Under Article 168bis Alinea 6 LITL, a taxpayer belonging to a consolidated group may, upon request, benefit from the full deduction of exceeding borrowing costs if it can demonstrate that its own debt-to-equity ratio is higher, or at least not more than 2% lower, than the debt-to-equity ratio of the consolidated group to which it belongs.
The taxpayer has the choice to opt for the escape clause on a yearly basis. In case the option is granted, the carry forward of the exceeding borrowing costs and the unused interest capacity are not applicable.
This exemption, named escape clause, requires a comparison between the debt-to-equity ratio of the group and the one of the taxpayer. The Circular provides more details on (1) the condition to benefit from this option and on (2) how this comparison should be made.
On the first point, some conditions need to be met, notably:
- The taxpayer should be fully part of a consolidated group; the Circular states that only the full line-by-line method of integration is accepted to benefit from the provision of Article 168bis.
- The accounting method used for consolidation should be in accordance with the international financial reporting standards (IFRS) or with the national financial reporting system of a Member State. Financial reporting systems of a third country are accepted if recognized as equivalent at EU level. The Circular refers to decisions of the Commission approving equivalence with US, Canada, China, South Korean, and Japan;
- The consolidated accounts must be controlled by an expert authorized for such control in accordance with the law applicable to the consolidated entity. This control should in principle result from a legal requirement. Control on voluntary basis is however admitted if the mission is carried out in compliance with standards equivalent to those which would have been applicable within the framework of a legal mission or, failing that, in compliance with standards equivalent to audit standards in Luxembourg laws;
On the second point, the Circular also provides first that the comparison should be made between the taxpayer and the highest consolidating entity of the consolidated group. In a second step, the accounts of the taxpayer should be adapted to be in line with the accounting method used in the consolidated accounts. As mentioned above, only line-by-line consolidation is accepted. Therefore, in a final step, consolidated accounts should also be reviewed to remove any consolidation through another method (such as equity method for example).
The comparison is made between the debt-to-equity ratio of both entities. For this purpose, debt-to-equity ratio should be understood as a ratio, expressed in percentage, between the equity of the relevant entity and the total assets of its commercial balance sheet.
The taxpayer must disclose relevant information and documents in its tax returns to evidence that the required conditions to benefit from the escape clause are met and to support the computation of the ratio. Luxembourg tax authorities may also require some additional information such as the consolidated accounts, the audit report prepared by the independent certified auditor as well as an attestation prepared by an auditor confirming that the adjustments have correctly been made.
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The Circular constitutes administrative guidance and in principle has a binding effect on the Luxembourg tax authorities and essentially form an instruction on inspectors on how to interpret and apply the legal provisions covered by the Circular. However, taxpayers are generally not bound by clarifications given in circular letters. It is generally advisable to take note of the positions clarified in circular letters as a deviation therefrom may increase the risk on positions being challenged by the Luxembourg tax administration.
Taxpayers are generally recommended to review their financing position in light of this new guidance given and see how, if any, it may impact them.
Tiberghien Luxembourg remains committed to monitor the practical implementation of the interest limitation rules.
For any questions, please contact your trusted advisor at Tiberghien Luxembourg or contact any of the authors of this publication.
Michiel Boeren – Partner (michiel.boeren@tiberghien.com)
Gauthier Mary – Senior Associate (gauthier.mary@tiberghien.com)
Madeline Morel – Associate (madeline.morel@tiberghien.com)