On 14 June 2023, the Lower Administrative Court (Tribunal administratif) took a decision (docket n°45759) on the Luxembourg tax treatment of the repurchase of shares by a Luxembourg company. The decision builds on previous case law on the matter and clarifies that in case of a proportional repurchase of shares with continuation of equivalent legal and economic rights by the shareholders after such buy-back, the operation can be treated as a sale only if it corresponds to the economic reality.
Incidentally, the decision at hand confirms that the repurchase and cancellation of a class of so-called alphabet shares can be considered as a partial liquidation (free from withholding tax) and restates some relevant conditions to be met.
Chronology of facts
22 April 2016: A holding company migrated from Cyprus to Luxembourg (“LuxCo”). The latter had two shareholders (non-Luxembourg resident individuals) and its share capital was composed of 12,500 ordinary shares. Each shareholder held half of LuxCo’s share capital.
- 2 November 2017: LuxCo received a dividend distribution.
- 6 November 2017: LuxCo’s share capital was split into 20 classes of shares (A and AA, B and BB, …, J and JJ) entirely subscribed by the existing shareholders (the first shareholder holding classes A to J and the second shareholder holding classes AA to JJ). All classes had the same legal and economic rights that were also identical to those of the ordinary shares previously in issuance. In case of share capital reduction through a repurchase and cancellation of a class of shares, LuxCo’s by-laws provided that each holder of the relevant class was entitled, to a prorate share of LuxCo’s net profits including profits carried forward.
- 22 November 2017 and 20 December 2017 : LuxCo received additional dividend distributions.
- 29 December 2017: LuxCo repurchased and cancelled classes J and JJ shares ; the redemption price was paid out of distributable profits / reserves and share capital reduction. On the same day, LuxCo’s by-laws were also amended to grant the remaining share classes (A to I and AA to II) a preferential dividend right corresponding to a percentage of their nominal value.
LuxCo treated the repurchase and cancellation as a sale of shares and did not apply withholding tax (“WHT”) on the amount paid to the shareholders.
The Luxembourg tax authorities (“LTA”) considered the transaction as an abuse of law, characterised by the fact that, within a short time frame, the share capital was split into different classes, the company received dividend income, two classes of shares were repurchased and cancelled while these two classes provided for the exact same rights to the shareholders which were also similar to those previously granted by the ordinary shares in issuance before the share capital split. The LTA requalified the transaction as a dividend distribution and assessed a 15% WHT.
Confirmation of the legal framework on repurchases of shares and considerations relating to abuse of law
Building on previous case law on repurchases of shares (Lower Administrative Court, 27 January 2023, docket n°42432, see our previous newsflash and Higher Administrative Court, 23 November 2017, docket n° 39193C), the Lower Administrative Court restated the relevant legal framework to analyse the tax qualification of a share repurchase. The judges recalled that the disposal of a participation is characterised by, on the one hand, the payment of a price equivalent to the fair market value of the shares and, on the other hand, the loss of the rights to the source of income resulting from the investment. The value of the participation being notably composed of shares’ nominal value and undistributed reserves. Despite this composition of the share price, the disposal can be assimilated to a capital gain for the seller whether the buyer is a third party (Articles 99bis and 100 of the Luxembourg income tax law or “LITL”) or the company having issued the shares (Article 101 of the LITL). Along the lines of previous case laws, the Court adds that such qualification is not exclusive of a hidden dividend distribution for the price portion exceeding the shares’ fair market value.
A notable point is that neither the LTA nor the Lower Administrative Court challenged that the repurchase and cancellation of one class of shares can fall within the (partial) liquidation regime of Article 101 of the LITL and thus fall outside the scope of the Luxembourg WHT.
The Court continues that in application of the above principle, the repurchase and cancellation of classes J and JJ should analysed as a disposal of shares.
Analysis based on facts and economic reality
In analysing the facts of the case, the Tribunal relied on the above described chain of events to outline that from their issuance to their cancellation, classes J and JJ granted similar legal and economic rights to the shareholders (rights on the assets and profits being proportional to the number of shares) and that those rights were also similar to those previously granted by the ordinary shares. Therefore, their repurchase resulted in a proportional and equal reduction of the two shareholders’ participation and rights in LuxCo’s share capital.
Based on these specific facts, the Lower Administrative Court concluded that the shareholders did not intend to exit, neither totally nor partially, from LuxCo’s share capital. Therefore the operation cannot be analysed as a disposal affecting the substance of their participation in LuxCo, as they did not lose any right to a specific source of the underlying income deriving from their investment in LuxCo’s share capital. The Tribunal further found that the facts at hand demonstrate LuxCo’s intention to transfer funds to its shareholders since the amount transferred economically corresponds to the dividends received by the LuxCo. This view being corroborated by LuxCo’s annual accounts mentioning that the shares repurchase was financed by distributable reserves available following the dividend income received in 2017.
Relying on parliamentary documents, the Lower Administrative Court considered that the qualification as a sale can be challenged where the facts and circumstances point to a hidden dividend distribution. Indeed, the parliamentary work relating to the elaboration of the LITL provide as an example of a sale that can be requalified as a hidden distribution, the situation where a company repurchases the same amount of shares from all its shareholders without other economic reasons than repatriating profits.
Key takeaways
This interesting decision confirms that the repurchase and cancellation of an entire class of shares can be analysed as partial liquidation, which is not subject to Luxembourg WHT. It however also stresses the importance of the economic substance of each repurchase transaction, where elements like different economic rights attached to the different classes of shares, timing and underlying income (in particular recurrent income vs. repayment of substance in the context of a divestment) are to be considered as relevant.
