On 25 March 2020, the Luxembourg Government adopted a draft bill introducing new defensive measures denying the tax deduction of interest and royalty payments made to a related entity located in a blacklisted jurisdiction.
This draft bill comes at a time when the Cayman Islands was added in February to the EU list of non-cooperative jurisdictions for tax purposes. These upcoming measures could have a significant impact on holding structures as well as on private investment funds. What these measures will look like remain to be confirmed as the draft bill remains to be published.
On 18 February 2020, the EU Council updated its list of non-cooperative jurisdictions, adding four jurisdictions – the Cayman Islands, Panama, Palau and Seychelles – to the 8 jurisdictions that were already listed, which are the US Virgin Islands, American Samoa, Guam, Samoa, Oman, Trinidad and Tobago, Fiji and Vanuatu. These jurisdictions did not implement the tax reforms to which they had committed by the agreed deadline, though the Cayman Islands had recently strengthened their economic substance rules for investment funds. However, this new legislation did not come into force until 7 February, after the deadline set by the EU to assess the Cayman Islands' compliance status, thus capturing the Cayman Islands in the list of non-cooperative jurisdictions.
While updating the list of non-cooperative jurisdictions, the EU Council has produced a guidance on national defensive measures to be taken by Member States towards non-cooperative jurisdictions in December 2019. Member States have been invited to introduce one of the following legislative tax measures by the start of 2021:
- Non-deductibility of costs;
- CFC rules;
- (Increased) withholding taxes; and
- Limitation of the participation exemption on profit distributions.
The new draft bill adopted by the Luxembourg Government will introduce the first of these measures, i.e., the non-deductibility of costs. Until now, there weren't really any defensive measures in Luxembourg other than the obligation for Luxembourg companies to disclose any intragroup transactions made with entities located in blacklisted jurisdictions in their tax returns.
This draft bill is in line with the general trend of other member states which have taken some defensive measures. Several member states have even begun to establish their own national blacklist, which comes in addition to the EU list. This was first the case in Italy. The Netherlands followed and have published their own blacklist of low-tax jurisdictions, which is more extensive than the European one and includes countries such as the BVI, Guernsey, Jersey and the Isle of Man. France also maintains its own blacklist, which is also harder than the European one and may trigger various tax measures, including increased withholding taxes or denial of tax deductions on payments.
Furthermore, the EU blacklist has implications for EU funding as funds from certain programs cannot be channeled through entities in listed countries. There is also an interaction between the EU list and the EU transparency requirements for intermediaries (‘DAC6’), which was required to be transposed by member states into national laws by 31 December 2019. Under DAC6, a tax scheme routed through an EU listed country will be automatically reportable to tax authorities.
Going forward, the EU Code of Conduct is tasked with reviewing such measures from July 2021, with a view to assessing the need for further coordinated measures in the tax area and the need to apply defensive measures in a more targeted way from 2022.
II. What is the impact of these new measures?
As the new draft bill has not yet been published many questions arise, in particular as to the entry into force of these defensive tax measures. Will they come into force when the final law is published or only from January 2021? The issue is particularly relevant to structures involving the Cayman Islands. Indeed, the introduction by the Cayman Islands of new rules on economic substance, although too late to avoid being blacklisted by the EU Council, may, however, suggest that the Cayman Islands should be able to get out of the EU blacklist short or medium term, possibly when the list is revised next October.
Beyond the effective date of these new rules, other issues arise with the first question of whether investment fund structures will benefit from an exemption of these measures? Also, what happens if a jurisdiction is removed from the EU blacklist in the course of a specific tax year?
We are still waiting for the draft bill to be released as there are a number of issues that need to be clarified before assessing the impact of these measures on financing or IP structures involving entities located in blacklisted jurisdictions such as the Cayman Islands.
However, we recommend that Luxembourg taxpayers with transactions with entities located in blacklisted jurisdictions seek advice from their tax adviser in order to anticipate the potential impact of these measures and take the actions needed.
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