By Jan Neugebauer & Henner Heßlau, Arendt & Medernach S.A., Luxembourg
On 19 December 2020, the Luxembourg Parliament adopted the 2021 budget law, introducing several tax measures designed to strengthen Luxembourg’s competitiveness and attract talent to the country.
Other provisions aim to address the impact of the COVID-19 pandemic and support sustainable recovery, and address abuses involving real estate assets located in Luxembourg.
Contrary to previous Luxembourg government announcements, a comprehensive income tax reform was not implemented for 2021.
Measures to increase tax competitiveness
Luxembourg’s tax incentives for recruiting skilled foreign workers (the inpatriate regime), initially described in Circular No. 95/2 of 27 January 2014, have been revised and regulated by law with said circular being abolished.
Under prior law, costs paid by an employer on behalf of a skilled worker who moves to Luxembourg are tax-exempt to the employee, including compensation for moving costs, the cost of furnishing, increased costs for housing, certain travel expenses, additional costs for children in school, and tax equalisation payments.
The new inpatriate regime adds a 50% tax exemption for an annual inpatriation bonus (prime d’impatriation) in place of the previous tax exemption for monthly lump-sum compensation for increased living costs.
Eligibility criteria include inter alia that the inpatriation bonus must not exceed 30% of the employee’s gross annual salary (excluding bonuses and pecuniary benefits).
The employee must also be a foreign specialist who has not been resident for tax purposes in Luxembourg for the past five years or lived in the country of origin within 150 kilometers of the Luxembourg border and has not been subject to Luxembourg income tax on his professional income.
An important new feature under the inpatriate regime is that there is no longer any required minimum number of full-time employees for the Luxembourg employer (previously at least 20).
This could make the regime attractive even to employers with a smaller labour force. In addition, the associated tax benefits apply for up to 9 years (previously up to 6 years).
Finally, the employee’s annual salary in Luxembourg (excluding bonuses and benefits in kind) must now be at least EUR 100,000 (previously EUR 50,000).
50% exemption for participating bonuses
A new participating bonus regime is available to employees. This type of discretionary annual bonus now benefits from a 50% tax exemption and is fully tax-deductible to the employer.
The new participating bonus regime replaces the stock option regime previously announced in an administrative circular (Circular No. 104/2 of 29 November 2017).
As of 1 January, the so-called “warrant regime,” among others provided for in the circular, is abolished.
However, it remains to be seen whether the Luxembourg tax administration will maintain its approach regarding transferrable options (options librement négociables) and non-transferable options (options individuelles ou options virtuelles) with respect to the timing and valuation of the relevant benefit in kind, or whether new administrative guidance will be published in this regard. From a technical perspective, there are sound arguments for maintaining the distinction between transferrable options and non-transferrable options even after the stock option circular repeal.
Employers using participating bonuses must have made a profit from commercial operations, agriculture, forestry, or self-employed work in the financial year preceding that in which the participating bonus is paid, and must have performed regular bookkeeping for both financial years (the year in which the participating bonus is paid and the preceding year).
Under the new Luxembourg budget law, the relevant employee must pay into the Luxembourg social security system or an equivalent foreign social security system.
The 50% exemption only applies if two thresholds are met: the total amount of participating bonuses allocated by the employer for an operating year must not exceed 5% of the employer’s profit for the preceding operating year and a participating bonus must not exceed 25% of the relevant employee’s gross annual income (excluding bonuses and monetary benefits).
Under the budget law, before paying out participating bonuses, the employer must first provide Luxembourg tax authorities with a list enabling them to verify adherence to the participating bonuses’ legal requirements.
Subscription tax lowered for UCIs with sustainable investments
Subscription tax has now been reduced for undertakings for collective investment (organisme de placement collectif, UCI) with sustainable investments within the meaning of Article 3 of Regulation (EU) 2020/852 of 18 June 2020.
Generally, UCIs are subject to annual subscription tax at a rate of 0.05% of their net assets.
The subscription tax now decreases as the percentage of sustainable investments out of total investments reaches certain thresholds.
At or above 5% sustainable investments, subscription tax decreases to 0.04%; from 20% it decreases to 0.03%; from 35% to 0.02%; and from 50% to 0.01%.
A newly issued administrative circular (Circular No. 804bis of 17 February 2021) provides examples of the procedure UCIs must follow in this respect.
Anti-abuse measures targeting Luxembourg real estate assets
New 20% levy on real estate
A lump-sum 20% real estate levy has been introduced as of 1 January on gross income (rents and capital gains) derived by certain Luxembourg investment funds from real estate located in Luxembourg.
The funds concerned are Luxembourg specialised investment funds (fonds d’investissement spécialisé, SIF), the UCI and reserved alternative investment funds (fonds d’investissement alternatif réservé, RAIF). Previously, those funds were only subject to a subscription tax (taxe d’abonnement) levied on their net assets.
The 20% levy applies to funds taking the legal form of a corporation. The 20% levy also applies where the Luxembourg real estate of a SIF, RAIF, or UCI is held via a domestic or foreign company that qualifies as tax-transparent in Luxembourg. In Luxembourg, the most common tax-transparent entities are the Luxembourg partnership (société en nom collectif), the simple limited partnership (société en commandite simple (SCS), the special limited partnership (société en commandite spéciale, SCSp), the civil law company (société civile), and the collective investment fund (fonds commun de placement, FCP).
The 20% levy is calculated on the gross rental income and, in case real estate is sold, on the notarized sale price of the Luxembourg real estate minus the purchase price at the time of acquisition. When shares in a tax-transparent entity holding Luxembourg real estate are sold, the amount subject to tax is the fraction of the share sale price that corresponds to the value of the Luxembourg real estate, minus the fraction of the share purchase price that corresponds to the value of the Luxembourg real estate at the time of the acquisition, if the relevant shares were acquired as such. Alternatively, if the Luxembourg real estate itself was acquired by, constructed by, or contributed to the tax-transparent entity, the amount subject to tax is the fraction of the value of that real estate at the time of the acquisition, construction, or contribution that corresponds to the shares sold.
The 20% levy is neither deductible nor creditable at the level of the investor.
The 20% levy came into effect on 1 January. The deadline for filing the return will be 31 May of the respective following year, and payment will be due by 10 June of that year. Thus, for the tax year 2021, affected funds will have to file a return by 31 May 2022 and pay the 20% Levy by 10 June 2022 at the latest.
Under the budget law, each SIF, RAIF, and UCI must declare if it held Luxembourg real estate in 2020 and 2021, directly or through a tax-transparent entity, by 31 May 2022 (regardless of whether it generated any rental income or sales proceeds from Luxembourg real estate).
If a fund does not report on time, the budget law provides that the tax administration can impose a lump-sum penalty of EUR 10,000.
Real estate transfer tax
Until now, the contribution of Luxembourg real estate to a company in exchange for shares has triggered registration fees (droits d’enregistrement) of 1.1% of the fair market value (valeur estimée de réalisation) of the real estate (0.5% registration fee plus 2/10, plus 0.5% transfer fee (droit de transcription)).
The contribution of Luxembourg real estate against remuneration other than shares is subject to registration fees of 7% (5% registration fee plus 2/10, plus 1% transfer fee), or 10% where the real estate is located in Luxembourg City.
According to the new budget law, to mitigate this difference, the contribution of Luxembourg real estate to a Luxembourg civil law company or commercial company (société commerciale) in exchange for shares will now be subject to higher registration fees starting 1 January 2021, of 3.4% (2% registration fee plus 2/10, plus 1% transfer fee), or 4.6% for real estate in Luxembourg City.
Although a newly issued administrative circular (Circular No. 803 of 23 December 2020) mentions this new provision, it merely repeats what the budget law states in this respect.
It remains to be seen whether this measure will indeed cause a reduction in the number of share deals going forward.
SPFs and real estate
It is already legally prohibited for a Luxembourg private wealth management company (société de gestion de patrimoine familial, SPF) to hold real estate assets directly.
However, despite the tax transparency principle in Luxembourg tax law, it has so far been possible for an SPF to hold real estate via an FCP or a Luxembourg or a foreign partnership. Now, from 1 July 2021, this will also be prohibited (regardless of whether the property is located in Luxembourg or elsewhere).
However, it should still be possible for an SPF to invest in a corporation that owns real estate.
Summary and outlook
Despite the loss of tax revenue due to the COVID-19 pandemic, Luxembourg’s new budget law does not provide for substantial additional tax burdens; rather, it continues the previous tax policy with an increased emphasis on the goal of sustainability.
In this spirit, the intended tax incentives for UCIs making sustainable investments could further strengthen Luxembourg’s leading position in sustainable investments.
In light of Brexit in particular, but also as part of a general effort to increase Luxembourg’s appeal to the global workforce, the amended inpatriate regime may well prove to be an effective tool.
Those who have relocated their activities to Luxembourg or plan to do so may find the inpatriate regime a particularly attractive means of facilitating their personnel’s relocation to Luxembourg.
-Jan Neugebauer, LLM, is a partner at Arendt & Medernach S.A., Luxembourg
–Henner Heßlau is a Senior Associate in the Tax Law practice of Arendt & Medernach S.A., Luxembourg
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