Luxembourg to deny deductibility of interest and royalties towards blacklisted jurisdictions.

On 5 December 2019, the ECOFIN adopted and endorsed the agreement reached by the Code of Conduct Group on their 'Guidance on defensive measures in the tax area towards non-cooperative jurisdictions”. The guidance invites all member States to apply at least one of the proposed legislative defensive measures vis-à-vis non-cooperative jurisdictions as of 1 January 2021. The aim is to encourage those jurisdictions to comply with the Code of Conduct screening criteria on fair taxation and transparency.

In this framework, Luxembourg has filed on March 2020 the bill n° 7547 expected to enter into force as from 1 January 2021. introducing a new article 168 (5) to the Luxembourg income tax law and providing for a denial of tax deductibility of interest and royalties paid or due to associated enterprises located in a non-cooperative jurisdiction.

The tax deductibility of interest or royalties will be denied if the following conditions are met:

• The beneficial owner (bénéficiaire effectif) of the interest or royalties must be a collective entity (organisme à caractère collectif), as defined in Article 159 of the Luxembourg income tax law. If the recipient is not the beneficial owner, the actual beneficial owner will have to be considered. Collective entities generally cover entities that are opaque for tax purposes and not partnerships;
• The collective entity which is the beneficial owner must be an associated enterprise (as defined in Article 56 of the Luxembourg income tax law). In this respect, two undertakings are associated enterprises where one of them participates directly or indirectly in the management, control or capital of the other, or where the same persons participate directly or indirectly in the management, control or capital of both undertakings; and
• The collective entity which is the beneficial owner must be established in an non-cooperative jurisdiction (the Blacklisted Jurisdiction). The list of Blacklisted Jurisdictions will have to be approved by the Chamber of Deputies on a yearly basis, based on a proposal from the Luxembourg Government, relying on the EU list of non-cooperative jurisdictions at the time of such proposal.  The current EU list includes American Samoa, the Cayman Islands, Fiji, Guam, Oman, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, the US Virgin Islands and Vanuatu.

As an exception, deductibility may be accepted if the taxpayer requesting the deduction proves that the transaction triggering the interest or royalties is used for valid commercial reasons reflecting the economic reality. The concept of valid commercial reasons reflecting the economic reality is already used in the Luxembourg general anti-abuse rule (GAAR) contained in §6 StAnpG in order to define a genuine arrangement. However, while for the GAAR, it is to the tax authorities to demonstrate the absence of valid economic reasons, these new provisions shifts the burden of proof to the taxpayer, in line with the recommendations of Code of Conduct Group.

The Netherlands to impose withholding on interest and royalties towards blacklisted jurisdictions.

As a reminder, effective 1 January 2021, a 21.7% withholding tax will be introduced in the Netherlands on interest and royalties payments by Dutch tax resident taxpayers that are directly or indirectly made to related (hybrid) entities that are resident in, or permanent establishments of related entities located in, low tax jurisdictions.

Entities are related if (i) the payee has a qualifying interest in the payor, (ii) the payor has a qualifying interest in the payee or (iii) a third entity has a qualifying interest in both the payee and the payor. A qualifying interest is an interest through which decisive influence on the decision making process of the entity can be exercised, which is deemed to be the case if it represents more than 50% of the statutory voting rights in the entity. Please note that entities can also be related if they are considered a cooperating group and such group has a qualifying interest.

Low tax jurisdictions are jurisdictions (i) with a statutory corporate income tax rate of less than 9% and designated as such pursuant to the Dutch low tax jurisdictions list and/or (ii) that are included on the EU blacklist. Effective 18 February 2020, the following jurisdictions are included in these Dutch and EU lists: Anguilla, Bahamas, Bahrein, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Fiji, Guam, Guernsey, Isle of Man, Jersey, Oman, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, Turkmenistan, Turks- and Caicos Islands, Vanuatu, the United Arab Emirates and the United States Virgin Islands. The Dutch list will be updated annually in October. The EU list will be updated up to two times per year. If at the end of 2020 the aforementioned jurisdictions are still on the Dutch and/or EU lists, payments of interest and royalties to payees located in these jurisdictions are in the scope of the Dutch withholding tax.

If the Dutch withholding tax applies, there are no domestic exemptions therefrom or reductions thereof. Therefore, the tax may only be mitigated under a tax treaty, subject to meeting the applicable main/principal purpose tests. In this respect, it is noted that where relevant the Netherlands will seek to amend the relevant treaties in order to be able to levy the tax.

If you have any questions please do not hesitate to contact one of your regular contacts at AKD.