Luxembourg Ordered To Dismantle Holding Company Tax Regime

by Ulrika Lomas, Tax-News.com, Brussels

20 July 2006

The European Commission has ordered the government of Luxembourg to dismantle its system of tax breaks for financial holding companies.

In a statement released yesterday, the EC announced that after an investigation, opened in February, and a preliminary four-year review, it had concluded that the preferential tax regime in favour of Luxembourg’s Exempt, Milliardaire and 1929 Financial Holding companies violates EC Treaty state aid rules.

According to the EC, the scheme grants "unjustified tax advantages" to providers of certain financial services who set up holding structures in Luxembourg.

"It distorts competition and trade by altering the level playing field between financial undertakings and induces them to create dedicated structures in Luxembourg to reduce their current tax liabilities," the EC stated.

In June 2005, Luxembourg amended the 1929 law by abolishing the exempt status for holdings receiving more than 5% of their yearly dividend income from participating companies which have not been subject to a tax comparable to the one applied in Luxembourg. While this narrowed the scope of the law, the EC argued that the regime still constitutes state aid, as the tax advantages remain unchanged.

The Commission decision requires the scheme to be repealed by the end of 2006, while its effects for the existing holdings must be definitively eliminated by the end of 2010. This will allow the existing beneficiaries to exit from the holding structures without incurring tax penalties.

As the scheme is existing aid, the Commission’s decision is forward looking, and beneficiaries need not repay aid received until its final elimination.

Competition Commissioner Neelie Kroes commented: “Today’s decision to eliminate a scheme providing sizable tax advantages to Luxembourg’s financial holdings will help to restore a level playing field in the EU’s financial services industry."

Under the 1929 law, exemptions from direct business taxation are granted to Luxembourg’s holdings providing certain financial and capital-intensive services to related and unrelated business entities within a multinational group. The Exempt 1929 Holdings are companies which are exclusively engaged in holding the stocks of companies, managing collective investments, providing financing and licensing intangibles to related entities within a group.

The Milliardaire Holdings are a subgroup of Exempt Holdings which have been formed by initial cash or stock contributions of at least EUR24 million (formerly one billion Luxembourg Francs). The Financial Holdings are another subdivision of the Exempt Holdings, specialising in providing structured finance to related entities and managing collective investment funds. The revenues earned by all categories of Exempt 1929 Holdings have traditionally been tax free, and the distributions made by such Holdings exempt from withholding taxes.

In June 2003, the Council of EU Finance Ministers considered that the Exempt Holdings’ exemption from dividends constituted a harmful tax measure within the EC Code of Conduct on business taxation, on the grounds that the exemption was not conditional upon the payment of a sufficient tax by the distributing company.

The Council recommended that Luxembourg eliminate this harmful legislation by 31st December 2010 at the latest.

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