Additional guidelines on the interest deduction limitation rule

On 28 July 2021, the Luxembourg tax authorities issued a new circular replacing the one published on 2 June 2021, itself replacing the first circular issued in 8 January 20211 n°168bis/1 regarding the interest limitation rule (the Circular). The Circular consolidates the previous circulars and clarifies the concept of "equity escape provision", by including collective undertakings which are members of a tax consolidated group.

As a reminder, article 168bis of the Luxembourg income tax law (LITL) provides that tax deductions of exceeding borrowing costs are limited to 30% of the fiscal EBITDA (ie Earnings Before Interest, Tax, Depreciation and Amortisation), or up to an amount of EUR 3,000,000, whichever is higher. In other words, the taxpayer whose exceeding borrowing costs are not higher than EUR 3,000,000 can deduct said costs without any justifications. For more information, please refer to our previous article on the subject at the following link.

The Circular issued on 2 June 2021 already provided clarifications on article 168bis -6 LITL, which is the legal basis for the equity escape provision.

The equity escape provision is an exceptional rule which allows the taxpayer, under certain conditions, to deduct the full amount of the exceeding borrowing costs it has incurred (the Equity Escape Provision).

Article 168bis -6 LITL provides that, when a taxpayer is a member of a consolidated group for financial accounting purposes, the full amount of the additional borrowing costs is, upon request, deductible, if the taxpayer can demonstrate that the ratio of its equity over its total assets is equal to, or greater than the group equivalent ratio, provided that the following two conditions are met cumulatively:

1. the ratio of a taxpayer's equity over its total assets shall be deemed to be equal to the group equivalent ratio if the ratio of the taxpayer's equity over its total assets is less than the group equivalent ratio by not more than two percentage points; and
2. the total assets and liabilities are estimated in accordance with the same method as that used in the consolidated financial statements issued in accordance with international financial information standards or the national financial information system of a Member State.

The Equity Escape Provision is, under article 168bis-6 LITL, applicable to collective undertakings which are members of a consolidated group for financial accounting purposes. The circular issued on 2 June 2021 provides further guidelines on this Equity Escape Provision and clarifies that the consolidated group should not be understood as a tax consolidated group. The details with respect to the cumulative conditions which have to be fulfilled to benefit from the Equity Escape Provision and described in the circular issued on 2 June 2021 and which have been transposed in the Circular are summarized as follows:

1. the taxpayer must be a member of a consolidated group either based on a legal obligation or on a voluntary basis, ie the taxpayer must be fully integrated into the consolidated financial statements prepared by the entity heading the group, on a line by line basis (proportional consolidation or equity method are excluded);
2. the consolidated financial statements must be prepared in accordance with one of the recognised accounting standards, which refer to either the International Financial Reporting Standards (IFRS) or to the national financial reporting framework of a Member State, including standards applicable in each Member State and standards for which the Member State recognise the equivalence; and
3. these consolidated financial statements must be subject to an appropriate audit, either based on a statutory audit or a contractual audit. The Circular provides that the consolidated financial statements must be audited by a licensed auditor under the national law of the ultimate consolidating entity.

To the extent that the above conditions are met, the Equity Escape Provision could apply. However, it should be noted that, before comparing the equity over the total assets ratios of the taxpayer and of the group, certain adjustments may have to be made:

• If the statutory financial statements are not prepared under the same accounting standard as the ultimate consolidating entity, then the assets and liabilities of the taxpayer have to be evaluated according to the same accounting method as the accounting method used in the consolidated financial statements. In other words, if the consolidated accounts are done according to IFRS method, then the taxpayer will have to adjust its stand alone accounts in order to be in line with the IFRS method.
• Exclude from the consolidated accounts - by way of adjustments - the entities which are not fully integrated on a line by line basis (for example, entities consolidated based on the proportional consolidation or equity method).

The Circular includes additional guidance on the application of the Equity Escape Provision to collective undertakings which are members of a tax consolidated group based on article 164bis-9 n°9 LITL. To benefit of the Equity Escape Provision, collective undertakings being in a tax consolidation have to fulfil similar conditions as described above. For example, all members of the tax consolidated group should also all be members of the same consolidated group for financial accounting purposes and the consolidated accounts have to be prepared on the basis of the full consolidation method for financial accounting purposes.

Luxembourg taxpayers who wish to benefit from the Equity Escape Provision, under articles 168bis-6 LITL even if in a tax consolidation based on the article 164bis-9 n°9 LITL, should pay attention to their financial accounting situation to ensure their eligibility to this exceptional rule.