A. History And Background
Luxembourg is a parliamentary representative democracy with a constitutional monarchy, governed by a multi-party coalition.
Luxembourg covers 2,586 square km in the heart of Western Europe, between France, Belgium and Germany.
The population amounts currently to approximately 503,000 of whom about 40 per cent are non-Luxembourg nationals.
Luxembourg is a trilingual country where French, German and Luxembourgish are the official languages.
Luxembourg is a founding member of the European Union (EU), North Atlantic Treaty Organisation, Organisation for Economic Cooperation and Development and United Nations. Luxembourg hosts the seat of several EU institutions and agencies.
Luxembourg is in the top ten financial centres worldwide and is the second largest investment funds centre after the US. Luxembourg is the leading private banking centre in the eurozone and the leading captive reinsurance market in the EU.
The currency is the euro (EUR).
B. Legal System
Luxembourg has its own legal system, based on Roman law.
A. Trusts And Fiducie
The concept of the Anglo-Saxon trust is not codified in Luxembourg but a law of 2003 ratified the Hague Convention on the Law Applicable to Trusts and on their Recognition, 1 July 1985. By application of this law, Luxembourg respects the rules applicable to foreign trusts.
This law of 2003 also replaced the previous laws on the Luxembourg Trust (Fiducie), whose concepts are quite similar to trusts and which is used in the scope of estate management/planning.
B. Luxembourg Civil Company (lcc)
An LCC is commonly used for estate tax planning and inheritance tax planning. The rules applicable to the LCC are very flexible and in many cases can reduce taxes (direct or indirect) due on transfer of real estate.
C. Private Wealth Management Company (spf)
An SPF is a company whose sole purpose is the management of private wealth of individuals and that benefits from a specific tax regime largely inspired by the Holding 1929 regime, which was abolished as from 1 January 2011.
An SPF is not subject to any income taxes or wealth tax. Moreover, no withholding tax is levied on distribution of dividends. An SPF is subject only to annual subscription tax of 0.25 per cent on its share capital, share premium and part of debts exceeding the debt-to-equity ratio of 8/1 with a minimum of EUR100 and a maximum of EUR125,000 per year.
To benefit from this specific tax regime, the activities of the SPF must be limited to the acquisition, holding, management and disposal of financial assets and may not include commercial activities. In this respect, the SPF may not grant interest bearing loans, nor may directly hold real estate or intellectual property rights.
Moreover, only individual, private wealth management entities (trust, foundations, stichtings, etc.) and intermediaries acting on behalf of the latter (e.g. based on a fiduciary agreement) may invest in the SPF.
Multiple types of company form exist in Luxembourg, ranging from the ordinary limited liability company to the ordinary limited partnership.
The corporations most often used in practice are public or private limited liability companies (SA or Sàrl).
The Limited Partnership by shares (SCA) is also widely used in estate planning because it allows division of control and economic rights.
The minimum share capital required for an SA is EUR31,000, whereas it is EUR12,400 for Sàrl. Both may be set up by a single shareholder. Shares of a SA may be issued in bearer form, whereas shares of a Sàrl are always in registered form.
Luxembourg resident companies and individuals are taxable on their worldwide income.
Corporations are subject to corporate income tax (CIT) whose rate is currently 22.05 per cent and municipal business tax (MBT) whose rate depends on the municipality where the company has its seat (rates from 6.75 per cent to 12 per cent). The current MBT applicable in the municipality of Luxembourg is 6.75 per cent, so that the aggregate income tax rate applicable to companies set up in Luxembourg City amounts to 28.8 per cent.
As from 1 January 2011, Soparfi (meaning companies where the sum of their fixed financial assets, transferable securities and cash at bank represents more than 90 per cent of their total assets) are subject to a minimum CIT of EUR1,500 per year.
Corporations are also subject annually to net worth tax (NWT) at the rate of 0.5 per cent based on their unitary value (i.e. broadly speaking their net asset value) as at 1 January. Exemptions, specific valuations of certain assets (e.g. immovable property has specific unitary value determined based on the Luxembourg market prices in 1941) and tax credits are available and may substantially reduce the NWT due.
Resident individuals are taxable at progressive tax rates comprising 18 brackets whose rates vary between 0 per cent for the first tranche (up to EUR11,265) and 39 per cent for the last tranche (above EUR41,793). Various deductions, exemptions and allowances are available and reduce the income tax due.
The ordinary value added tax (VAT) rate is 15 per cent. In some cases, the VAT rate is reduced to 12 per cent, 6 per cent or 3 per cent.
Capital duty has been abolished and only fixed registration duty of EUR75 is due upon contribution to Luxembourg resident company. However, transfer tax of 1.1 per cent is due upon the contribution of real estate located in Luxembourg.
B. Main Estate Tax Features
I. Inheritance Taxes And Transfer Taxes
Inheritance taxes are levied on all property inherited from a Luxembourg resident individual at the time of death, except for real estate located abroad.
Moreover, transfer taxes are levied on real estate located in Luxembourg inherited from a non-resident.
Properties inherited between spouses with common children and in direct line (to the extent of the legal portion) are exempt from inheritance taxes and transfer taxes. In other cases, inheritance tax and transfer tax rates range between 2.75 per cent and 48 per cent depending on the relationship between deceased and beneficiaries and the size of the estate inherited.
Ii. Gift Taxes
Under the Luxembourg civil code, donations must be made through a notarial deed. Donations by Luxembourg notarial deed must be registered and incur gift taxes with rates ranging between 1.8 per cent and 14.4 per cent depending on the relationship between deceased and beneficiaries.
No gift taxes are due on donations of real estate located abroad made through a Luxembourg notarial deed.
Manual gifts do not have to be made through notarial deed, so no gift taxes are due (except if the donor dies within the year).
C. Main Corporate Tax Features
I. 50 Per Cent Exemption On Dividend Income
Dividend income benefits from a 50 per cent exemption if the following conditions are met:
- distribution by a fully taxable resident corporation
- distribution by a corporation resident in a state with which Luxembourg has concluded a double tax treaty and that is fully subject to tax comparable to CIT (i.e. a taxation of at least 10.5 per cent on a basis comparable to Luxembourg CIT)
- distribution by a company covered by the Parent-Subsidiary directive.
Ii. Withholding Taxes
- Dividends: Withholding tax (WHT) of 15 per cent applies to gross dividend distributed by Luxembourg companies. This WHT may be reduced by application of a double tax treaty or by application of the participation exemption regime (see conditions hereafter).
- Artists and sportsmen: Final WHT at the rate of 10 per cent is levied on gross income derived from professional literary, artistic and sporting activities performed by a non-resident.
- Director fees: WHT at the rate of 20 per cent is levied on gross directors’ fees. This WHT is final for a non-resident provided directors’ fees are below EUR100,000 per annum and no other Luxembourg professional income is derived.
- Interest: Note that a 10 per cent final WHT applies to interest paid to Luxembourg resident individuals and that payment of interest to non-resident individuals may be subject to WHT by application of the Savings Directive if the beneficiary does not elect for the exchange of information. Moreover, certain profit participating bonds are subject to WHT at the rate of 15 per cent.
- Royalties: No WHT.
- Liquidation proceeds: No WHT.
Iii. Debt-to-equity Ratio
The Luxembourg tax law does not provide for any debt-to-equity ratio. Nevertheless, Luxembourg tax authorities usually require that companies having holding activities comply with a debt-to-equity ratio of 85/15. If this ratio is not met, the portion of interest in relation with the excess part of the debt will be requalified as a hidden dividend distribution.
Iv. Participation Exemption Regime
Provided certain conditions are fulfilled, dividends, liquidation proceeds and capital gains are exempt from CIT and MBT, distributions of dividends are exempt from WHT and qualifying participations are exempt from NWT by application of the participation exemption regime.
- Exemption for dividends, liquidation proceeds and capital gains received
The main conditions to be fulfilled in order to benefit from the exemption of dividends, liquidation proceeds and capital gains for CIT and MBT are the following.
1) Status of the recipient:
- a fully taxable entity resident of Luxembourg, or
- a Luxembourg permanent establishment of a collective entity falling within the scope of the Parent-Subsidiary Directive/of a corporation resident in a State with which Luxembourg has concluded a double tax treaty/of a corporation or a cooperative company resident of the EEA.
2) Status of the subsidiary:
- a fully taxable corporation resident of Luxembourg/non-resident but liable to a tax corresponding to CIT
- a collective entity falling within the scope of the Parent-Subsidiary Directive.
3) Minimum holding period: uninterrupted period of at least 12 months at the date the dividends, liquidation proceeds or capital gains are derived by the beneficiary. A commitment to hold such shareholding for this 12-month holding period is sufficient in the case of dividends or capital gains.
4) Size of the shareholding: at least 10 per cent in the capital of the subsidiary or an acquisition price of at least EUR1.2 million for dividends/liquidation proceeds and EUR6 million for capital gains.
- Recapture rule
Expenses in direct economic connection with qualifying shareholding (e.g. interest on the debt financing the shareholding) are not deductible up to the amount of the exempt dividends received in a given year.
Capital gains realised on qualifying shareholding remain fully subject to tax up to the amount of expenses in direct economic connection with this shareholding that would have been deducted in the year of disposal and in previous years.
- Exemption for NWT
Qualifying shareholding is exempt from NWT at the level of the parent company provided the same conditions as for the exemption of dividends are met regarding the subsidiary.
No minimum holding period is required.
Debt financing exempt shareholding may not be deducted from the unitary value.
- Exemption for NWT
Dividends distributed by a Luxembourg company are exempt from the 15 per cent WHT provided the following main conditions are met.
1) Status of the subsidiary:
- a fully taxable entity resident of Luxembourg.
2) Status of the recipient:
- mainly a fully taxable entity, resident of Luxembourg and its permanent establishment/resident of the EEA and its permanent establishment/resident of a State with which Luxembourg has a double tax treaty and its Luxembourg permanent establishment/falling within the scope of the Parent-Subsidiary Directive and its permanent establishment/resident of Switzerland.
3) Minimum holding period (same as for dividend exemption).
4) Size of the shareholding (same as for dividend exemption).
D. Tailor-made Vehicle For Private Equity
The SICAR (Société d’investissement en capital à risque) is a vehicle created by a law of 2004 and specifically designed for investors in venture capital and private equity. The SICAR combines an attractive tax regime with lighter regulatory requirements compared with a regulated investment fund.
The purpose of the SICAR is to invest in risk capital (contribution of funds to entities in view of their launch, development and listing on a stock exchange).
The SICAR is not subject to any debt-to-equity ratio or risk diversification requirements.
The SICAR benefits from an exemption of CIT and MBT on income from transferable securities (dividends, interest, capital gains). Moreover, distributions made by the SICAR are not subject to WHT. Finally, the SICAR is not subject to NWT.
Since the SICAR is fully subject to CIT and MBT for any other income, it should, in theory, benefit from the Luxembourg double tax treaty network and also from the Parent-Subsidiary Directive.
The SICAR is reserved to well-informed investors, i.e. institutional investors, professional investors and investors who confirm in writing they understand the risks of their investments and invest more than EUR125,000.
E. Intellectual Property Exemption
Income and capital gains derived by Luxembourg enterprises or companies from patent, trademark, design and model, copyright on software and domain names benefit from a 80 per cent exemption from CIT and MBT.
These IP rights are also exempt from NWT.
Other Relevant Matters
A. Anti-money Laundering
Luxembourg enacted laws (Law of 11 August 1998) setting Know Your Client rules and obligations for financial institutions and professionals to inform and cooperate with the authorities. Circulars and directives have been issued by different supervisory authorities in the fight against money laundering.
B. Advance Tax Clearance Practice
On 28 January 2011 and on 8 April 2011, the Luxembourg tax authorities issued two circular letters that clarify the tax treatment of Luxembourg companies performing intra-group financing activities and set out the procedure to follow (information regarding the taxpayer and the envisaged transactions, preparation of a transfer pricing report, etc.) and conditions to fulfil (substance, minimum equity, etc) in order to get an Advance Pricing Agreement regarding the tax treatment of these companies.
In other cases, Luxembourg has no formal ruling procedure. In practice, any Luxembourg tax payer may, on a case-by-case basis, obtain an advance tax clearance from the Luxembourg tax administration regarding the tax treatment applicable to their situation.