AGEFI Luxembourg8Avril 2016

Economie

By Oliver R. Hoor and Keith O’Donnell, Atoz*

On 29 February 2016, theLuxembourg Governmentpresented the contempla-ted changes to the Luxembourgcorporate tax system whichshould be implemented in 2017.The main changes comprise (i) areduction of the corporate inco-me tax rate, (ii) an increase of theminimum net wealth tax and (iii)limitations to the use of tax lossesincurred as from 2017. Thisarticle provides a clearand concise overviewof these measuresand analyses theirimpact on the com-petitiveness ofLuxembourg as a loca-tion of choice for thestructuring of interna-tional business activitiesand investments.

I. Introduction

The tax reform comes at a time where the inter-national tax landscape is characterized byextreme uncertainty. On 5 October 2016, theOECD released their final reports on the OECDBase Erosion and Profit Shifting (BEPS) Projectwhich provide for recommendations as to howindividual countries should amend theirdomestic tax laws.

On 28 January 2016, the European Commissionpresented its Anti-Tax Avoidance Package thataims at the implementation of a number ofBEPS measures. One of the core pillars of thispackage is a Draft EU Anti-Tax AvoidanceDirective proposing anti-tax avoidance ruleswhich are meant to be implemented by eachEU Member State. In addition, individualcountries around the globe started implement-ing unilateral tax measures aiming at tacklingperceived tax avoidance.

In this environment, it is important forLuxembourg to remain attractive for multina-tional enterprises and international investors.Today, Luxembourg is a financial centre (with astrong fund and banking sector) and a primeholding location.

The competition between European countriesfor international investments did, however, notdecrease over the last years. Whether or not thecurrent proposals would improve the competi-tiveness of the Grand Duchy is analyzed in thefollowing sections.

II. Analysis of the contemplated tax measures

1. Decrease of the corporate income tax rate

1.1. Proposed measure

The corporate income tax rate is proposed to bereduced in two steps from 21% to 19% (in 2017)and from 19% to 18% (in 2018). The proposedmeasures do neither foresee a change of the 7%solidarity surcharge levied on the corporateincome tax nor a change to the municipal busi-ness tax rate due by companies (6.75% inLuxembourg-City). Accordingly, the aggregatecorporate tax rate applicable to companiesestablished in Luxembourg-City would bedecreased from currently 29.22% to 27.08% (in2017) and 26.01% (in 2018).

Small and start-up companies with a taxableincome which does not exceed EUR 25.000would benefit from a reduced corporateincome tax rate of 15%. Thus, the aggregatecorporate tax rate for these companies wouldbe 22.08% in Luxembourg City (including soli-darity surcharge and municipal business tax).

1.2. Impact analysis

The corporate tax rate is an important featureof a corporate tax system. Whenever businessleaders compare jurisdictions, the tax rate isone of the key criteria that is taken intoaccount. This is hardly surprising given thattax laws are very complex and decision makersare usually not tax experts.

With an aggregate tax rate of currently 29.22%(in Luxembourg City), Luxembourg has cur-rently rather a high tax rate. Other Europeancountries which are competing withLuxembourg for foreign investments havelower tax rates. The most prominent examplesinclude:

Malta: 10% (effective tax rate after tax refund to the shareholder)

Cyprus: 12.5%Ireland: 12.5% United Kingdom: 20% (to be decreased to 18%)Switzerland: 25%The Netherlands: 25%

In the authors‘ view, the LuxembourgGovernment should take a bold step and cut thecorporate tax rate more significantly. Even areduction of the corporate income tax rate by10% should be considered. This would be a clearsignal to international investors thatLuxembourg will remain attractive in the post-BEPS era which will be characterized by moreharmonized tax rules.

When considering such a measure, the questionarises as to how a decrease of the corporate taxrate may impact the Luxembourg tax revenue.The impact of a decrease of tax rates on tax rev-enues has been analysed in various studies.(1) Allthese studies come to the conclusion that a fall ofcorporate tax rates would not give rise to adecrease in corporate income tax revenues rela-tive to GDP. This should encourage theLuxembourg Government to take a step that ismore courageous than the small decrease that iscurrently proposed.

2. Increase of minimum net wealth tax

2.1. Proposed measure

Since 1 January 2016, Luxembourg companieshaving their statutory seat or central administra-tion in Luxembourg are subject to a minimumnet wealth tax. Within the 2017 tax reform, it isplanned to increase the amount of minimum taxfor holding and finance companies(“SOPARFIs”) from EUR 3,210 to EUR 4,815(including solidarity surcharge).(2)

2.2. Impact analysis

When analysing the impact of the contemplatedincrease of the minimum net wealth tax, it is vitalto remember the previous developments of theminimum tax rules.

The minimum tax has first been introduced in2011 as a minimum corporate income tax of EUR1,575 for SOPARFIs Then, in 2013, the minimumcorporate income tax for SOPARFIs has beenincreased to EUR 3,210 together with the intro-duction of a general minimum tax of up to EUR21,400 for non-SOPARFI companies (dependingon a company’s total balance sheet – not the netasset value). In case Luxembourg companieswere part of a Luxembourg fiscal unity, the min-imum taxation was capped to EUR 21,400 for theentire tax group (for the fiscal years 2013 until2015).

In 2015, EU Commission expressed their con-cerns that the minimum corporate income taxrules would not be consistent with the EUParent-Subsidiary Directive. Therefore, in 2016,the minimum corporate income tax has beenconverted into a minimum net wealth tax. Whilethe minimum tax for SOPARFIs has been kept atEUR 3,210, the general minimum tax has beenincreased to an amount of up to EUR 32,100(depending on a company’s total balance sheet –not the net asset value) and extended to securiti-zation companies and SICARs (risk capital com-panies). The increase of the minimum tax to EUR32,100 also applies to companies forming part ofa fiscal unity. Moreover, in contrast to the previ-ous minimum corporate income tax, the new

minimum net wealth tax rules do notprovide for a tax credit mechanism.

In other words, while the previousminimum corporate income taxwas – at least in theory – anadvance payment for futurecorporate income tax, the mini-mum net wealth tax cannot becredited at all.

Accordingly, the minimumtax rules have been tightened

quite a number of times sincetheir introduction in 2011. As partof the 2017 corporate tax reform, it

is now planned to furtherincrease the minimum net

wealth tax applicable toSOPARFIs to EUR

4,815.

All these changesand proposalsshake Luxem-

bourg’s image as astable location for

doing business andinvestors are asking

themselves thequestion when to

expect the next increaseof minimum taxes. While it might be questionedwhy levying a minimum tax at all on companiesthat do not realize taxable income (and that arepossibly in financial difficulties), the existingminimum tax rules should at least not be aggra-vated to sustain a certain level of stability.

The proposed increase of the minimum tax forSOPARFIs would further increase the mainte-nance costs of Luxembourg structures. The min-imum tax is particularly severe for large multi-nationals and investors with dozens and hun-dreds of Luxembourg SOPARFIs. Ultimately, theincrease of the minimum taxation should resultin a reduction of Luxembourg investment struc-tures and a decrease in the number ofLuxembourg companies.

3. Restrictions on the use of future tax losses

3.1. Proposed measure

According to the announcement of the Ministerof Finance, it is further proposed to limit the useof tax losses generated as from 1 January 2017.The limitation on the use of tax losses is pro-posed to be twofold:- Firstly, such losses would only be available tooffset 80% of the taxable income realized in sub-sequent periods;- Secondly, such losses should only be carriedforward for a period of maximum 10 years.

Hence, it would be necessary to track the taxlosses incurred until the fiscal year 2016 and taxlosses incurred in each year as from 2017.

3.2. Impact analysis

When considering the impact of this proposal,the two restrictions on the use of corporate taxlosses have to be analysed separately:

a) 80% limitation

The proposed 80% restriction on the use of taxlosses looks at first glance like a reasonable com-promise that would lead to an effective tax rateof circa 5.5% (i.e. 27.08% * 20% of the income).However, there exist some systematic issueswith regard to such restriction which may entailunintended collateral damage. These issues aredepicted in the following examples:

• The Luxembourg participation exemptionregime

Luxembourg companies benefit from an attrac-tive participation exemption regime according towhich dividends, capital gains and liquidationproceeds derived from qualifying participationmay benefit from a full tax exemption.

As a beneficial feature of the Luxembourg par-ticipation exemption regime, Luxembourg com-panies may deduct costs incurred in relation toqualifying participations to the extent theyexceed tax exempt dividend income realized in agiven year. However, such costs are subject torecapture. This means that future capital gainswould be taxable up to the total amount of costsdeducted in relation to a shareholding.

If the proposed 80% limitation would be applied,a Luxembourg holding company would becomesubject to tax on 20% of the capital gains that aresubject to recapture. Such treatment would notbe consistent with the European Parent-Subsidiary Directive and turn a positive featureof the Luxembourg participation exemption intoa negative one.

Example: Recapture rule

A Luxembourg holding company (LuxCo) owns a100% participation in a French subsidiary(FrenchCo) that benefits from the Luxembourg partic-ipation exemption regime. For 5 year the Luxembourgholding company realizes 100 of costs whereas no div-idends are realized. Thus, 100 of costs are deductibleeach year and subject to recapture (after 5 years the taxlosses and the recapture amount to 500). In year 6,LuxCo disposes of its participation in FrenchCo andrealizes a profit of 300 which is taxable in Luxembourg(as it is subject to recapture). Under currentLuxembourg tax law, the recapture may be fully offsetby the tax losses available (i.e. 500). Under the pro-posed rule, LuxCo would be subject to tax on 60 of tax-able income in year 6 (i.e. 20% of 300).

• Write-up in value of assets

Under Luxembourg GAAP, the prudence prin-ciple requires that the book value of an asset hasto be written down in the financial statements ifthe fair market value of such asset decreases(under certain conditions). When the value of anasset that has previously been written downincreases in subsequent years, a write-back invalue has to be recorded up to the amount of thehistorical acquisition costs (potentially, afterdepreciation).

While the write-down in value is reflected asexpenses, the write-back would be treated as(taxable) income that cannot be fully offset bytax losses. Hence, a company may become tax-able on income from a write-back in value (inthe absence of any action by the company) onthe mere grounds of applying accounting prin-ciples.

Example: Loan receivables

A Luxembourg company (LuxCo) owns a loanreceivable of 100 owed by a subsidiary that is in finan-cial difficulties. At year end, the accountants recog-nize a write-down in value of 60 that is treated as aloss for accounting and tax purposes. One year later,the subsidiary is recovering and the accountant cor-rects the previous value adjustment of 60 whichresults in taxable income of 60. Under the new rules,LuxCo would be subject to tax on 12 (i.e. 20% of 60)only because of a changes in the fair market value ofits asset and the application of the prudence principle.

• Release of a provision

From a Luxembourg accounting perspective,companies may (have to) record provisions forfuture expenses that are generally consideredfor Luxembourg tax purposes. When the rea-sons for such provisions disappear, the provi-sions have to be released resulting in corre-sponding income. In these circumstances, it maybe that tax losses created when the provision hasbeen recorded cannot be used to offset relatedincome when the provision is released.

Example: Provision in regard to a court case

LuxCo records a provision in regard to a court casewhere a penalty of 200 is expected. The provision of200 creates a tax loss of 200. One year later, the courtcase has been won and LuxCo releases the provisionwhich results in taxable income of 200. Under theproposed rules, LuxCo could not fully offset theincome of 200 with the losses incurred one year beforewhen the provision has been recorded. Instead, LuxCowould be taxable on an income of 40 (i.e. 20% of 200).

• Debt waivers

When a shareholder waives a loan granted toLuxCo, income realized by the company uponthe waiver is generally treated as a hidden capi-tal contribution and not subject to Luxembourgtaxation. However, in case the shareholder loanis not valuable anymore (for example, becausethe investments of LuxCo have not been suc-cessful), the hidden capital contribution is to bevalued at zero and the income should be fullytaxable. Hence, a loss-making company may betaxed on 20% of a mere accounting profit thatcould otherwise be offset by tax losses previous-ly incurred by LuxCo.

Example: Debt waiver

LuxCo financed an investment with a shareholderloan of 100. Unfortunately, the investments of LuxCohave not been successful and losses of 100 have beenrealized. Before the liquidation of LuxCo, the share-holders waive the outstanding shareholder loan of100. While this debt waiver should be classified as ahidden capital contribution, the value thereof shouldbe zero. Thus, LuxCo would realize taxable income of100 which may only be offset as to 80% by tax lossesresulting in a tax base of 20. Economically speaking,this would mean that losses on investment create arti-ficially a taxable income.

Continued on next page

Analyzing the contemplated 2017 Corporate Tax Reform: The Good, The Bad and The Ugly

Avril 20169AGEFI LuxembourgEconomie

Continued from previous page

• Summary

The aforementioned examples make it clearthat it would be necessary to introduce specialrules that are designed to deal with all thesesituations in which an 80% restriction on theuse of tax losses would be inappropriate.Evidently, such complex set of rules will causea substantial administrative burden on bothtaxpayers and the Luxembourg tax authori-ties. The tracking of all the details would alsoincrease compliance costs.

It should further be considered to introduce asafe haven up to which the losses may be usedwithout restriction. Other countries that intro-duced such rules (for example, Germany andFrance) chose an amount of EUR 1m up towhich tax losses may be used without restric-tions.

b) 10 year limitation

Under current Luxembourg tax law, corporatetax losses may be carried forward for an indef-

inite period of time. From an economic per-spective, the value of losses decreases overtime due to inflation.

Accordingly, companies have already anincentive to use tax losses as soon as possible(for example, through the shifting of addition-al taxable activities to Luxembourg).

The restriction on the use of tax losses to 10years would not be consistent with fundamen-tal tax principles. Furthermore, why should acompany not be able to carry forward its taxlosses for an indefinite period until it is liqui-dated?

III. Conclusions and outlook

The proposed changes to the Luxembourgcorporate tax system are a mix of positive andnegative measures. In addition, Luxembourgmight be forced to implement harsh tax mea-sures in accordance with the anti-BEPSDirective that is currently proposed by the EUCommission (including, limitations on thedeductibility of interest, controlled foreigncompany rules, anti-hybrid mismatch rules,etc.).

Combined with the changes to theLuxembourg income tax law applicable toindividuals (which would further increasetaxes on higher salaries), the 2017 tax reformhas the potential to damage the competitive-ness of Luxembourg, at a time, where highlyqualified people are needed in order to createmore substance in Luxembourg (to respond torequirements from an international tax per-spective and to make Luxembourg set-ups fitfor the post-BEPS era).

With the right strategy, the current develop-ments in the international tax arena may evenbe an opportunity for Luxembourg to rein-force its position as a location of choice.

A formula for future growth should, however,rely on improving the tax environment with aview to attract more businesses and invest-ment. This would create more activities,employment and, ultimately, tax revenue inLuxembourg.

Nevertheless, the decrease of the corporateincome tax rate is too minor to make animpact, whereas the increase of the minimumtax as well as the proposed limitations on the

use of tax losses has the capacity to damagethe competitiveness of the country.

* Oliver R. HOOR is a Tax Partner (Expert Comptable,Steuerberater) and Keith O’DONNELL is theManaging Partner with ATOZ Tax Advisers (TaxandLuxembourg).

The authors may be contacted at: oliver.hoor@atoz.lukeith.odonnell@atoz.lu

www.atoz.lu

1) The impact of a decrease in tax rates on the amount of taxrevenue has, for example, been analysed in the following study:http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_papers/taxation_paper_12_en.pdf.2) For the purposes of the minimum tax, a company is classi-fied as “holding and financing companies” if the fixed financialassets, transferable securities and cash at bank (as reported inthe financial statements presented in the standard Luxembourgform) exceed 90% of its total gross assets. As from 2015, when90% of the qualifying financial assets do not exceed EUR350,000, holding and financing companies are subject to thegeneral minimum tax rules and would be liable to an annualtax of EUR 535 (for the fiscal years 2013 and 2014, a SOPAR-FI was always subject to the minimum taxation of EUR 3,210,no matter of its total balance sheet).

On March 23rd, morethan 200 professio-nals from the ban-king industry gathered atthe ECCL for the 7th edi-tion of PrivateBanker.This year's topic focusedon the future of privatebanking with discussionsaround the disruptiveeffects of technology onwealth management, custo-mer experience, the need fornew business models, andnew regulations leading tomore transparency.

Serge Krancenblum (picture), Presidentof LAFO (Luxembourg Association ofFamily Offices) and CEO of SGG,opened the day by stating that"the future is now", and thenlisted what are, according tohim, the main challenges forthe private banking industry,the first one being the necessi-ty to deal with its legacy after thecrisis it went through. Other challengesare the necessity to adapt to new regulations,and of course, structural changes. As a matterof fact, barriers are falling with new technology.

"Banks and private banks need to be aware ofthe fact that the new generation was raisedwith technology. Therefore, technology willeventually replace schmoozing" added Mr.Krancenblum. Disruptive technology to rein-vent the economic model of banks The first dis-cussion panel was moderated by Joshua

Franklin from Reuters. According toClaude Hirtzig, Senior VP Head of

Private Banking, BCEE, and MarcDebois, Head of New Markets,ING Luxembourg PrivateBanking, the digitalisation of pri-vate banking won't be sudden,

but is certainly coming as thegeneration is expecting itfrom their banks.

Grzegorz Prososwicz, Head ofProduct Management for

Comarch Capital Markets, high-lighted the fact that "the situation is

different in Europe than inMiddle-East Asia, where

Private Banking is farmore digitalised".

He also addedthat Virtual

Reality advicewould be the nextstep.

Mourtaza Asad-Syed,founder & CEO of

Yomoni, said that "it's moreabout innovation diffusion",meaning that Private Banking

has to cope with the needs of the clients, andnotably with mobile. He added: "we need touse what already exists to actually disrupt andreinvent the economic model of banks".

On the question of client experience, Mr. Asad-Syed compared FinTech to Amazon and itsonline offers, meaning that if FinTechs couldlay a hand on distribution and diffusion, theycould have a competitive advantage overbanks: "FinTech is the Amazon of WealthManagement".

Claude Hirtzig insisted on the fact that privatebanks need to show their added value, which isonly possible by knowing their clients and pro-viding them with a personalised customerexperience.

Mr. Debois reassured the audience: "humanrelations are still extremely important forHNWIs who look for personal advice, a speci-fic portfolio, and even to be recomforted intimes of crisis… which cannot be achieved withstandardisation".

Yet, according to Grzegorz Prososwicz, the gapis closing between what HWNI wanted a fewyears ago and what they want now, as globally- not inEurope -, they tend to prefer digitalcontact with their advisors. But, the challenge isactually more cultural than anything else, accor-

ding to Mr. Debois. ING has therefore appoin-ted a Head of FinTech and a Chief InnovationOffier. A deep tranformation of the business ison the way. On the other hand, robo-advisorswill have to play a big role, notably when itcomes to client management and knowledge.

Mr. Prososwicz added: "digital opens new waysto interact and engage with the client. It alsobrings operational efficiency". The next steps?The use of social media to create a communityand scan interests, but also an increase in videointeraction. What also needs to be done, accor-ding to Mr. Hirtzig is educating Private Bankerswith the use of the new digital tools.

Marc Debois concluded by stating that techno-logy was an opportunity for banks, who needto partner with FinTech companies.

PrivateBanker 2016

Digital and transparency to reinvent the business model of banks

La commission "formation desprix" du Conseil de la consomma-tion s’est réunie en date du 17mars 2016 dans le cadre des travaux del’Observatoire de la formation des prixdu ministère de l’Économie. Composéede représentants des consommateurs,des organisations patronales et du gou-vernement, cette commission estchargée d’étudier et de discuter les ana-lyses et rapports de l’Observatoire de laformation des prix.

L’Observatoire de la formation des prix a pré-senté une nouvelle édition de son rapportsemestriel qui comprend, pour le deuxièmesemestre 2015, une analyse de l’évolution del’inflation au Luxembourg, une comparaisonde l’inflation avec les pays voisins et une ana-lyse de l’évolution des prix administrés.

En 2015, le Luxembourg a connu un relève-ment de différents taux de TVA pour la plu-part des biens et services consommés (+2points de pourcentage). Ce changement struc-turel avait un impact majeur sur les résultats etanalyses relatifs à l’évolution des prix à la

consommation au Luxembourg pour l’année2015. Cependant, l’inflation générale a conti-nué de reculer en 2015: le taux moyen était de+0,47% au Luxembourg l’année passée (contre+0,63% en 2014) et ce malgré la hausse de diffé-rents taux de TVA. L’explication se trouve dansl’écroulement du cours du pétrole, qui a exercéune forte pression à la baisse sur le taux d’in-flation au Luxembourg (comme à l’étranger).

Le niveau de l’inflation a été faible dans toutel’Union européenne en 2015, avec des tauxproches de 0% pour l’UE (-0,01%) et pour lazone euro (+0,03%), donc largement en des-sous du taux de 2%, correspondant à l’objectiffixé par la Banque centrale européenne (BCE).

Avec +0,47%, l’inflation luxembourgeoise a étéplus élevée que celle de l’Allemagne (+0,11%)et de la France (+0,09%), mais elle est restée endessous de celle de la Belgique (+0,62%).

Huit pays de la zone euro ont eu des taux néga-tifs en 2015, avec le taux le plus bas observé enChypre (-1,55%). Toutefois, le rapport indiqueque, pour des raisons méthodologiques, lescomparaisons en termes d’inflation doiventêtre réalisées et analysées avec prudence.

Source: ministère de l'Économie

La commission "formation desprix" analyse l’inflation en 2015

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