Tax

Jul 25, 2025 - On 24 July 2025, Draft Law No 8590 was submitted to the Luxembourg Parliament (Chambre des Députés) intending to update and render more attractive the tax regime for carried interest granted to managers of alternative investment funds (“AIF”). The proposed changes aim at attracting more front office employees to Luxembourg by increasing the scope of beneficiaries and taking into account various forms of carried interest. Background The proposal is in line with the 2023-2028 coalition program of the government that committed to provide for an attractive framework for alternative investment funds and their managers including a review of the carried interest tax regime. The existing carried interest tax regime was introduced by the Law of 12 July 2013 relating to alternative investment fund managers transposing the AIFM directive 2011/61/EU including a standard regime and a temporary favourable regime. The standard regime is dedicated to employees of the alternative investment fund manager (“AIFM”) or management company and provided for the full taxation of the carried interest based on a profit-sharing right and the application of the ordinary regime for capital gains (which could result in the tax exemption of the capital gains realized after a 6-months holding period) on the portion of the carried interest that could be linked to the disposal of a participation held by the manager in an underlying corporate entity. The temporary favourable tax regime provides for a reduced taxation of the carried interest for a period of 10 years at the quarter of the applicable global tax rate under the condition that the beneficiary redomiciled to Luxembourg before 2018. The Draft Law draws from this regime and the feedback it received thereon to propose amendments that increase legal certainty and broaden the scope of eligible persons and forms of carried interests. Proposed tax regime The Draft Law broadens the scope of eligible persons and provides for a different tax regime depending on whether the carried interest is a contractual arrangement only or involves the holding of an interest. Eligible individuals  Eligible persons are broadly defined as including any natural person who can be the manager or any other person at the service of the manager or the management company of an AIF. Commentaries to the Draft Law mention that the beneficiary can be employed by another entity than the AIFM, such as an advisor, and be in a relationship other than employment with the AIFM, such as an independent director. Compared to the existing regime, the scope of the proposed regime is broader and not limited to employees of the AIFM or the management company. Contractual arrangements Carried interest definition: The Draft Law refers to a participation in the fund’s “outperformance” on the basis of a profit-sharing arrangement granting specific rights over the fund’s net assets and income in order to include the broadest possible definition of carried interest. Commentaries to the Draft Law clarify that “outperformance” refers to the performance exceeding a pre-determined hurdle rate. It is also mentioned that such hurdle rate shall correspond to market practice to steer clear from any requalification under the abuse of law concept. Form: The carried interest is solely based on a contractual arrangement (e.g., provided for in the Limited Partnership Agreement). Under this form, the beneficiary is not required to acquire an interest in the AIF nor hold an interest mirroring the AIF’s performance. Payment: The commentaries to the Draft Law provide that the remuneration can be paid by the AIF or another entity (e.g., the general partner). The preexisting requirement that investors shall be repaid their invested amounts first is removed considering that AIF investors are informed and contractual arrangements generally provide sufficient protection (such as claw back clauses). Thus, carried payments on a deal-by-deal basis would now be eligible to the regime. Reduced taxation: The remuneration under those types of carried interest will be subject to a quarter of the global tax rate applicable to the taxpayer. Eligibility to such tax regime is not time limited as under existing rules which provide for a favourable tax treatment for only up to a 10-year period. Participation based arrangements Form: The participation based carried interest covers two forms. First, the above-described contractual interest when it is accompanied with the requirement to hold a direct or indirect participation in the AIF. The commentaries add that the link between the carried interest and the participation should have an economic reality in terms of amount and duration to avoid steer requalification under the abuse of law concept. The second form is where the individual can acquire a participation in another vehicle entitling the holder of said participation to a carried interest. Taxation: The remuneration representing the carried interest follows the ordinary rules applicable to capital gains and is not considered as a taxable income if received more than 6 months after the investment (unless it represents a participation in a corporate entity exceeding a stake of 10% in the capital of such entity). Income resulting from the participation and not representing the carried interest remains subject to the ordinary tax regime. Legal forms of the investment vehicle: For the taxation of the participation based carried interest at the level of the beneficiary, the legal form of the interest issuer is disregarded. This is a welcome simplification as applying the tax transparency of partnerships or mutual funds could complexify the tax qualification at the level of the carry beneficiary. Interaction with existing carried interest regime The Draft Law that should come into force, if approved by the parliament, in 2026 intends to abolish the existing carried interest tax regime as from fiscal year 2026. The commentaries provide that the new rules are sufficiently broad provide for a more favourable taxation of all beneficiaries under the current carried interest regime. Key Takeaways The current carried interest tax regime is being phased-out as some shortcomings were identified. The Draft Law provides for a favourable tax regime to a larger variety of carried interest arrangements available in the market. In addition, it enlarges the scope of eligible beneficiaries previously limited to AIFM employees. In addition, it should limit preexisting difficulties pertaining to the qualification of the income received when the beneficiary is also an employee. Author: Pol Mellina, Partner, Daniel Riedel, Partner, Ali Ganfoud, Senior Counsel

Jan 30, 2025 - Significant changes have taken place in the Luxembourg tax landscape in the course of the year 2024, as demonstrated by the intense legislative activity until the last days of 2024, with several measures taking effect as from fiscal year 2025, as summarised below. Corporate taxpayers Corporate income tax reduction by 1% bringing the standard rate from 17% to 16% resulting in an aggregate tax rate of up to 23.87% (incl. municipal business tax and solidarity surcharge) instead of 24.94% for a company with its registered seat in Luxembourg-City (see our July 2024 newsflash). Minimum net wealth tax is simplified as from 2025 with only three brackets (EUR 535, EUR 1,605 and EUR 4,815) and reliance only on the total balance sheet size (see our May 2024 newsflash). Share redemption tax regime is clarified on the basis of previous case law with specific conditions now set out in the law (see our May 2024 newsflash). Opt-out mechanism for dividends and capital gains exemption: as from fiscal year 2025, where an exemption of dividends/capital gains is available under the participation exemption regime solely relying on the minimum acquisition price threshold or where the requirements to obtain a 50% exemption on dividends are met, the taxpayer can opt out of the exemption annually and per participation (see our May 2024 newsflash). The rules limiting the deduction of interest expenses are amended as from fiscal year 2025 for entities forming a single entity group. Tax credit for investment, applicable to corporate taxpayers and entrepreneurs, is amended as from fiscal year 2024, reaching up to 18% of eligible investments or expenses with specific rules for digital transformation, ecological and energetic transition (see our dedicated newsflash). Simplified liquidation and its related tax regime has now been clarified by the Luxembourg direct tax administration by way of a circular (see our dedicated newsflash). Mandatory digital filing for tax returns is extended as from fiscal year 2025 to include several withholding tax returns and most notably the withholding tax returns for directors’ fees (see our May 2024 newsflash). Actively managed ETFs and Private wealth management companies (“SPF”) Actively managed ETFs now benefit from a full subscription tax exemption. SPFs: the minimum subscription tax is increased from EUR 100 to EUR 1,000 and audit measures are reinforced. Pillar Two Luxembourg legislator continued the update of the Luxembourg domestic Pillar Two legislation introduced in 2023 (see our July 2024 newsflash). Amendments include several measures from subsequent OECD administrative guidance issued until July 2024 and have been reflected in the Law of 20 December 2024 (Official Gazette N° 576 of 23 December 2024) with retroactive effect to fiscal years starting 31 December 2023. The Government aims at maintaining the Luxembourg Pillar Two legislation compliant with OECD requirements and to provide in-scope taxpayers with the highest amount of legal certainty, thus further updates can be expected depending on future developments at OECD level. Tax measures enhancing the employment market The following measures apply, unless mentioned otherwise, as from fiscal year 2025 (see our July 2024 newsflash): Impatriate tax regime is simplified with a 50% exemption of the salary up to an annual gross salary of EUR 400,000. The participative bonus regime providing for a 50% exemption of the bonus paid to employees in connection with the employer’s profits is enhanced with the increase of applicable thresholds. Employees entering the workforce can benefit from a 75% tax exemption for the bonus paid by the first Luxembourg employer under a permanent contract for a 5-year period. The employee must be below 30 at the beginning of the year and the annual salary below EUR 100,000. A tax credit for cross border workers’ overtime hours subject to taxation in their country of residence is introduced subject to certain conditions which, in practice, should mainly apply to German residents. A partially tax-exempt (25%) rent subsidy that can be paid by the employer to its employee below 30 since 1 June 2024, subject to certain conditions (see our dedicated newsflash). The tax credit for the hiring of unemployed persons is extended until 31 December 2026. Tax measures targeting the real estate sectors The Government adopted several measures to ease existing tensions on the real estate sector (see our February 2024 newsflash): Short term targeted measures only for 2024 include (i) an increase by EUR 10,000 of the allowance for registration and transcription duties for the acquisition of the main residence, (ii) a EUR 20,000 allowance for registration and transcription duties for investment in rental properties (sold in future state of completion, “VEFA”) by individuals, (iii) a reduced tax rate for capital gains on Luxembourg real estate held for more than 2 years, (iv) a roll-over of real estate capital gains and (v) a special deduction which adds to the usual amortisation for rented real estate acquired in 2024 in future state of completion. Long term measures include (i) an increase of the holding period from 2 to 5 years to benefit from the more favourable long term real estate capital gains regime, (ii) the extension of the favorable regime for disposals and rentals through organism in charge of social housing and (iii) an increase in the tax deductibility of interest expenses in relation with the acquisition of the main residence. Draft Law No. 8470 has been submitted to the Luxembourg Parliament (Chambre des Députés) on 18 December 2024, in order to extend the short-term measures of 2024 to the first semester of 2025, but it has not been voted yet. In addition, the 2025 budget law reduced by 50% the taxable basis for registration and transcription duties applicable to real estate acquisitions between 1 October 2024 and 30 June 2025, subject to certain conditions (see our dedicated newsflash). Tax measures for individuals As from fiscal year 2025, an adjustment to the tax scale with 2.5 indexation tranches has taken effect together with targeted measures alleviating the tax burden for taxpayers within Class 1a, for single parents, taxpayers with children outside the household and taxpayers paid the minimum tax wage (see our July 2024 newsflash). Looking forward, the Government is working towards the implementation of a single tax class for individuals with a first project to be issued in 2026. Tax administration and procedure In March 2023, the Government had submitted to the Luxembourg Parliament Draft Law No. 8186 aiming at implementing an ambitious reform of Luxembourg tax procedures. Pursuant to initial backlash on the erosion of taxpayer rights foreseen in the draft law, the project has been split in two, and while the first significant part of the reform is still undergoing legislative process, the second part has been introduced through the Law of 20 December 2024 (Official Gazette N° 571 of 23 December 2024), with the following notable measures for taxpayers: Payment of the tax liability in instalments: corporate and individual taxpayers can request a payment through instalments of their tax liability directly to the officer in charge of tax collection (receveur). Taxes concerned are corporate income tax, municipal business tax and net wealth tax for corporate entities and income tax for individuals (excluding withholding taxes and tax advance payments). Several conditions apply: a specific and motivated requested should be addressed to the tax collector, the payment of the initial tax liability must result in considerable difficulties for the taxpayer and the tax claim must not be jeopardised by the granting of the additional deadline (the tax authorities can request guarantees). The payment in instalments does not prevent the application of interests for late payments. The relevance of this additional procedure compared to the pre-existing request for a deferred payment, is that the new procedure can take place after the due date for payment. Statute of limitations and exit tax: amendments clarify that in case a deferred payment of the tax liability is obtained in the context of the application of an exit tax, the statute of limitation is suspended, thus ensuring that the exit tax liability is not extinguished by the statute of limitation prior to its payment within the standard statute of limitation period. Other relevant measures notably include the implementation of exchange of information possibilities between the tax authorities and the CSSF as well as the Commissariat aux assurances to enhance their cooperation within their respective fields of supervision. Author: Daniel Riedel, Partner, Ali Ganfoud, Senior Counsel

Apr 24, 2025 - On 17 April 2025, the Luxembourg Higher Administrative Court (Cour administrative), delivered its long awaited decision on case n° 50.602C pertaining to the qualification of interest free loans under Luxembourg tax law and the existence of a permanent establishment in a treaty jurisdiction. With its decision, the Higher Administrative Court brings further clarity in the process to be used when assessing the tax qualification of financial instruments as well as the existence of permanent establishments. Background to the case law A Luxembourg company (“LuxCo”) held two participations that it allocated to its Malaysian branch after the acquisition given that they could not benefit from a tax exemption and funded these investments through two interest free loans from its indirect shareholder (“IFLs”). LuxCo applied for a tax ruling seeking confirmation that the branch would qualify as a permanent establishment (“PE”) under the Luxembourg-Malaysia double tax treaty (“DTT”) and that as a result the right to tax the assets and income of the branch would be allocated to Malaysia rather than Luxembourg. The Luxembourg tax authorities (“LTA”) denied the request based on the abuse of law. Despite the refusal, in its 2015 tax returns, LuxCo considered the branch as a PE, allocated the two participations to said PE and sought to treat the assets and related income as tax exempt in Luxembourg in accordance with the DTT. Additionally, the LuxCo treated the IFLs as debt instruments. The LTA rejected the position taken in the tax return and considered that the branch did not qualify as a PE and was in fact an abusive legal construction. In addition, the LTA requalified the IFLs as equity instruments. As a result, LuxCo was considered as holding two participations not meeting the requirements of the participation exemption and could not deduct the IFLs, considered as equity, from its net wealth tax basis. The Lower Administrative Tribunal followed the LTA (see our previous newsflash) in these conclusions, leading the taxpayer to file an appeal. Decision of the Higher Administrative Court The Higher Administrative Court (the “Court”) confirmed the judgment of the Lower Administrative Tribunal (the “Tribunal”) on both points, denying the debt qualification of the IFLs based on the substance over form principle and the permanent establishment qualification of the branch under the Luxembourg-Malaysia DTT. Qualification of the IFLs for tax purposes Preliminary to its analysis, the Court put aside the two arguments raised in the case at hand to assess the qualification of a financial instrument and recalled the process required to assess financial instruments: The principle set by article 40 of the Luxembourg income tax (“LITL”) that the tax balance sheet follows the commercial balance sheet unless specific tax rules provide otherwise, is relevant only for valuation of assets and liabilities. The substance-over-form approach whereby economic ownership primes over legal ownership mentioned in paragraph 11 of the Luxembourg adaptation law (Steueranpassungsgesetz), is merely a specific application of the substance-over-form principle and not its source, said principle being rather intrinsically existing in our tax law. As a result, paragraph 11 is only used to guide the allocation of income and assets to the relevant taxpayer and is not the legal source of the substance-over-form principle. The Court then engaged in the assessment process by relying on its previous decisions and guidance from the parliamentary work of the LITL. The process relies on the review of the loans’ characteristics and the economic circumstances surrounding the operation, the Court putting heavy emphasis on the fact that the economic circumstances surrounding the operation weigh as heavily in the determination as the loans’ characteristics. Use of borrowed funds  As the Tribunal considered that the use of borrowed funds helped sustain an equity qualification of the IFL, the taxpayer tried to challenge the conclusions of the Tribunal that the IFLs were fundings long-term assets (i.e., shares in subsidiaries) by putting forward several arguments: that despite the fact that the parliamentary comments used the words “long term assets” (immobilisations de longue durée) those are not defined in the LITL; that the Tribunal took into consideration the assets ultimately held by the subsidiaries (gas pipelines) and not just the direct holdings of LuxCo; and that LuxCo ultimately sold the shares in the subsidiaries after a 6 year investment period and the fact that the shares were funded a 10 years maturity debt. The Court dismissed these arguments on the grounds that: The term long term assets as used under the LITL aims necessarily to long term assets given that they would have been qualified as short-term assets (actifs circulants) if they weren’t and several indicators point to the fact that the investment was necessarily long term, such as the accounting treatment of the shares, the details provided in the notes to the financial statements, the use of the same corporate designation throughout the group and the fact that the underlying investments required approval by local authorities before being disposed (foreign direct investments clearances, etc…). The underlying investment by the subsidiary must be considered especially given its complexity in the case at hand. This does however not mean that the direct subsidiary is disregarded. The fact that the IFLs’ agreements provided for a 10-year maturity is not relevant as in fact the maturity was extended by granting additional loans throughout the ownership period. Disproportion between debt and equity The taxpayer challenged the conclusion of the Tribunal that the taxpayer’s debt-to-equity ratio is disproportionate and considered that the proportionate character should be analysed in light of the administrative practice requiring a 85/15 ratio. The taxpayer attempted to justify the 85/15 debt-to-equity ratio by providing a transfer pricing study reviewing the debt structures of peers in the same industry during fiscal year 2015. In addition, LuxCo claimed that such analysis should be done at the time it acquired the assets rather than at year-end as done by the Tribunal (despite previous case laws providing that the analysis should be done upon transfer of the funds). The Court considered that: On the timing of the review, the taxpayer invested progressively during the year 2015 without providing interim accounts to analyse his position upon each investment and the taxpayer did not demonstrate that his capitalization was different before year end, entailing an absence of prejudice and the appropriateness of referring to the year-end accounts, those being the only ones available. Administrative practice requiring a 85/15 ratio for holding companies is not legally binding and thus has to be disregarded when assessing the situation at hand. Beyond the typographical error in the taxpayer’s designation, the Court held that the relevant issue is not whether other groups adopted an 85/15 debt-to-equity ratio, but rather which ratio would have been applied had the transaction occurred between unrelated parties. It seems that the Court placed emphasis on debt-to-equity ratio observed among independent entities. Notwithstanding the foregoing, the Court rejected the transfer pricing study finding that the section intended to provide an analysis of the accurate delineation of the covered transaction, including the commercial rationale behind as well as the other options realistically available was incomplete and lacked accurate explanation. Apart from a vague explanation of the business purpose, the study failed to offer a robust justification of the chosen structure or an analysis of viable alternatives. On the amount of debt to be requalified  The taxpayer argued that the outcome of the requalification should be to restate an arm’s length debt-to-equity ratio. As mentioned above, the Court dismissed the transfer pricing study and the legal value of the administrative practice. The judges took the view that in the context of qualifying a financial instrument, the assessment process can only result in one qualification, either disguised capital or debt, for the entirety of the instrument without the possibility to reach a hybrid qualification. In other words, the appropriateness of the indebtedness needs to be factored in during the qualification phase of the financial instrument in order to reach a conclusion whether it is effectively a debt instrument. Absence of guarantee The taxpayer argued that in the absence of a limited recourse clause, there is no need for a guarantee and in an intra-group context, especially in presence of a shareholder loan (here an indirect shareholder), such guarantees are less frequent in practice. The Court found that despite the absence of a limited recourse clause in the loans agreement, the notes to the LuxCo’s financial statements explaining that the lender will not request repayment if the borrower does not have sufficient funds, resulted in the existence of a de facto limited recourse. In an intra-group context, the Court agreed with the statement that intra-group relationships imply a level of trust and control not comparable to relationships with third parties. However, the Court considered that where the lender is the indirect shareholder controlling 100% of the borrower, the possibility of granting guarantee or pledges on the borrower’ shares are not excluded. This criterion thus, amongst others, points to an equity qualification of the IFL. Assessment process The taxpayer further argued that the majority of the characteristics pointed to a debt qualification and that the judges thus couldn’t conclude otherwise. The Court again sided with the Tribunal, the judges recalling that the assessment process relies on two parts, a review of the characteristics and a review of the overall operations in which the transaction takes place. Thus, meeting a majority of debt characteristics, especially when it results from the absence of dedicated clauses in the agreement, does not automatically result in a debt qualification, when a review of the overall operation leads to a different result. Non recognition of the foreign branch as a permanent establishment  Lastly, the Court analysed whether the Malaysian branch could qualify as a PE under the DTT, by looking at the wording of the DTT and the OCED commentary to the OCED model convention. The judges analysed (i) the existence of a place of business, i.e. a physical place of business of any kind, in particular, a branch or an office, (ii) the fixed nature of that place of business, i.e. it must be established in a specific place and be characterized by a certain degree of permanence, and (iii) the carrying on of all or part of the business of the undertaking in question through that place of business in the sense that persons carry on the business in the State in which the fixed place of business is situated, in this case in Malaysia and (iv) the absence of any preparatory or auxiliary character of that business. The taxpayer was not able to provide coherent, non-contradictory and substantial evidence as to the existence and the exact place of the leased offices of the branch, the existence of an activity at the level of the branch, as it had no employee or the carrying out (part) of the business of the LuxCo through it, leading the judges to deny the qualification of PE to the Malaysian branch. Finally, the Court did not analyse the abuse of law aspects of the appeal as it would not change the above conclusions. Conclusion On the qualification of financial instruments for Luxembourg tax purposes, this case further clarifies on the relevant characteristics to be analysed and sets aside arguments often invoked but not relevant in this context such as the principle of attachment of the tax and commercial balance sheet. On the method, the Court recalls that the assessment is not an “arithmetical computation” based on a listing of the characteristics but a balance of characteristics and context. Incidentally, the Court tackles the subject of the right balance between debt and equity for a holding company. First, it confirms once again that the administrative practice requiring a 85/15 debt-to-equity ratio is not legally binding and thus should be disregarded and secondly provides insight on how the Court analyses a debt capacity analysis and at which stage this debt capacity becomes relevant, i.e. during the qualification of the financial instrument stage. The major contribution of this “landmark” decision is that the debt-to-equity ratio has now been clearly reframed as being one of the major components assessed during the process of qualification of a financial instrument (within the second limb where one should assess the overall operations the financial instrument is financing) rather than a stand-alone concept applied after the fact. Authors: Daniel Riedel, Partner, Ali Ganfoud, Senior Counsel, Harun Cekici, Associate