Investment tax credit
New opportunities for cross-border activities
By John Hames and Giuseppe Tuzzè, Ernst & Young, Luxembourg
On 31 March 2010, the Luxembourg direct taxation authorities (” Administration des Contributions Directes”) issued a new circular L.I.R. n° 152bis/3 aiming to confirm that investments physically used on the territory of a Member State of the European Economic Area (EEA) agreement are also eligible for the investment tax credit under article 152bis of the Income tax law (“ITL”).
The issuance of the new circular L.I.R. n° 152bis/3 is consequent to the judgment of the Court of Justice of the European Union (CJEU) of 22 December 2010 in the proceedings between the Director of the “Administration des Contributions Directes” and the Luxembourg shipping company Tankreederei SA.
Description of the CJEU case law
Tankreederei SA, a company established in Luxembourg and engaged in international shipping activities, made an investment in two inland navigation vessels for its refueling business carried out in the ports of Antwerp (Belgium) and Amsterdam (Netherlands).
Tankreederei SA asked the investment tax credit on the concerned vessels on the basis of Article 152bis ITL which had however been denied by the Luxembourg direct tax administration on the reasoning that the vessels have been used abroad.
Indeed, the investment tax credit rules foresee that a qualifying tangible fixed asset (except land and buildings) is eligible to the tax credit if invested in an undertaking in the sense of article 14 ITL (i.e. an undertaking carrying out a commercial, an industrial, a mining or a crafts trade business). Furthermore, the investment should be made in an establishment situated in Luxembourg and intended to remain there on a permanent basis and the investment must be physically used on the territory of Luxembourg. It should also be pointed out that in view of Luxembourg's geographical situation, a Luxembourg shipping company investing in a sea vessel operated in international traffic is exempted from the condition that the investment should be physically operated on the Luxembourg territory.
Tankreederei SA filed a claim against the decision of the Luxembourg direct tax authorities arguing, among others, that the refusal of the investment tax credit for its vessels resulted in a less favorable tax treatment than that of companies engaged in similar activities in Luxembourg and that this was an obstacle to the freedom to provide services between EU Member States.
The CJEU ruled in the said judgment that Luxembourg’s rules regarding the investment tax credit under article 152bis ITL are contrary to article 56 of the Treaty on the Functioning of the European Union (TFEU) (i.e. freedom to provide services) as the investment tax credit cannot be denied to an undertaking established in Luxembourg on the sole ground that the investment is physically used on the territory of another Member State.
Although Luxembourg has not put forward overriding reasons to justify the application of such restrictive rules, the CJEU analyzed the main justifications that Luxembourg might have been used to support such a restriction to the freedom to provide services like the balanced allocation of the power to impose taxes, coherence of the national tax system, the reduction of national tax revenues, the prevention of abuses and the discretion of the Member States to grant tax advantages for social purposes. The CJEU came however to the conclusion that the restrictive provisions of the Luxembourg investment tax credit regime cannot be justified by overriding reasons of public interest.
New investment tax credit rules
Following the CJEU decision of 22 December 2010 and the subsequent circular issued by the Luxembourg tax authorities, the granting of an investment tax credit within the meaning of article 152bis ITL is no longer limited to eligible investments physically used on the Luxembourg territory, but applies also to those physically used on the territory of another European Union (EU) Member State as well as a state which is part to the EEA Agreement (i.e. the 27 EU Member States as well as Iceland, Liechtenstein and Norway).
In that context, it is important to specify that even though an investment that is physically used on the territory of another country (i.e. EU or EEA) is now eligible for the investment tax credit under article 152bis ITL, that investment still have to fulfill the other condition that the asset has to be operated in an establishment located in Luxembourg. In other words, an investment which is made by Luxembourg company and operated abroad is eligible to the investment tax credit to the extent however that the said activity or investment does not create a permanent establishment in that foreign country.
The Luxembourg tax authorities have also confirmed in the said circular that legislative changes will occur in order for the Luxembourg tax legislation to comply with article 56 TFEU and article 36 of the EEA Agreement (i.e. freedom to provide services). In the meantime, the Luxembourg tax authorities will apply the principles outlined in the said CJEU judgment to all tax assessments that will be newly issued or which are not yet final (e.g. for which a complaint is not precluded).
Quid? Cross-border leasing activities
Having said the above, it is interesting to mention that for investments financed through leasing techniques, special investment tax credit rules are applicable.
In fact, in case a qualifying investment is made through a leasing operation which attributes the economical ownership to the lessor (e.g. operate lease or rent agreement), the lessor can in principle benefit from the investment tax credit calculated on the acquisition or cost price if the following two conditions are fulfilled:
- If the investment, subject to the lease agreement, is used by the lessee within a commercial undertaking in the meaning of article 14 ITL and situated in Luxembourg; and
- If the lessee’s commercial undertaking, in which the said investment is operated, is fully taxable in Luxembourg.
Put differently, a lessor will benefit from the investment tax credit if the qualifying leased asset is operated in the frame of the lessee’s fully taxable undertaking, which could be either a Luxembourg fully taxable company or a Luxembourg permanent establishment of a non resident taxpayer.
These restrictive provisions have been introduced in order to prevent abuses by using leasing techniques. For example, if the lessee is not subject to tax in Luxembourg (e.g. non-resident company) or if it runs an independent profession (in principle not eligible for the investment tax credit), the said lessee could nevertheless indirectly benefit from the investment tax credit on qualifying assets by obtaining a reduction of the leasing terms from the lessor, as the latter could reflect in its rents the investment tax credit granted on the leased assets.
The above mentioned restrictions for qualifying assets financed through leasing operations do however not apply to “financial leases” as defined by the Luxembourg tax law. Indeed, in financial leases, the lessee is generally considered as the economical owner of the leased assets and benefits from the investment tax credit rather than the lessor.
Based on the above analysis, it is permitted to ask the question whether the restrictions posed by the investment tax credit rules for leasing operations are in line with the EU legislation, especially with article 56 TFEU relating to the freedom to provide services. Indeed, the restrictions for leasing operations included in article 152bis ITL could discourage domestic undertakings from providing cross-border rental services as such rules make the provision of cross-border rental services less attractive than the provision of such services within Luxembourg. Affaire à suivre...
By John Hames, Partner, Ernst & Young Tax Advisory Services
and Giuseppe Tuzzè, Senior Manager, Ernst & Young Tax Advisory Services