Good News And Bad For Luxembourg 1929 Companies

by Ulrika Lomas, Tax-News,com, Brussels

13 April 2004

Luxembourg is expected to implement the EU's Interest and Royalty Directive shortly, under which withholding taxes are abolished in respect of payments of interest and royalties between associated EU companies. Two companies are regarded as associated companies when one has a direct minimum holding of 25% in the capital of the other, or when a third company has a direct minimum holding of 25% in the capital of both companies. Both companies must be subject to corporation tax.

However, Luxembourg is proposing to go further, and exempt all nonresidents and Luxembourg 1929 holding companies will no longer be taxed on Luxembourg-source royalty income. Currently, royalties are subject to a 10% withholding tax. The term royalties refers in this respect to any payment made to nonresidents for the use of, or the right to use, any copyright on literary, artistic or scientific work, as well as any payment made to nonresidents or to Luxembourg 1929 holding companies for the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process, or any other similar right, and any information relating to industrial, commercial or scientific experience.

In fact, under most of Luxembourg's tax treaties (which follow the OECD Model Treaty), Luxembourg-source royalty payments usually are subject to tax only in the beneficiary's residence state, resulting in a zero (or reduced) withholding tax rate.

In addition to eliminating withholding taxes on interest and royalty payments between affiliated EU-resident companies (required by the EC Directive), the draft law provides for the complete abolition of the taxation of nonresidents on Luxembourg-source royalty income, whether by withholding or assessment, whether or not they are in the EU, and regardless of whether they are associated with the payor of the royalty. The same exemption will be granted to Luxembourg 1929 holding companies.

In accordance with the Directive, the proposed legislation should become effective retroactively, i.e. as from 1 January 2004.

It isn't all good news, however. Luxembourg is being forced to comply with the EU's Code of Conduct Committee's campaign against 'harmful tax practices' by modifying the dividend taxation regime for 1929 holding companies. Currently,1929 holding companies are exempt from all Luxembourg taxes, with the exception of the annual subscription tax levied on their net asset value and the capital contribution tax. Thus, a 1929 holding company can receive dividends from a foreign subsidiary and claim an exemption, even if the distributing subsidiary is not subject to tax or is subject to a tax regime that is notably more advantageous than the regime applicable to fully taxed Luxembourg resident subsidiaries.

Under draft legislation, a 1929 holding company will lose its tax-exempt status if at least 5% of its dividends received relate to foreign participations that are not subject to tax at a rate comparable to the Luxembourg corporate income tax rate. An effective tax rate will be considered to be comparable if it is at least 11%, equating to approximately one-half of the current corporate income tax rate that applies to regular resident taxpayers and is in line with the tax rate generally applicable to dividends received from participations that do not qualify for a full exemption.

Further, the taxable base will need to be determined under a method similar to the methods used in Luxembourg. An auditor or accountant will be required to certify annually that the eligibility requirements have been met. A 1929 holding company that loses its tax-exempt status will be subject to the normal corporate income tax regime.

For newly incorporated 1929 holding companies, the amendment will apply as from 1 January 2004. For existing 1929 holding companies (i.e. those incorporated under the law applicable before 1 January 2004), the new rules will apply as from 1 January 2011.

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