Luxembourg: Domestic Corporate Taxation
Calculation of Taxable Base
For companies, IRC is normally assessed for income arising in the previous fiscal year, which is the calendar year unless a company has chosen otherwise.
For resident Luxembourg companies 'income' for the purposes of the IRC is calculated by comparing the net worth (net balance sheet assets) of the taxable entity at the beginning and end of the period concerned. Businesses with very low turnover may be able to use a simplified 'receipts and expenses' method of calculation, but this is not pursued further here.
NB: Although for general information some very brief details are given below about the calculation of IRC, this is not a full treatment of what is a complex subject and requires appropriate professional advice.
Allowable expenditure needs to be incurred exclusively and directly for the business; certain types of expense are not deductible, of which the most important are directors' fees, self-insurance provisions, foreign taxes and expenses connected with 'exempt' income. The 'foreign taxes' rule would seldom operate in practice, either because of a Double Taxation Treaty, or because of Luxembourg unilateral tax credit provisions.
'Exempt income' is income qualifying under the Luxembourg Participation-Exemption system, meaning dividends, interest, capital gains or royalties income received from another company in which the receiving company has a share interest greater than 10%, providing the paying company is in a jurisdiction levying at least 15% (at the time of writing) tax on such payments. Note that the interest costs on debt finance of such a exempt share interest would only be deductible up to the level of the exempt income received.
Profit distributions in the course of a year (widely defined) are added back to net worth at the end of the year prior to calculation of IRC.
Evidently, rules for asset valuation are particularly crucial in a 'net worth' income tax system. In Luxembourg there are rules dealing with what assets are to be included, their valuation, and permitted depreciation. The rules cover land and buildings, leased assets, goodwill, participation in other companies, inventory etc. The treatment of provisions is likewise important and is covered by a set of rules. Foreign exchange gains and losses can also have a major impact on valuation of foreign assets, and are dealt with under rules that provide for their 'neutralisation' (deferral) in many circumstances.
There are some tax credits available for certain types of investment into assets for use inside Luxembourg itself.
Losses at the taxable income level can be carried forward, but not back. Group relief exists under 'fiscal integration' provisions, applying subject to permission from the Minister of Finance with some differences to 99% and 75% participation. The rules for valuation of 'substantial participation in other companies' would have the same effect as group relief up to a point since a reduction in the net worth of a subsidiary would be reflected in a reduced valuation in the parent balance sheet.
For non-resident corporate entities, IRC applies to:
- Income attributable to a Luxembourg permanent establishment (but see Double Taxation Treaties regarding the definition of such);
- Passive Luxembourg-sourced income such as dividends, interest, royalties and capital gains (see Withholding Taxes below as regards the taxability of income under this heading);
- Income from immovable property in Luxembourg;
- Interest on loans secured by immovable property in Luxembourg.
The calculation of taxable income is the same as it is for a Luxembourg-resident corporation. It follows that any foreign company doing business in Luxembourg should be extremely careful not to create a permanent establishment in the country. With exceptions under Double Taxation Treaties, 'permanent establishment' is defined to include 'branches, factories, warehouses, place of purchase and sale, landing areas, offices or any other place of business which the entrepreneur uses to carry out its business'. The definition is looser under OECD-model Double Tax Treaties, which would for instance not count warehouses as constituting permanent establishment. E-commerce servers used for sales purposes would however probably amount to permanent establishment in either case, and this might be the case whether or not the server was owned by the company doing the selling. It's not a risk to take.
In July, 2006, the European Commission called on Luxembourg to comply with the judgement of the European Court of Justice in the case of Commission v. Grand-Duchy de Luxembourg, delivered on 8 December 2005.
In this Judgment, the European Court of Justice declared that Luxembourg had failed to fulfil its obligations to transpose Directive 2001/65/EC on accounting rules into its national legal order.
Directive 2001/65/EC amended Directives 78/660/EEC, 83/349/EEC and 86/635/EEC. These Directives defined which types of companies have to produce accounts, establish which format should be used for the profit and loss account and the balance sheet and lay down which valuation principles should be applied. The Directives also impose requirements to disclose the accounts.
Directive 2001/65/EC brought EU accounting requirements into line with modern accounting theory and practice. It allows for certain financial assets and liabilities to be valued at fair value. This will enable European companies to report in conformity with current international developments.