Blogs Archive - Van Campen Liem

VCL Luxembourg flash – February 2023

Luxembourg administrative tribunal issues landmark judgment on share class redemption

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On 27 January 2023, the Luxembourg Administrative Tribunal (Tribunal) gave its long-awaited judgment (n°42432) on the tax treatment of a redemption (and cancellation) of a class of shares by clarifying that such redemption should in principle qualify as a capital gain and thus be free of Luxembourg withholding tax (WHT).

We would like to share with you our insights thereof.

Background

In the case at hand, a Luxembourg limited liability company (LuxCo) redeemed one of its 10 different classes of so-called ‘alphabet shares’ (Alphabet Shares) at a price significantly above its proportionate nominal value from its sole shareholder. Each class of Alphabet Shares represented 5% of LuxCo’s nominal share capital and had only been incorporated one year prior to the redemption subject to the litigation at hand. LuxCo’s articles of association did not attach any different economic rights to the various Alphabet Share classes but merely specified that any repurchase of an entire class of Alphabet Shares should be made in a reverse alphabetical order.

LuxCo considered the repurchase of the class of shares as a partial liquidation and therefore not subject to WHT.The Luxembourg tax authorities (LTA) challenged this treatment on the basis of several specific aspects of the case and requalified the transaction as a hidden dividend distribution which is subject to 15% WHT.

The Tribunal’s judgment

In its judgment, the Tribunal confirmed that a redemption followed by a cancellation of shares qualifies, in principle, as a capital gain instead of a dividend distribution and should thus not be subject to WHT. This conclusion is subject to the shares’ redemption price corresponding to its fair market value (FMV) and being justified based on valid economic reasons and not solely the shareholder relationship.

As a consequence, to the extent that the redemption price exceeds the share’s FMV and is not based on serious economic reasons, the LTA may requalify the redemption and cancellation of shares as a hidden dividend distribution subject to 15% WHT. However, the LTA may solely impose the 15% WHT on the amount exceeding the FMV of the redeemed shares, and not the entire redemption price.

In the case at hand, the Tribunal concluded due to the lack of necessary evidence to compute the redeemed shares’ FMV, the absence of different economic rights allocated to the Alphabet Shares, as well as the fact that the redeemed shares only represent 5% of LuxCo’s share capital, that the redemption price did not correspond to the shares’ real value. In that respect, it referred the valuation of the shares’ FMV back to the LTA.

In light of the above, the Tribunal did not deem it necessary to assess the existence of an abuse of law.

Furthermore, the Tribunal, despite the following factual elements in the case at hand, did not consider that it was necessary to analyse the potential existence of an abuse of law:

LuxCo was owned by one sole shareholder;
All different classes of Alphabet Shares were created without distinct economic rights;
All different classes of Alphabet Shares were established after LuxCo’s incorporation and only one year before the redemption of a class of Alphabet Shares.

Conclusion

While the Tribunal’s judgment is not final yet and may still be subject to an appeal, it is a positive message to taxpayers and advisors by providing clarity on the tax treatment of the redemption of shares followed by a reduction of share capital. Indeed, the Tribunal confirmed that a redemption followed by a cancellation of shares qualifies, in principle, as a capital gain not subject to WHT in Luxembourg.

In its reasoning, the Tribunal seems to focus on whether the shares’ redemption price corresponds to its FMV and whether a sufficient amount of shares are being redeemed in light of the redemption price paid (i.e. the share capital represented by the redeemed shares should somewhat be proportionate to the redemption price).

We would therefore recommend to Luxembourg taxpayers who have or are thinking of implementing Alphabet Shares in their share capital, to prepare appropriate documentation and valuations in advance of implementing any future share redemption transactions in case of a challenge by the LTA. In addition, the article of associations should be carefully drafted upon implementation of Alphabet Shares in order to ensure that different economic rights exist between each class of shares.

It is unfortunate that the Tribunal did not address the concept of abuse of law, as this remains highly relevant for share redemptions and will be important to follow closely in the future.

We trust you find this publication useful and welcome the opportunity to answer any questions or comments you may have. We will keep you updated on any additional tax measures.

Raffaele Gargiulo
Partner
E:rafaelle.gargiulo@vancampenliem.com
T:+352 691 205 340

Andrew de Vries
Partner
E:andrew.devries@vancampenliem.com
T: +352 691 205 768

Eduardo Trancho
Partner
E:eduardo.trancho@vancampenliem.com
T: +352 691 205 349

Gabriel Amar
Counsel
E:gabriel.amar@vancampenliem.com
T: +352 691 205 709

ChristinaStrauven                                                                             Associate
E:christina.strauven@vancampenliem.com
T: +352 691 205 165

Diego Gonzalez Manso
Associate
E:diego.gonzalezmanso@vancampenliem.com
T: +352 691 205 080

Assia Sadki
Associate
E:assia.sadki@vancampenliem.com
T: +352 691 205 167

Oona Jokinen
Associate
E:oona.jokinen@vancampenliem.com
T: +352 691 334 723

Budget Law 2023 – Tax

Topics

Reverse Hybrid Rules – Clarification
Tax Returns – Extension of the filing deadlines
Temporarily reduction of VAT rates
Impatriate Regime
Profit participating scheme
RELIBI Law
Conclusion

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On 12 October 2022, the Luxembourg Government presented the 2023 Budget bill (n°8080) which was later on 23 December 2022, adopted (the “Budget”). In general, and as expected, the Budget does not contain any major tax changes, rather clarifications to certain existing rules.

Reverse Hybrids Rules – Clarification

The Budget clarified the scope of application of article 168quater of the Luxembourg Income Tax Law (“LITL”) on so-called ‘reverse hybrid rules’. The current rules in place provide that Luxembourg tax transparent entities will become liable to corporate income tax on the portion of the income which is not taxed in Luxembourg nor in any other jurisdiction, where one or more associated non-resident persons/entities holding in aggregate a direct or indirect interest in 50 % or more of the voting rights, capital interests or profit entitlement in such entity are located in a jurisdiction that regard the Luxembourg entity as an opaque entity.

The proposed changes aim to clarify that the reverse hybrid rules would only apply if the non-taxation of the income realized by the investor result from the difference in qualification of the Luxembourg entity. In case the income realized by the investor benefits from a subjective exemption in its state of residence, such investor and the portion of income realised by the Luxembourg entity allocable to him would not fall within the scope of the reverse hybrid rules.

This clarification is especially welcome for situations where a Luxembourg investment fund has an investor base composed of, for instance, foreign pension funds, sovereign wealth funds, other tax-exempt funds or entities set up in jurisdictions that do not levy a tax similar to a corporate tax or that apply a territorial tax system where foreign income is exempt from taxation as in these cases the reverse hybrid rules should not apply as these would be subjective exemptions.

Therefore, the clarification means that the reverse hybrid rules would only apply in cases where the double non-taxation would arise from an actual hybrid mismatch (i.e., transparent vs. opaque) and not from other factors, such as the tax-exempt status of the investors.

This clarification shall already apply for tax year 2022.

Tax Returns – Extension of the filing deadlines

As per the Budget, the deadline for the filing of corporate income tax, municipal business tax, net wealth tax and personal income tax returns would be extended to 31 December compared to the current deadline of 31 March. The new filing deadlines apply for tax returns as from tax year 2022.

Temporarily reduction of VAT rates

As from 1 January 2023, the standard, intermediate and reduced VAT rates will decrease by 1% to reach 16%, 13% and 7%, respectively. In principle, the measure is of a transitional nature and should end on 31 December 2023. The super-reduced rate will remain at 3%.

Inpatriate Regime

A special tax regime exists in Luxembourg where the costs incurred in moving highly skilled employees (impatriates) which are borne by the company may be reported as operating expenses. Furthermore, an impatriate may, under certain conditions, and for a limited period of time (up to 8 years), receive a full or partial tax exemption for the allowances received (in cash or in kind) and directly linked to the move to Luxembourg.

As laid in the Budget, the limit of the gross wage to be earned (before benefits in cash and kind) in order to apply this regime shall be lowered from EUR 100,000 to EUR 75,000.

Profit Participating Scheme

Currently the Luxembourg Law allows employees to participate in the beneficial tax regime under the profit participating scheme (prime participative) which allows a tax exemption of 50% of the renumeration in the form of a profit participating scheme, subject to certain conditions, such as that the profit participating scheme does not exceed 5% of the profit of the employing company in the relevant financial year.

The Budget brought greater flexibility, so that instead of assessing the 5% positive result at the level of each company, those companies that are part of a tax unit group may opt to be assessed jointly, rather than individually.

RELIBI Law

The Budget also brought further clarification to the Luxembourg Law of 23 December 2005 (“RELIBI Law”). Currently the law states that a final withholding tax (“WHT”) of 20% will be imposed on certain interest income realized by natural persons who are resident in Luxembourg. The 20% withholding tax must be levied by a paying agent.

The Budget clarifies the definition of a paying agent to only consider professionals of the financial sector who pay interest as part of their normal economic activity. Furthermore, the Budget specifies that should a bank intervene in a passive way, the bank should not be considered as a paying agent. Additionally, it is further stated that the RELIBI Law does not apply in cases where the interest payments have been made between private persons.

Conclusion

As can be seen from this short summary to the Budget, no major tax changes were brought up. From an alternative investment view, the major takeaway is the clarification on the anti-hybrid rules for them to only apply in cases where the mismatch arises from a pure classification of the entities and not of subjective situations.

Feel free to reach out to our tax team should you have any question or require any assistance.

Raffaele Gargiuolo