Measure denying the tax deduction of interest and royalties to entities in blacklisted jurisdictions: scope updated

OUR INSIGHTS AT A GLANCE

• A draft law adopted by the Luxembourg Government in March 2020, which should be passed soon, will introduce a new Luxembourg tax measure denying under certain conditions the corporate income tax deduction of interest and royalty expenses directed at entities located in non-cooperative tax jurisdictions.
• The list of non-cooperative tax jurisdictions is determined at EU level and updated twice a year. Following the latest update of the EU list on 6 October 2020, the scope of the new measure has changed: while interests and royalties to entities located in the Cayman Islands and Oman will nally be out of the scope of the measure, interests and royalties to entities located in Anguilla and Barbados will now be within the scope when the measure will enter into force, i.e. on 1 January 2021.
• Given the regular updates to the list, the scope of application of the new rules will keep on evolving, even after the new rules have entered into force. The timing of transactions will be key to determine the potential Luxembourg tax impact and the analysis will change from time to time.
• Therefore, Luxembourg taxpayers with investments into and from non-cooperative jurisdictions should seek advice from their tax advisers in order to analyse the potential impact of the new provisions on their investments and take action, if necessary. Also the evolution of the legislation of jurisdictions under the radar of EU institutions should be closely monitored in order to anticipate an addition to or a removal from the EU list of non-cooperative tax jurisdictions in the future.

A draft law adopted by the Luxembourg Government in March 2020, which should be passed soon, will introduce a new Luxembourg tax measure denying under certain conditions the corporate income tax deduction of interest and royalty expenses directed at entities located in non-cooperative tax jurisdictions.

Background

The list of non-cooperative tax jurisdictions is determined at EU level. It is a result of a thorough screening and dialogue process with non-EU countries, to assess them against agreed criteria for good governance relating to tax transparency, fair taxation, the implementation of OECD BEPS measures and substance requirements for zero-tax countries. The list is updated twice a year, taking into consideration the evolving deadlines for jurisdictions to deliver on their commitments and the evolution of the listing criteria that the EU uses to establish the list. Given those regular updates, the scope of application of the new Luxembourg measure will constantly evolve over time.

As of 6 October 2020 (date of the latest update of the list), the list included the twelve following jurisdictions: American Samoa, Anguilla, Barbados, Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, US Virgin Islands and Vanuatu.

In parallel, in December 2019, the Council produced guidance on further coordination of national defensive measures in the tax area regarding non-cooperative jurisdictions and invited EU Member States to apply one of the following legislative defensive measures in taxation vis-à-vis the listed jurisdictions as of 1 January 2021, with the aim of encouraging those jurisdictions’ compliance with the Code of Conduct screening criteria on fair taxation and transparency:

• ƒ non-deductibility of costs;
• ƒ CFC rules;
• ƒ withholding tax measures;
• ƒ limitation of the participation exemption on profit distributions.

It is in this context that the Luxembourg Government has decided to introduce the first of these measures, i.e. the non-deductibility of costs.

Presentation of the new measure

As from 1 January 2021, interest and royalties due to entities located in non-cooperative tax jurisdictions will no longer be tax deductible, if the following cumulative conditions are met:

• The beneficiary of the interest or royalty is a collective undertaking within the meaning of article 159 Income Tax Law, “ITL”, which means that tax transparent partnerships are out of scope; if the beneficiary is not the beneficial owner, then the beneficial owner has to be taken into account;
• The beneficiary of the interest or royalty is an associated enterprise within the meaning of article 56 ITL; and
• The collective undertaking which is the beneficiary of the interest or royalty is established in a country or territory which is on the list of non-cooperative tax countries and territories.

Interest and royalties will remain tax deductible to the extent that the taxpayer can demonstrate that the operation to which the interest or royalties relate has been put in place for valid economic reasons which reflect economic reality.

Interest is defined as follows: “interest due relating to debt claims of every kind, whether or not secured by a mortgage and whether or not carrying a right to participate in the debtor’s profits, and, in particular, interest from bonds or debentures, including premiums and prizes attaching to such securities. Penalties for late payments shall not be regarded as interest payments.”

Royalty is defined as follows: “remuneration of any kind due as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.”

These two definitions are largely inspired by the definitions included in the EU Interest and Royalty Directive and in the OECD Model Tax Convention.

Timing for application

The new measure will apply to interest and royalties due as from 1 January 2021.

The list of non-cooperative tax jurisdictions to be taken into account will be the latest EU list available at the time of the entry into force of the law. Since no further update of the list is expected before year-end, the countries to be taken into account as from 1 January 2021 will be the twelve countries mentioned above and listed as of 6 October 2020.

As from 1 January of the following years, the same principle will apply, i.e. the measure will apply to interest and royalties due to countries listed as of the latest list available at that time and published in the Official Journal of the European Union.

What is the effect of a country being added or removed from the list?

• Countries added will be taken into account for interest and royalties due as from 1 January of the following year (i.e. there will be no retroactive nor immediate effect but only an impact as from the following calendar year);
• Countries removed will no longer be taken into account for interest and royalties due as of the date of the publication of the relevant EU list in the Of cial Journal (i.e. the removal will have an immediate effect).

Implications

Luxembourg taxpayers with investments into and from non-cooperative jurisdictions should seek advice from their tax advisers in order to analyse the potential impact of the new provisions on their investments and take action, if necessary. The evolution of the legislation of jurisdictions under the radar of the EU Council should also be closely monitored in order to anticipate an addition to or a removal from the EU list of non-cooperative tax jurisdictions in the future and thus a change in the scope of application of the new Luxembourg measure.