A Luxembourg tribunal decision barring a local company from using investment losses to write off capital gains taxes imposed on a real-estate transaction has caused worry in some corners of Luxembourg’s investment world. Using losses to cut income tax due is a well-established practice. However, a legal analysis by ATOZ, the law firm that alerted many to the 30 March 2023 court decision, says the decision is unlikely to survive an appeal.
A company owned by a Luxembourg resident individual, established in 2000 and active in the share-investment business, but dormant from 2009 to 2013 was used to write off capital gains taxes imposed on a 2014 real-estate transaction.
The real estate property was quickly flipped after 6 months of ownership for a significant profit of about 80% of the acquisition costs.
‘Abuse of law’
The Luxembourg Tax Authority held that using long-dormant tax losses to achieve a new corporate purpose constituted an “abuse of law”. Its decision was supported by the Luxembourg Tribunal, the court of first instance, and is now under appeal to Luxembourg’s Administrative Court of second instance.
The tribunal, according to an ATOZ account, held that “there is every reason to believe that the company was only ‘reactivated’ in 2014 for the purpose of carrying out the real estate investment.”
“The Tribunal concluded that there is sufficient evidence that the legal and tax personality of LuxCo was used solely to benefit from its tax loss carry-forward and to reduce the tax that would have otherwise been incurred on such a transaction.” LuxCo is a pseudonym used by ATOZ in its document.
Strong protections
However, according to the 19-page analysis by ATOZ’s Oliver R. Hoor, a tax partner and head of transfer pricing and the German desk, there is settled case law stemming from a 1986 German court decision that’s been endorsed by Luxembourg courts and featured in a 2011 Luxembourg tax authority circular which holds that there are strong protections on a shareholder’s right to do whatever he wishes with his or her company.
“In my view, there is no doubt that this cannot stand because of the way the tribunal does not properly consider all the aspects that are available,” said Hoor.
Hoor pointed in his analysis to case law based on the German case — called “Mantelkauf” — which dealt with a company acquiring a dormant company with losses on its balance sheet. “The “Mantelkauf” jurisprudence defines the scope of application of the abuse of law provision in case of corporate tax losses,” according to Hoor’s report.
Share sale vital
With this precedent in mind “the question whether the abuse of law concept might apply, in case of corporate tax losses, can only be asked if most, if not all, of the shares of a company are sold to a new shareholder,” said Hoor.
In the LTA/Luxembourg tribunal case, the shareholder is an individual who’s always controlled the company, so there was no change in shareholders.
All the income realised by the Luxembourg company is classified as commercial income,” said Hoor. “Therefore, realising losses in regard to holding activities, staying dormant for a few years and then using the losses to offset capital gains realised upon disposal of Luxembourg real estate is legitimate and not open to being challenged on grounds of the abuse of law concept.”
Trading tax losses
“The concept of abuse of law may be applied in order to avoid the trading of tax losses incurred by a company,” said Hoor. He explained that when the shares of a dormant Luxembourg company are sold to a new shareholder, the company ceases its loss-generating activity and, following the transfer of its shares, exercises a completely different and profitable activity, the tax losses may be denied on grounds of abuse of law.” said Hoor.
The Tribunal’s decision emphasised the change in LuxCo’s activity from shareholding to real estate. “Since there was no change in shareholder here, they have been actually making up this economic identity change,” Hoor said the lower court asked a question for which there is no starting point. “Only where there is a change of shareholder might this question be asked,” he said.
“Analysing all the facts and circumstances and all the existing case law and the 2011 tax circular guidance, the Luxembourg tax authorities and the Tribunal erred in their decisions,” said Hoor.
Legal uncertainty
Hoor described the case as raising “a very important question” for Luxembourg as it adds to what he described as already-substantial legal uncertainty surrounding the fact that in Luxembourg, tax losses can only be considered final in the year you use them.
This can be several years after you incur the loss, Hoor explained. “So that is already creating a bit of legal uncertainty, which is very bad for businesses, which are confronted with an ever-changing tax environment.”
Hoor said that simply changing the law so the tax authority assesses the tax losses in the year they were incurred “would provide legal certainty to investors”.
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