Luxembourg’s financial sector has found itself in the crosshairs of the European Commission’s tax policy. The Grand Duchy has been grappling with three successive anti-tax avoidance directives, known as Atad 1, 2 and 3, each introducing more stringent reporting requirements and compelling adjustments to tax structures.
In a significant move in July, the Commission referred Luxembourg to the Court of Justice of the European Union, challenging its extension of an exemption from interest deductibility limits to EU securitisation entities under the first Atad directive. However, Luxembourg remains undeterred, confident in its position and prepared to defend it in court.
The Commission argues that Luxembourg’s transposition of the directive erroneously extends the derogation to securitisation entities, which are not recognised as financial undertakings by Atad 1. This interpretation, however, is not shared by Luxembourg.
According to interviews with several lawyers, adding EU securitisation vehicles to the Luxembourg implementation is an obvious case of “failing to correctly transpose” the directive. Of course, Luxembourg’s government doesn’t agree.
Maintains confidence
“The ministry maintains confidence in its initial definition of financial undertakings within the transposition of Atad 1, considering it both logical and precise,” said a finance ministry spokesman replying to a query from Investment Officer.
Luxembourg’s legal position is that its definition “has been recently affirmed by the European Commission in various directives, including Debra, which explicitly categorizes securitisation special purpose entities as financial undertakings.”
Debra is an acronym for the proposed “debt-equity bias reduction allowance” directive that the Commission tabled in May 2022.
Tax deductibility limit
The Atad 1 directive contains a rule limiting the tax deductibility of interest income, allowing a maximum amount of additional borrowing costs of 30 percent of earnings before interest, taxes, and amortisation (Ebitda).
The rule exempted EU-regulated financial entities. However, EU securitisation companies were left off a list of regulated financial entities included in Atad 1 when the Commission adopted it in July 2016.
According to the finance ministry, this was due to “the lack of specific European regulation” on securitisation at that time. However, the following year, in 2017, a European regulation on securitisation companies was adopted.
Financial undertakings
According to the finance ministry spokesman, “Given the objective that guided the European legislator when drawing up the definition of ‘financial undertakings’ as part of the process of adopting Atad 1, when Atad 1 was transposed into Luxembourg law, Luxembourg included the securitisation companies referred to in the European regulation on the list of regulated financial entities for the purposes of applying the rule limiting the tax deductibility of interest expense.”
“Luxembourg’s initial approach of considering regulated securitisation companies as ‘financial entities’ within the meaning of the Atad 1 directive was therefore indirectly and implicitly confirmed,” said the finance ministry spokesman.
On 9 March 2022, a bill to modify Luxembourg’s tax laws to comply with the Commission’s view followed the Commission’s December 2021 “reasoned opinion” calling on the country to do so.
A good case
“They had a good policy reason why they should be excluded and even the commission, in the follow-up legislation, excluded those vehicles as well. So I think probably what happened is that Luxembourg hoped also in the context of those new regulations that the commission would basically follow its position,” said Jan Neugebauer, a partner with Arendt & Medernach.
Geoffrey Scardoni, a partner with Clifford Chance, explained Luxembourg’s view as: “Look, maybe you should review your own way to assess financial institutions with Atad 1, to harmonise things.” He added that this “would be also helpful for us advisors and for the market, not to have 10 different definitions of financial institutions — I usually like one definition to be consistent over various pieces of legislation.”
“The Commission now seems to be criticising Luxembourg for the choice it made when transposing Atad 1”, the finance ministry spokesman said.
Another directive that includes EU securitisation vehicles is the “Unshell” directive, also known as Atad 3.
“They have it even in Atad 3, and not in Atad 1,” pointed out Scardoni. “Even in three ATADs, they are not consistent.»
Implementation stands
Luxembourg states that since the 14 July 2023 Commission decision “has not yet reached Luxembourg» its implementation stands. “Luxembourg remains convinced that the choice made when transposing Atad 1 in relation to the definition of «financial undertakings» is not inconsistent with the text and spirit of the directive,” the finance ministry spokesman said.
“I think Luxembourg will just change the law,” said Neugebauer, referring to the bill before Luxembourg’s parliament. “They will just implement it and modify it and take it out — I don’t think they will go to court.”