Trésorier/Treasurer magazine - N°99 - Nov/Dec/Jan 2018 - 23

BART
VAN DROOGENBROEK

BERTRAND
DROULEZ

INTERNATIONAL TAX SERVICES LEADER

INTERNATIONAL TAX SERVICES DIRECTOR

EY LUXEMBOURG

The reasoning behind the notion
of genuine economic activity
This means that when
a taxpayer carries out
requirements. Profit should be
its operations and
allocated where the value is
has financed them by
created and where risks and
debt, it might face a
higher tax liability due
functions are located.
to the non-deductibility of a portion of its
exceeding borrowing costs. Luxembourg should have the possibility to lighten this interest limitation rule as the directive
offers EU member states some options in the implementation
of this rule (such as the inclusion of a de minimis rule or the
non-application of the rule to standalone companies).
well-known transfer pricing

Last but not least, the directive also provides for a so-called
CFC rule. According to this rule, a Luxembourg taxpayer which
controls a subsidiary (or a permanent establishment) located
in a low-taxed jurisdiction might be taxed on the non-distributed income of the subsidiary (or permanent establishment).
This should be the case when (i) the tax paid by the subsidiary
or the permanent establishment is lower than 50% of the tax
that would have been paid in Luxembourg and, (ii) when more
than 50% of the subsidiary is held by a Luxembourg taxpayer
(this condition is presumed to be met for a permanent establishment). Fortunately, the CFC rule contains a safeguard
clause and should not be applicable to controlled foreign
entities which run a genuine economic activity. Similarly to
the interest limitation rule, the directive provides for some
options for the EU member states, which can choose to implement a de minimis rule and/or not to apply this provision to
some financial undertakings.
As Luxembourg has not yet published any bill for the implementation of these measures, it is still not known which
options will be chosen by the Grand-Duchy.

2. The MLI
On 7 June 2017, 68 jurisdictions signed the MLI, which is
expected to lead to an unprecedented wave of amendments
to approximately 1,100 double tax treaties. Therefore, the following developments should only be applicable to taxpayers
which rely on Double Tax Treaty provisions for cross-border
transactions. At the earliest, the MLI is expected to be applied
to some Double Tax Treaties signed by Luxembourg as from
1st January 2019. Apart from some technical provisions which
would be too complex to analyze in this article, the MLI may
trigger significant cash tax impacts for Luxembourg companies. In situations where the MLI is applicable, a taxpayer may
not be entitled to treaty benefits if it cannot prove that obtaining these benefits was not one of the main purposes of the
transaction. This rule is called the principal purpose test ("the
PPT"). In other words, in order to rely on Double Tax Treaties,
a taxpayer should always follow genuine economic purposes.
In practice, this means that Luxembourg companies should
prepare appropriate documentation in order to prove the
economic rationale behind each transaction.

3. Conclusion
Both the ATAD and the BEPS are expected to significantly
change the tax environment in the world. For Luxembourg
corporations, these new rules are expected to introduce more
complexity in the assessment of the tax treatment of their
operations and may have material (cash) tax impacts. While
some of the new rules contain mechanical provisions to avoid
profit shifting (interest limitation, hybrid mismatches...),
others focus on the business rationale of the taxpayers,
which is a vague concept. The reasoning behind the notion
of genuine economic activity is intrinsically related to the
well-known transfer pricing requirements. Profit should be
allocated where the value is created and where risks and
functions are located. In this context, it is highly recommended for each Luxembourg taxpayer involved in cross-border operations to review its structure and check the potential
impacts that ATAD and BEPS measures will have on its group
going forward.

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is intrinsically related to the

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