Tax residency and substance in Luxembourg

• A company is a resident taxpayer of Luxembourg if its statutory seat or its effective place of management is located in Luxembourg.
• Luxembourg company law and tax law do not require that one or several shareholders, managers or board members have a regular presence in Luxembourg.
• A range of criteria are also taken into account in the light of double tax treaties and Luxembourg tax practice in order to determine the tax residency of company:
  • A shareholders meeting must take place in Luxembourg at least once a year;
  • Most boards of directors must be held in Luxembourg with preferably physical presence of the directors/managers;
  • Sometimes it may be necessary that one director/manager be resident in Luxembourg;
  • This person must be competent to exercise the function of director/manager;
  • Depending of the type and volume of activity carried out in Luxembourg, some additional substance is required in the Luxembourg company such as offices, a part-time employee whose function depends on the activity carried out by the Luxembourg company, but generally an accountant.
• The tax residency may be denied by the other country based on the double tax treaty concluded by Luxembourg with this country or based on its own legislation. This may lead to double taxation. In order to avoid such harmful situation, the level of economic substance in Luxembourg could be enlarged based on the other jurisdiction’s requirements.

The level of substance required is determined on a case-by-case basis based on the business case, the foreign jurisdiction involved and the advance tax agreement obtained from the tax authorities.

This area is an evolving field for which we recommend seeking advice from professional experts.

Luxembourg as a prime location for holding, finance and service companies enhanced by the EU decision on the Cadbury-Schweppes ECJ decision issued on 12 September 2006.

The taxation of the profits realized by a foreign subsidiary at the level of its UK parent company is allowed under UK tax law if the “Controlled Foreign Company” is subject to a lower level of taxation (less than 3/4th) than the UK tax that would be paid on the same profits. These rules do however not apply if (motive test) it may be proven that the main motive for the establishment and operation of the foreign company is not the reduction in UK tax.

In the Cadburry-Schweppes judgment the ECJ recalls that the establishment of a company in a particular Member State because of a more favorable tax regime does not in itself constitute an abuse of the freedom of establishment. The ECJ moreover states that the CFC rules application have to be limited to cases where wholly artificial arrangements are organized aiming at obtaining a tax advantage and where the objective pursued by the freedom of establishment has not been achieved.

How to prove for a foreign subsidiary that the objective of freedom of establishment has been pursued and achieved in addition to the choice of the more tax efficient place?
The ECJ addresses the following comments in this respect:

• The participation in the economic life of the host Member State on a stable and continuing basis, and to profit there from;
• The actual pursuit of an economic activity through a fixed establishment in another State for an indefinite period, which presupposes
• The actual establishment of the company in the host Member State and the pursuit of genuine economic activity there.

Moreover the ECJ states that the foreign subsidiary must be given an opportunity to produce evidence of establishment and genuine economic activities carried out.

Further to this judgment Member States applying CFC taxation on a broader basis must have to amend their legislation in order to be compliant with the European Community law.

Impact in Luxembourg.

As far as Luxembourg is concerned, “CFC rules” with respect to subsidiaries resident in the European Union do not exist. Therefore the “Cadbury Schweppes” judgment will not have any direct impact on the tax legislation in Luxembourg. Changes in other EU Member States may however have a positive impact on Luxembourg as a location for holding, finance and service companies controlled by parent companies resident in EU Member States applying CFC rules since the ECJ Cadbury Schweppes case still emphasizes the legitimacy and reliability of the Luxembourg tax regime.