With tax reforms high on the agenda for many countries worldwide, international businesses have increasingly been looking to foreign jurisdictions for incentives that may not be available in their domestic markets.

In Luxembourg, to accommodate this growing trend, the legislative authorities have updated the country’s tax environment while taking EU proposals into consideration. Recent developments should be favourable for companies with an interest in Luxembourg.

New tax regime for IP income

In December 2007 Luxembourg introduced a special tax regime for IP income managed from Luxembourg. This is a development that is expected to help assist with technical innovation as well as offering businesses another possibility for the management of their IP rights.

Other jurisdictions, such as Belgium, Ireland and the Netherlands, already offer tax incentives in the same area, so this presents another alternative. The new regime is applicable to technical and commercial IP and allows for an 80 per cent exemption of the net income derived from specific IP rights. Only 20 per cent of the net IP income will be taxed at the corporate income tax rate of 29.63 per cent, which provides an effective tax burden of roughly 5.9 per cent.

Eligible for the new regime is income derived from the use of, or licensing of copyrights for, computer software, patents, industrial or commercial trademarks and industrial models and designs. The relevant IP, however, must have been created internally or acquired after 31 December 2007, while income derived from copyrights other than on software, from plans, formulas and similar IP is not included.

The scope of Luxembourg’s regime is broader than that of Belgium, which normally does not include copyright, trademarks, models and designs. It is wider than that of Ireland, which normally does not include trademarks and copyright. Therefore Luxembourg offers a particularly favourable tax regime for these areas.

The new regime is not, however, available for IP rights acquired from an ‘affiliated’ company. The exclusion of IP acquired from such a company is aimed at avoiding any repetitive use of the tax incentives offered. Considering that the law refers to affiliated companies without distinction in terms of residence, the exclusion should also apply to transfers made by foreign affiliated companies – despite the fact that a transfer by a foreign affiliated company does not in principle result in a multiple use of the beneficial tax regime in Luxembourg.

However, this exclusion does not apply to certain indirectly affiliated companies, and the 80 per cent exemption applies even if the income derived from the IP right is received from an affiliated company.

Implementation of EU Directive 2005/19/EC

Luxembourg legislation of December last year has primarily implemented the EU Directive 2005/19/EC – revising the EU Directive 90/434/EEC (the merger directive) on the common system of taxation applicable to mergers, which has set forth a system of deferral for the taxation of capital gains relating to the assets transferred upon mergers or similar operations.

Having already implemented some of the provisions previously, Luxembourg has made further changes, including an extension of the merger regime to European companies and cooperative companies, as well to companies established in a country of the European Economic Area (EEA) other than EU member states.

The entity classification rules have been further amended, which means that any entity covered by Article 3 of the amended EU directive is now considered as non-transparent for all relevant Luxembourg tax purposes. However, as previous legislation had already extended the definition of non-transparent entities to those listed in Article 3 of the EU parent-subsidiary directive, and as the entities mentioned in Article 3 of the merger directive are roughly the same as those listed in the parent-subsidiary directive, except for some minor exceptions, this new provision should not have any significant effects on the entity classification rules.

For entities not covered by Article 3 of the merger directive or by Article 2 of the parent-subsidiary directive, the classification of foreign entities is made on the basis of a comparison of their legal features with Luxembourg entities. For instance, for a German closed Kommanditgesellschaft (KG), which is listed neither in Article 2 of the parent-subsidiary directive nor in Article 3 of the merger directive, the tax authorities will compare its legal features with those of Luxembourg companies in order to determine whether the KG will be considered transparent or not for tax purposes.

There has also been a reduction from 25 per cent to 10 per cent of the minimum threshold required from the absorbing company, allowing it to benefit from the exemption of capital gains on its own shares held in the absorbed company.

The application of the main EU tax directives has been extended to Romania and Bulgaria and that of the merger regime and the parent-subsidiary regime to capital companies or cooperative companies resident in a country of the EEA other than EU member states such as Liechtenstein, Norway and Iceland. The latter must, however, be subject to a tax in their country of residence comparable to the Luxembourg corporate income tax – ie levied at a rate of at least 11 per cent on a basis comparable to the tax basis determined under Luxembourg rules.

Capital duty reduced

At the same time, Luxembourg has lowered its rate of capital duty from 1 per cent to 0.5 per cent. The definitive phasing out of capital duty in Luxembourg has already been mentioned in the official commentaries of the law reducing the rate of capital duty and should be achieved by the beginning of 2010 following the recommendations set out by the European Commission. Meanwhile, the present share-for-share and asset-for-share capital duty exemptions remain in force.

Luxembourg offers many benefits to the domestic and international business communities. It has the lowest standard VAT rate in the EU, while companies also gain from the wide tax treaty network, including 58 signed tax treaties – the latest being the double tax treaty with Hong Kong signed last November and with Kuwait last December. There are also 11 tax treaties currently in negotiation.

However, Luxembourg is not without its inadequacies. Less favourable is capital duty, although it will be phased out soon, and the 29.63 per cent Luxembourg corporate income tax rate, which is superior to that of some other EU member states. This is less attractive for operating companies unless their activities consist mainly in the development and holding of certain IP rights, for which the effective tax rate can be very low, as detailed above. Financing activities can, however, be structured in a tax-efficient way, while holding companies can benefit from favourable tax treatment, as with the Luxembourg participation exemption regime. The authorities are also generally accessible and open to discussion.

Frédéric Feyten is a partner and Marc-Antoine Casanova is an associate at Oostvogels Pfister Feyten