Luxembourg – an attractive location for multinational cash-pooling
Magasine du Trésorier
For many multinational companies or groups (MNCs), multinational cash-pooling has become a core component of their global cash management strategy. The key drivers which make multinational cash-pooling interesting for MNC’s treasury functions are in most instances:
- Improved, real-time visibility on the MNC’s global cash position enabling an enhanced group wide cash forecasting
- Reduction of external debt through a more efficient (re)allocation of cash available with the MNC
- Obtain an improved credit rating through a centralized net cash position
- Get access to better placement conditions for excess cash balances
Even though in most cases, taxes are not the original driver to implement a multinational cash-pooling, they may considerably impact on its overall efficiency. Thus, the overall efficiency of a multinational cash-pooling is notably impacted by tax draw-backs such as withholding taxes on interest payments, limited deductibility of interest expenses, transfer pricing requirements, but also anti-avoidance rules and controlled foreign company (CFC) legislation restricting tax planning opportunities, as well as stamp duties and registration taxes. The actual impact of tax draw-backs depends to a large extent on the design of the cash-pooling solution and the locations where the cash-pool leader and the cash-pool members are established.
Simplified example of a multinational cash-pool
The following examples provide an overview, why Luxembourg may constitute an attractive location to establish a multinational cash-pooling.
Withholding taxes on interest payments
Interest expenses paid in the frame of a cash-pool may be subject to withholding tax (WHT), ranging depending on the country of source from 5% to 35% of the interest paid. If WHT is applied, this generally leads to an immediate cash outflow. If WHT is, in addition, neither recoverable nor creditable, it will constitute a final cost and reduce the income earned by the recipient. This would negatively impact on the overall efficiency of the cash-pool.
By establishing the pool-leader in Luxembourg, interest payments made by pool-members established within the EU may be exempt from WHT based on the EU interest and royalty directive. In addition, Luxembourg has an extensive double tax treaty network providing at least for a reduced WHT on interest payments to a Luxembourg company. Finally, interest paid out of Luxembourg, for instance by the Luxembourg pool-leader to the pool-members should be exempt from WHT, based on Luxembourg domestic rules.
Limited deductibility of interest expenses
Another inefficiency may arise within a cash-pooling if the deductibility of interest expenses paid by the pool-leader to pool-members, or vice versa, were limited for income tax purposes, whereas the corresponding income realized by the pool-members (or the pool-leader) would be taxable for the full amount.
The limited deductibility of interest expenses may be due to various reasons such as thin capitalization rules, interest barrier rules, CFC legislation and local anti-avoidance rules, or simply very stringent transfer pricing rules.
Unlike some other European States, Luxembourg has not implemented interest barrier rules, local anti-avoidance rules or CFC legislation. Interest expenses incurred by a Luxembourg pool-leader should therefore be deductible for Luxembourg income tax purposes, to the extent that the interest expenses are at arm’s length. Thin capitalization rules are applicable if an advance clearance is sought from the Luxembourg tax administration on the arm’s length character of the remuneration realized by the Luxembourg pool-leader.
Moreover, Luxembourg is a member of the European Union. As a consequence, CFC legislation or anti-avoidance rules existing in certain European States should not be applicable to interest payments made by pool-members located in these countries, to the extent the Luxembourg pool-leader has sufficient substance in Luxembourg.
Transfer pricing requirements
The tax legislation of most countries requires that transactions between related parties are carried out at arms’ length. If that would not be the case the taxable result of the related parties may be increased by the competent tax authorities. If no corresponding downward adjustment is made by the tax authorities competent for the counterparty in the transaction, such profit adjustment may lead to a double taxation of the same income. Luxembourg tax authorities generally agree to corresponding transfer pricing adjustments if justified.
The Luxembourg income tax law also requires the application of the arm’s length criteria on transactions between related parties. On 28 January 2011, the Luxembourg tax authorities issued an administrative circular on the tax treatment of companies carrying out intra-group financing activities. The circular confirms that the arm’s length principle included in the Luxembourg income tax law follows the arm’s length principle as defined in the OECD Model Tax Convention. The circular also confirms that according to Luxembourg general tax law, transfer prices applied on transactions between related parties have to be properly documented. Luxembourg has, however, not implemented comprehensive transfer pricing regulations.
Finally, the circular foresees the possibility of obtaining, under certain conditions, a binding tax clearance from the Luxembourg tax authorities on the transfer prices applied on intra-group financing transactions.
Establishing a cash-pooling in Luxembourg might also give access to various planning opportunities. Thus, a pool-leader established in Luxembourg may for instance be refinanced through tax efficient debt instruments.
Moreover, tax losses carried forward by a Luxembourg company may, in principle, be used without any restrictions, except in certain abusive cases. Tax losses may also be carried forward indefinitely. As a consequence, by lodging the pool-leader of a multinational cash-pooling in a Luxembourg company that has tax losses, profits realized by the pool-leader may be completely offset with the tax losses available.
In summary, Luxembourg is a very attractive location to establish the pool-leader of a multinational cash-pooling. The Luxembourg tax framework in combination with the possibility of obtaining binding tax clearances provides a unique opportunity to enhance the financial and operational benefits arising from a multinational cash-pooling. Additionally, if cash management is combined with corporate finance, holding and even intellectual property management activities in Luxembourg, a MNC may get the full benefit of Luxembourg’s tax framework.