On 8 January 2021, the Luxembourg Tax Authorities published a Circular clarifying the interest limitation rules introduced in Luxembourg legislation in 2018, which implemented the European Union Anti-Tax Avoidance Directive 2016/1164 (ATAD 1).
As a reminder, this legislation provides a limitation on the deduction of net financial costs referred to as exceeding borrowing costs (EBC). These rules limit the deductibility of borrowing costs to 30% of taxable EBITDA (Earnings before Interest, Tax, Impairments, Depreciation and Amortization). A de minimis rule allows the taxpayer to deduct EBC up to €3 million.
Below are summarized the main points covered by the Circular:
Scope Of The Interest Limitation Rules
The Circular confirms the law by providing that the interest limitation rules apply to resident companies and domestic permanent establishments of nonresident entities subject to Luxembourg corporate income tax, unless the taxpayer qualifies as stand-alone entity, financial undertaking, or if certain EU long-term public infrastructure projects are at stake.
Moreover, the law contains a grandfathering clause providing that interest on loans concluded before 17 June 2016, are not subject to this legislation. However, this exception will not apply to any subsequent modifications of such loans. The Circular confirms that in the case of such modification, the grandfathering clause only applies to the original terms of the loan. In addition, the Circular provides non-exhaustive lists of changes that should and should not be considered as subsequent modification of a loan. For instance, contractual foreseeable changes would benefit from this clause.
Determination Of The Net Borrowing Costs
The law defines borrowing costs as (1) interest expenses on all forms of debt, (2) other costs economically equivalent to interest, and (3) expenses incurred in connection with the raising of finance. Then, to obtain the net borrowing costs, the amount of taxable income or other economic equivalence realized by the taxpayer should be deducted.
The Circular provides comments on this definition and practical examples to clarify what to consider in this calculation. It confirms that a symmetrical approach should be followed, i.e., what is regarded as interest expenses on all forms of debt payable or other economic equivalence to interest shall be regarded as interest revenue and other economically equivalent revenues when accrued on all forms of debt receivables.
The limitation on deduction only concerns items which remain deductible after application of other rules, for instance the anti-hybrid rules of ATAD 2 or the participation exemption “recapture” rules.
For its calculation, the Circular confirms that only taxable, i.e., non-exempt income is considered. Correlatively, exempt income under a domestic provision or a tax treaty is not considered and therefore does not affect the taxable EBITDA.
Carryforward Of EBC And Unused Interest Capacity
The Circular reaffirms the possibility for the taxpayer to carry forward EBC not deducted in a given financial year without limitation in time. Also, the EBC carryforward is an attribute that is retained in a tax-free transformation.
Also, there is a possibility for a five-year carryforward of unused interest capacity, i.e., the amount by which 30% of taxable EBITDA exceeds the amount of EBC.
The Circular clarified several elements contained in the interest limitation rules and described numerous examples that will be very useful for the tax practice. However, some questions remain unanswered like the qualification of capital gains realized on distressed or non-performing debts or how to allocate non-deductible exceeding borrowing costs between different debts.
Yann Ricard was a contributing author to this insight.