in this case, the court interestingly defined the concept of beneficial owner by reference to the Danish cases of the CJEU and confirmed that the beneficiary for the purpose of the Luxembourg participation exemption regime must be read as the beneficial owner.
Tax disputes in Luxembourg are growing in number and in complexity. Taxpayers, therefore, need to carefully monitor the evolving case law, and companies currently facing similar tax controversies need to consider safeguarding their rights.
In light of these recent court decisions, Luxembourg companies and foreign investors need to consider reviewing the structure of their investments in Luxembourg subsidiaries when using the account 115 (and if necessary, to make changes). Also, taxpayers need to consider setting up a proper process and documentation with custodian and paying agents, and preparing applications for a reduction at source and possible claims for refund of withholding tax in all countries that infringe EU law, tax treaty provisions, and domestic law by applying a discriminatory tax treatment to cross-border dividend distributions.
Read an April 2022 report prepared by the KPMG member firm in Luxembourg
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