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EU Anti-Tax Avoidance Directive 1 in Luxembourg - Where are we now

Insight 13 August 2020

EU Anti-Tax Avoidance Directive 1 in Luxembourg - Where are we now

It’s been more than 18-months following the new interest limitation rule being introduced into Luxembourg Tax law.

Since 1 January 2019, Article 168bis of the Luxembourg Income Tax Law limits the deductibility of “exceeding borrowing costs”, generally to a maximum of 30% of the corporate taxpayers’ Earnings Before Interest Taxes Depreciation and Amortization (EBITDA). The scope of the interest limitation rules includes all interest-bearing debts (irrespective of whether the debt financing is obtained from a related party or a third party), however, exceeding borrowing costs up to an amount of EUR 3 million may be deducted without any limitation.

“Exceeding borrowing costs” correspond to the amount by which the deductible “borrowing costs” of a taxpayer exceed the amount of taxable “interest revenues and other economically equivalent taxable revenues”. Article 168bis defines borrowing costs as interest expenses on all forms of debt and other costs economically equivalent to interest and expenses incurred in connection with the raising of financing.

As far as interest income and other economically equivalent taxable revenues are concerned, neither the Anti-Tax Avoidance Directive (ATAD) nor Luxembourg tax law provides for a clear definition of what is to be considered as “revenues which are economically equivalent to interest”, however, given that borrowing costs and interest income should in principle be mirroring concepts, the latter could be interpreted in accordance with the broad definition of borrowing costs.

As always, there are certain exemptions/entities excluded from the scope of the rules, limited to the below:

  • Securitisation qualifying as AIF
  • EU securitisation vehicles (note that the EU Commission has recently challenged this view)
  • Stand-alone entity
  • Grandfathering for debt instruments concluded before June 17, 2016
  • EUR 3m threshold
  • Group ratio

Since implementation of the above, challenges arose from the unclear definition or the classification of interest income and other economically equivalent taxable revenues.

Sanne has been in close contact and discussions with main market players in Luxembourg, either directly or through different working groups in the securitisation field in order to be able to correctly assess the impact of the above in day-to-day operations of Luxembourg securitisation vehicles, as well as to assess the direct impact on financial reporting/annual accounts of these.”

Marketa Stranska
So what are the findings?

When we are considering the direct debt structures (performing loan portfolio, trade receivables, lease receivables and debt collateral with TRS), the impact of the ATAD 1 and its presentation within the annual accounts is usually limited to a general disclosure to the annual accounts only (under the tax section). Typically, this consists of confirming the acknowledgement of the new tax limitation rules by the management of the securitisation vehicle and the conclusion of zero impact on the tax treatment or respective provisions.

The situation is rapidly changing, when we look at assessing equity investments, certain types of repackaging linked to investment funds, participations, non-performing loan investments and in some cases structured products (derivatives – linked to equity portfolio). Due to currently missing clear definition of interest income and other economically equivalent taxable revenues, each of the above-mentioned strategies needs to be assessed on an entity by entity basis, especially for the classification of income and expenses.

As for the audit, the analysis of the tax implication is usually prepared by the entities’ tax advisor and the impact is assessed by the Board. In some cases a certain testing is being processed by the auditors as part of their verification process of the Board assessment (similar to valuation assessment). Although the market has seen intense discussions over the last 18+ months amongst all participants, the opinion on such assessments could vary from one to another auditor or tax advisor. It is important to look at the transactions individually. Whilst the prudency principal is to be applied in all accounting matters (especially in case of uncertainty on technical interpretations), such assessment could also have potentially significant impacts for the structures and could jeopardise the overall securitisation concept. Imagine a case where one would build tax provisions by prudency that then could ultimately make the securitisation vehicle insolvent. A balanced approach is required.

What will happen next?

In the absence of clarity in the transposition in Luxembourg of the ATAD regulations, further clarifications on certain interpretations of the legislation, the implementation of ATAD 1 (and especially the interest limitation rules) is expected. The absence of such clarifications may have a significant impact on the domestic securitisation market. It is to be noted though that ATAD has not yet been transposed in all European countries and hence there is currently no level playing field.

On May 14, 2020, the European Commission decided to send a formal letter challenging the transposition of the interest limitation rules of the Anti-Tax Avoidance Directive (Article 4 of the Council Directive (EU) 2016/1164). Indeed Luxembourg has made use of the possibility to exempt specific financial undertakings from the interest limitation rules in the Anti-Tax Avoidance Directive (see above on EU securitisations).

The local key market associations continue to urge the Government or the tax administration to clarify the outstanding questions and have provided detailed technical analyses and comparatives to the ATAD implementation in other European countries. There are differences in interpretations, but it is important to note that there are also many aspects where the market is in full agreement. As such, one can be hopeful that clarifications will be delivered soon. Only time will tell.

How can SANNE help?

SANNE can provide the full range of fund services to comply with the obligations under the law.

SANNE’s team of professional private debt experts spans a global office network. The team have a proven track record in assisting clients and entities administered through new taxation and compliance requirements. We take an active role in industry consultations and disseminating our knowledge into the market, including presenting external training events. We take great pride in our ability to deliver the solutions required by our clients to support their private debt and capital markets investment structures, in an ever-evolving industry.

For more information, please get in touch with our people.

Let's talk...

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Rolf Caspers Global Head of Capital Markets - Luxembourg
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