On 27 January 2023, the lower administrative court rendered a decision (42432) dealing among others with the tax treatment applicable to the redemption of a class of alphabet shares. Under Luxembourg law, companies may issue in addition to their ordinary shares, several classes of shares having different economic rights and sometimes tracking features. According to the lower court, the amount paid by a company upon redemption of a class of shares followed by its immediate cancellation should qualify as a gain realized by the selling shareholder. No withholding tax should therefore be levied unless the redemption price exceeds the fair market value of the shares redeemed.
Facts and background
In the case at hand, a Luxembourg limited liability company (LuxCo) has been incorporated by a single shareholder, a Cayman Islands company. Following a share capital increase, LuxCo issued next to its ordinary shares 10 classes of alphabet shares, representing each 5% of its share capital. According to the articles of association of the company, all the classes of shares had the same economic rights.
In 2014, one year following the implementation of the classes of shares and further to a divestment in a Welsh company, LuxCo decided to redeem and cancel its Class J shares. LuxCo treated such redemption as a partial liquidation in accordance with the provisions of article 101 of the Luxembourg income tax law (LITL) and as such did not apply the 15% withholding tax on the redemption price.
Since the classes of shares issued by LuxCo did not have different economic rights (which is one of the features generally seen on the market), the Luxembourg tax authorities challenged the partial liquidation treatment on the grounds of abuse of law and requalified the transaction into hidden dividend distribution.
Decision of the lower court
The lower court reminded the various legal routes existing for a company to repatriate proceeds to its shareholder (i.e., dividend distribution as per article 97 LITL subject to withholding tax, the reduction of share capital as per article 97 (3) LIR which requires valid economic reasons for the exemption of withholding tax and finally the partial liquidation free of withholding tax since it should be analyzed as a disposal by the shareholder of a portion of its shareholding). According to the lower court, any transaction realized between a shareholder and its subsidiary that affects the substance of its participation and falls into the scope of article 101 LITL qualifies as proceeds from a disposal. By selling the shares, the shareholder no longer has rights (economic or political) attached to these shares. In the case at hand, the lower court concluded that the redemption by LuxCo of its Class J shares followed by its subsequent cancellation should qualify as a partial liquidation not subject to withholding tax.
However, given the excessive redemption price paid by LuxCo compared to the portion of shares redeemed, the lower court considered that the said price did not correspond to the fair market value of the shares redeemed. Moreover, LuxCo had not provided evidence of the contrary. The lower court therefore concluded that the qualification of hidden dividend distribution retained by the Luxembourg tax authorities was justified but only for the portion of the redemption price exceeding the fair market value of the shares redeemed.
This decision is more than welcome as it confirms that a share buy-back followed by its cancellation should be analyzed as a disposal by the shareholder of its participation and not as a profit distribution. However, given that the lower court did not rule on the qualification of the redemption as abuse of law, it is still unclear in which situation such qualification may be retained. It worth to note that some elements mentioned in the decision such as the existence of a single shareholder, the implementation of the classes of shares after the incorporation of LuxCo as well as the absence of different economic rights could be relevant for this analysis. It is then recommended that Luxembourg companies when implementing this kind of instrument (classes of shares) properly document and assess the fair market value of the shares prior proceeding with the redemption. It remains to be seen if the Luxembourg tax authorities will shed light on the methodology to assess the fair market value of the said shares.
Frédéric Feyten
Managing Partner | Avocat
Ali Ganfoud
Counsel
Delphine Danhoui
Knowledge Lawyer
