The setup of a debt fund typically involves a plurality of Luxembourg vehicles – the fund itself and, to the extent necessary, a separate lending vehicle underneath the fund.
At fund level, the major concern is the application of the ATAD 2 anti-hybrid rules, which mainly depend on the fund’s investor base. If the rules apply, the fund could be subject to corporate income tax on its revenue.
Put simply, fund managers have to think about the ATAD 2 rules if they use a Luxembourg tax transparent fund vehicle and they expect to have a majority of the fund’s interest held by taxable investors located in countries that consider the Luxembourg tax transparent fund as tax opaque. In such cases, it may be possible to setup the fund as a tax opaque vehicle.
The fund will perform its activities either directly or via a Luxembourg HoldCo which may or may not be subject to the securitisation regime. The interposition of a HoldCo is driven by the banking monopoly rules in the investment jurisdiction(s), lending often being a regulated activity, and the benefit of tax treaties providing reduced tax rates on interest payments from investment countries.
The benefit of treaty provisions is also subject to the HoldCo being considered as the beneficial owner of the income. Beneficial ownership is analysed on a case-by-case basis, although the HoldCo should generally not act as a de facto conduit company and should be able to demonstrate it has the decision-making power to reinvest the proceeds received.
Increased scrutiny from investment countries’ tax authorities may also require that the HoldCo has the substance to perform its activity, takes key decisions in Luxembourg and bears the risks associated to it and is remunerated at arm’s length for this activity.
From a Luxembourg tax perspective, the HoldCo should have Luxembourg tax resident board members holding board meetings in Luxembourg. Adjusting the HoldCo’s substance in light of the requirements of the investment countries’ tax authorities is even more important to ensure that the HoldCo can benefit from the relevant tax treaty provisions.
The implementation of the new ATAD 3 proposal should also be closely monitored. The current draft (which may be subject to substantial changes) requires premises with an exclusive use, an active bank account in the EU and at least one Luxembourg tax resident director with the necessary qualifications to take the investment decisions or a majority of Luxembourg tax resident employees.
If the HoldCo does not meet these requirements, it would not benefit from the application of tax treaties with investment countries and from the EU Directives.
Lastly, asset managers using HoldCos targeting discounted or NPL portfolios should also be mindful of the interest limitation rules that limit the tax deductibility of exceeding borrowing costs to EUR3 million or 30% of the company’s EBITDA. In this regard, the Luxembourg market has found solutions for debt holding vehicles to remain tax efficient in most cases, but careful structuring is advised.
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Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries.
There is also an exemption for funds meeting certain conditions, the interpretation of which remains uncertain.
In addition to the limited recourse and non-petition characteristics, payments by a securitisation company are considered as tax deductible interests payments. Luxembourg securitisations companies generally have access to double tax treaties, but this may involve increased scrutiny on substance and beneficial ownership from the investment countries’ tax authorities.
There are generally license requirements to be able to lend into a particular jurisdiction.
Proposal for a Council Directive laying down rules to prevent the misuse of shell entities for tax purposes and amending Directive 2011/16/EU.
Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States.
Simply put, the amount of interest expense exceeding the amount of interest income.