Luxembourg proposes various measures affecting individual and corporate tax

Executive summary

The Luxembourg government recently submitted a draft law (Draft Law) to Parliament containing a variety of tax measures. Overall, the proposed changes aim to alleviate the tax burden on households and enhance Luxembourg's appeal as a work and investment location, with provisions for both corporate and individual taxpayers.

Key suggested amendments affecting individual taxpayers and employers include the expansion of the employee profit-sharing regime (prime participative in French), improvements to the expatriate regime, the introduction of a bonus for certain young employees (young employee bonus) and a new tax credit for cross-border workers, as well as an adjustment to the income tax brackets.

Most of the changes will apply as from tax year 2025.

Detailed discussion

Expansion of employee profit-sharing regime

The Draft Law aims to enhance the existing profit-sharing regime by raising certain limits, while maintaining the fundamental structure of the system. The regime is applicable from 2021 and permits employers to distribute profit-sharing bonuses to freely selected employees. An employee who receives one of these profit-sharing bonuses benefits from a 50% income tax exemption on the bonus amount, while amounts paid under the regime are fully deductible to the employer for corporate income tax purposes.

The conditions for this preferential tax treatment to apply are:

• The employer must keep regular accounting records for the year any profit-sharing bonus is paid as well as for the preceding year.

• The beneficiary must be duly registered as an employee with the Luxembourg (or a recognized foreign) social security scheme.

Two limitations apply:

1. The total amount that may be paid to beneficiaries is limited to 5% of the employer's annual profit for the financial year preceding the year of payment (the employer being the Luxembourg entity employing the beneficiary).
2. A maximum of 25% of the beneficiary's annual salary (excluding benefits) of the year of payment can benefit from this 50% exemption.

The Draft Law would increase these two limits: the total bonus allocation a company may grant would increase from 5% to 7.5% and the individual bonus limit would increase from 25% to 30%.

The employer will continue to have specific reporting obligations to the tax authorities (wage tax office) and special rules will continue to apply (with the same increase in limits) if the employer is part of a fiscal unity.

Improvement of expatriate regime

To bolster Luxembourg's appeal as a destination for highly skilled professionals, the Draft Law proposes a significant overhaul of the expatriate tax regime, aiming for greater simplicity and effectiveness. The reformed regime would provide a 50% exemption of the total annual gross salary (excluding tax-exempt benefits in cash and tax benefits in kind) of qualifying expatriates (capped at €400,000 per annum), which replaces the current model that is based on the exemption of certain expenses incurred and a partial exemption of a so-called "impatriation premium."

The conditions that must be met to benefit from the reformed expatriate tax regime would remain largely unchanged from current legislation. However, the exemption will result in a significant reduction in administrative burden for employers.

The key conditions of the new regime (which are largely the same as under the current regime) are:

• The employee may either be seconded to Luxembourg from abroad or hired locally in Luxembourg from a foreign country. Employees hired through a temporary employment agency or under a labor-lending arrangement are excluded.

• The employee must become a Luxembourg tax resident.

• During the five preceding years, the employee must not have been a Luxembourg tax resident, residing less than 150 kilometers from the Luxembourg border or receiving professional income taxable in Luxembourg.

• The professional activity that qualifies for the exemption must occupy at least 75% of the employee's working time; this is a modification from the current requirement that it be the employee's primary activity.

• The employee's annual base salary must be at least €75,000.

• The employee must not replace one or more employees previously in that role who did not qualify for the expatriate regime.

• The employee must have certain experience in the group or sector (in the case of a seconded employee) or have gained in-depth expertise in the related sector (in the case of a local hire).

• Not more than 30% of the company's employees may benefit from the regime (unless the company has been established in Luxembourg for less than 10 years).

Both the new and existing expatriate tax regimes are designed to apply for a maximum period of eight years after the expatriate begins working in Luxembourg (provided that the qualifying conditions continue to be met throughout this period). As is the case under the current regime, employers must report relevant information to the wage tax office by 31 January of the following year.

For those currently benefiting from the expatriate tax regime, the regime will remain in effect for the remaining duration if conditions under the old regime continue to be met. Employees may opt into the new regime, which will then apply for the remainder of the eight-year period. This decision is final and cannot be reversed.

Introduction of a new bonus for certain young employees

The young employee bonus is a tax measure designed to encourage Luxembourg employers to hire young professionals entering the Luxembourg labor market. The bonus provides that 75% of the young employee bonus that employers pay to qualifying employees will be tax-exempt.

The eligible bonus is capped at €5,000 for annual gross salaries (on a full-time basis) up to €50,000, €3,750 for salaries between€50,000 and €75,000, and €2,500 for salaries between €75,000 and €100,000. Young employees with an annual gross salary of more than €100,000 do not benefit from the exemption.

To qualify for the young employee bonus, the following criteria must be met (when the bonus is paid by the employer):

• The employee must be younger than 30 years at the start of the tax year.

• The employee must hold his or her first permanent employment contract with an employer that is either based in Luxembourg or has a permanent establishment there.

• The employment contract must have been signed after the entry into effect of this provision.

The bonus exemption is restricted to a young employee's first employer and is valid for up to five years. If an employee changes employers, the employee is no longer eligible for the exemption.

Overtime tax credit for cross-border workers

The Draft Law proposes a new tax credit, applicable as from tax year 2024, for salary for overtime paid to certain nonresident employees. Overtime salary is exempt in Luxembourg, but nonresident employees may face taxation on this overtime salary in their home countries. The overtime tax credit is designed to compensate for the potential loss in income for such employees.

The credit depends on the salary level and amounts to:

• €700 per year for gross overtime remuneration exceeding €4,000 per year

• 25% of the amount exceeding €1,200 for gross overtime remuneration between €1,200 and €4,000 per year

No tax credit is granted for gross overtime remuneration not exceeding €1,200.

The tax credit only applies if the overtime salary is expected to be taxable in the nonresident's home country, as evidenced by the following conditions:

• The taxpayer must reside in a country that has a double taxation treaty with Luxembourg that allocates the right to tax employment income to Luxembourg.

• The applicable double taxation treaty provides that the employee's country of residence eliminates double taxation of the employment income through a tax credit or entitles the employee's country of residence to tax the employment income when it is not effectively taxed in Luxembourg.

• Under the domestic law of the taxpayer's country of residence no (partial) tax exemptions or other tax reductions apply to salary for overtime.

In addition, the taxpayer must:

• Earn employment income that is taxable in Luxembourg

• Not hold certain public-sector employment

• Receive overtime salary that is fully exempt under Luxembourg tax law

• Be affiliated with the Luxembourg or a foreign social security system that is covered by a bilateral or multilateral social security agreement

The overtime tax credit can be claimed on the annual income tax return or in the annual adjustment and is deducted from the tax due. Any excess credit is refundable upon request.

Adjustment of personal income tax scale

To increase the purchasing power of low- and middle-income taxpayers, the Draft Law would make an adjustment to the personal income tax scale as from tax year 2025. Income below €13,230 would not be taxable (an increase from the current €12,438 threshold), while the maximum rate of 42% would apply to incomes exceeding €234,870 (up from the current ceiling of €220,788).

Other tax measures reducing the tax burden of households

The Draft Law also includes changes to the tax calculation for taxpayers of class 1a (single persons with children as well as single taxpayers aged at least 65 on 1 January of the calendar year), an increase inthe maximum amount of extraordinary expense allowance for dependent children not living in the taxpayer's household and an increase in the single-parent tax credit.

Next steps and implications

The Draft Law will now go through the legislative process. Specifically, the text will be analyzed by a dedicated parliamentary commission; opinions will be collected from different advisory bodies (and, most importantly, the Council of State); and the final draft will be discussed and voted on in a parliamentary session before finally being published in the Official Gazette (Memorial). The entire process may take a couple of months.

Taxpayers and employers potentially affected by one or more of the different measures of the Draft Law should remain aware of its progress through Parliament and consult with their tax advisors to fully understand how it could affect them.