Luxembourg offshore tax and legal regimes

The term 'offshore' is not used in Luxembourg legislation or in describing company forms. Use of the special 'holding company' forms is the key criterion for obtaining offshore tax treatment for most types of business; special forms are also available for collective investment vehicles and investment funds.

In 2003 the European Union finally agreed its Savings Tax Directive, under which Luxembourg will be 'allowed' to apply a withholding tax to the returns on the savings of citzens of EU member states, initially at the rate of 15%, rather than providing information to the citizens' home tax authorities. It wasn't until May, 2004, however, that Brussels finally agreed acceptable rules with Switzerland for the imposition of a withholding tax and the preservation of banking secrecy, rules which will also apply to Luxembourg - the famous 'level playing field'. The Directive came into force in July, 2005. The effects on Luxembourg's banking and fund sector are uncertain, although for sophisticated investors there are as many holes in the Directive as in a Swiss cheese.

Tax withheld in Luxembourg during the first nine months of the Directive's operation amounted to EUR48m, which at an interest rate of 5% would indicate 'trapped' capital of EUR1.3bn. Bearing in mind that Luxembourg has banking assets of EUR900bn, it doesn't appear that the Directive has had a major effect.

The other key EU fiscal initiative affecting Luxembourg in particular, the EU's Code of Conduct Committee's campaign against 'harmful tax practices', resulted in the abolition of most of the holding company regimes in 2007, and their replacement by the new SPF format, aimed at the asset management sector.

Capital contributed to a Luxembourg company or branch is generally subject to a 1% capital tax on the net value of the property contributed. However, investment funds pay a flat registration duty of EUR1,250 when they are established. For contributions to other types of business entities, there may be an exemption under the following circumstances (subject to certain conditions):

The 2008 draft budget submitted on 10 October 2007 provides for a reduction in the rate of Luxembourg capital duty to 0.5% as from 1 January 2008. Official government comments refer to the phase-out schedule proposed by the European Commission in December 2006 and state that Luxembourg capital duty should be abolished by 2010.

Forms of Offshore Operation

Offshore operations may take place within the following forms:

Tax Treatment of Offshore Operations

See Domestic Corporate Taxes for the general principles of Luxembourg; however these do not apply to offshore entities except as indicated below. Offshore entities are not covered by Luxembourg's Double Taxation Treaties except as indicated below.

Offshore companies are taxed as follows:

Holding companies formed under the law of 31st July 1929 are exempt from income taxes (the IRC and the Municipal Business Tax on Profits) and from the Fortune Tax. No tax is levied on the transfer of shares, and there are no taxes due on the liquidation of a 1929 Holding Company. No withholding tax is due on dividends payable to a 1929 Holding Company. (But see below as regards changes being effected in 2004.)
1929 Holding Companies are subject instead to the capital contribution tax (droit d'apport) of 1% of subscribed capital, either on formation or on a later capital increase, and to the subscription duty (taxe d'abonnement) which amounts to 0.20% of the value of the shares issued by the Holding Company, payable annually in four equal instalments. If shares are quoted, the value is the current market value; if there is no quotation, the paid-in value is used. There are adjustments if dividends are paid out during the year, if profits are written to reserves, or if losses are incurred. Under legislation which came into effect in 2004, in order to satisfy the EU's 'harmful tax practices' initiative:

A 1929 holding company loses its tax-exempt status if at least 5% of its dividends received relate to foreign participations that are not subject to tax at a rate comparable to the Luxembourg corporate income tax rate. An effective tax rate is considered to be comparable if it is at least 11%, equating to approximately one-half of the current corporate income tax rate that applies to regular resident taxpayers and is in line with the tax rate generally applicable to dividends received from participations that do not qualify for a full exemption.

Further, the taxable base needs to be determined under a method similar to the methods used in Luxembourg. An auditor or accountant is required to certify annually that the eligibility requirements have been met. A 1929 holding company that loses its tax-exempt status is subject to the normal corporate income tax regime.

For newly incorporated 1929 holding companies, the amendment applied as from 1 January 2004. For existing 1929 holding companies (i.e. those incorporated under the law applicable before 1 January 2004), the new rules will apply as from 1 January 2011.

Milliardaire Holding Companies are taxed on the basis of various percentage rates applied to interest paid out and dividends distributed by the company, and on the remuneration and fees paid to directors, auditors and liquidators residing less than six months of the year in Luxembourg. The minimum annual tax liability of a Milliardaire Holding Company is much less than an equivalent 1929 Holding Company would pay.
Financial Holding Companies are taxed on the same basis as 1929 Holding Companies.
SOPARFI companies, which were created under the law of 24th December 1990, are subject to the normal regime of income taxes etc (see Direct Corporate Taxation) but do receive the benefit of Double Taxation Treaties, and in many circumstances are exempt from taxation on dividends received from or paid to resident and non-resident companies in which they have a significant participation. The EU Parent-Subsidiary Directive also provides some withholding tax exemptions (improved as from 2004, see below), but the SOPARFI benefits are more extensive. The rules are complex; there are conditions; and there are limitations on the deductibility of expenses.
The various forms of UCI are all exempt from all Luxembourg taxation, and pay only a small capital duty on start-up, plus an annual tax on net assets which varies between 0.01% and 0.06% depending on the type of fund. In June, 2004, the Luxembourg government announced that pension funds would be exempt from the 0.01% 'subscription' tax, in order to encourage the transnational pooling of pensions assets.
In 2004, Luxembourg introduced the SICAR, which may take one of a number of corporate forms, including that of a limited partnership (see Forms of Company). A fixed capital duty of Euro 1,250 applies to equity capital injections upon incorporation or thereafter. SICARs that are in corporate form are fully taxable and should in principle, like SOPARFIs and unlike 1929 holding companies, be eligible for benefits under Luxembourg’s tax treaties as well as benefits under EC directives. Investment income and realized gains are not considered taxable income, and realized losses and write-downs are not deductible. All other income and expenses are taxable in the normal way. Distributions are exempt from withholding tax, as are redemptions by nonresident investors, regardless of the amount or holding period. SICARs are exempt from wealth tax, and there is an exemption from VAT for management charges. SICARs are excluded from the benefits of fiscal consolidation. Investors seeking tax transparency will opt for a SICAR in the form of a limited partnership (SeCS). An SeCS is not liable to corporate income tax or net wealth tax, and is exempt from the municipal business tax. Income from the partnership and capital gains realized on units by nonresident partners will not be taxed in Luxembourg.

The EU's Parent/Subsidiary Directive

Changes to the parent/subsidiary directive in 2004 are reducing the holding requirement to 20% for 2005-06; to 15% for 2007-08; and to 10% for 2009 onward. Under the EU's Directive on Interest and Royalties, which also came into effect in 2004, both types of payment will be exempt from withholding tax if they are between associated companies (rules as for the participation exemption).

Luxembourg has actually gone even further, meaning that there is no withholding tax on royalties paid to non-resident companies, and Luxembourg holding companies incorporated according to the terms of the law of 1929 are not subject to such withholding tax either. In line with the directive, the laws came into force retrospectively, with effect from January 1st 2004.

Exchange Control

Luxembourg has no exchange controls.

Offshore Activities in Luxembourg

'Offshore', ie low-tax, activity in Luxembourg is possible only through the various specialised corporate forms listed above. These types of holding company and collective investment fund are limited to the specified holding and financial activities for which they were created. All other types of commercial and business activity have to be conducted in the mainstream, and therefore highly-taxed, economy.

There are no special privileges or disabilities for the employees of non-resident or offshore operations as such. Nationals of European Union member states have free right of movement in Luxembourg. However, any stay for the purposes of employment or remunerated activity, including remunerated or non-remunerated training courses, is subject to obtaining in advance both a provisional residence permit (autorisation de sejour provisoire) from the Ministry of Justice, and a work permit from the Ministry of Labour. Presumably these permits cannot be refused to EU nationals.