The intensifying relationship between tax and ESG in Luxembourg

Environmental, Social, and Governance (ESG) criteria have become essential components in the decision-making processes of investors worldwide, helping to evaluate the sustainability and ethical impact of investments in companies or businesses. As the global focus on sustainable finance grows, Luxembourg has emerged as a leading hub for ESG investments. The Grand Duchy's policies and strategic actions make it a significant player in the European finance sector, as recently illustrated with the new investment tax credit scheme. This scheme is designed to incentivize investments that meet ESG criteria, fostering a more sustainable economic environment. This article explores the intricate link between tax policies and ESG in Luxembourg, with a particular focus on the latest investment tax credit scheme.

The role of tax policy in promoting ESG

Tax policies can positively influence corporate behavior and support driving investments toward sustainable projects. Through tax incentives, governments can help lower the cost of capital for ESG-oriented projects, making them more attractive to investors. These incentives can take various forms, including tax credits, deductions, and exemptions.

Tax credits directly reduce the amount of tax owed by an entity, which can be a compelling incentive for companies to invest in ESG projects. Tax deductions lower taxable income, thereby reducing the overall tax burden. Both methods effectively increase the return on investment for sustainable projects, encouraging more companies to adopt ESG principles.

Luxembourg has a history of implementing tax policies that support sustainable finance. One example is the reduced subscription tax rate available for investment funds qualifying under ESG criteria. The latest illustration of this commitment is the revisit of the investment tax credit scheme. By understanding the structure and benefits of this scheme, investors can better appreciate its role in promoting ESG investments.

The latest investment tax credit scheme

The new investment tax credit scheme in Luxembourg is designed to further stimulate ESG investments by providing significant tax benefits to eligible projects focusing on digital transformation or the environmental and ecological transition. These projects will benefit from a revised tax credit of 18% reducing their tax payable. 

The key details of the revised scheme are as follows:

Eligibility criteria:

• Projects must align with either digital transformation or the environmental and ecological transition
• Investments and operating expenses must be recorded by a Luxembourg taxpayer, and investments be used in any states of the European Economic Area
• Projects must not exceed three years between their start and completion, but also exceed a cumulative budget in investment and operating expenses of EUR 20,000 for this period
• Eligible projects include renewable energy installations, energy efficiency upgrades, sustainable infrastructure developments, and other initiatives that contribute to ESG goals

Application process:

• Companies must submit a detailed application to the Ministry of the Economy
• Proposals are reviewed by a dedicated committee that assesses the project’s alignment with selected criteria and its potential benefits
• Approved projects will receive an attestation for their full period
• An annual certificate will then be requested every year within two months of closing the accounts and will be filed with the tax return for the taxpayer to receive tax credits that can be applied against corporate income tax liabilities

Potential benefits:

• The scheme aims to lower the financial barriers to entry for sustainable projects, making them more accessible to a broader range of companies
• By reducing the tax burden, the scheme increases the attractiveness of ESG investments, potentially leading to a significant uptick in sustainable projects in Luxembourg
• Overall, it will better position the Grand Duchy’s economy by assisting Luxembourg taxpayers in future-proofing their operations in areas which might not have been seen as strategically important a few years back

Case studies and examples

As an example, to illustrate the impact of the investment tax credit scheme, we can take the case of a Luxemburgish manufacturing firm that is undertaking a comprehensive energy efficiency upgrade of its facilities. The upgrades will lead to substantial reductions in energy consumption and carbon emissions, aligning with ESG goals of the investment tax credit scheme. The tax credits will help offset the costs of the upgrades, accelerating the company’s transition to more sustainable operations.

While for the purpose of this article, we have insisted on the ESG side of this scheme, it must be noted that it also applies to innovation. For example, a bank decided to undertake the development of its digital platform centralizing and integrating systems covering all banking operations across Europe, placing the Luxembourg operations as their hub for the area. This covered brand new developments as well as reengineering of existing modules and optimization of aging in-countries resources. A key element will be the cybersecurity and resilience of the platform which will benefit from the involvement of both an internal team and external expert consultants.

Challenges and opportunities

While the investment tax credit scheme offers substantial benefits, it also presents certain challenges for candidate taxpayers. The application process can be complex and time-consuming, in particular when considering the metrics of the energy and ecological transition projects, potentially deterring smaller companies from applying. Additionally, there may be uncertainties regarding long-term projects which might be constrained by the three-year time horizon of the scheme. Engaging with external consultants which are expert on the matter can therefore offer firms additional insights and support to maximize the benefits and overcome the complexities.

At the same time, the scheme provides a basis for assessment of projects which can also be used internally, at early design stages. The complexities faced will also ensure fluency of taxpayers on these matters, spreading education needs throughout operations. Finally, organizing projects into stages, with delineated investments and operating expenses, including staff and consultant costs, will provide steering committees with valuable and tangible milestones. 

Conclusion

Luxembourg’s new investment tax credit scheme represents a significant step forward in the country’s commitment to promoting ESG investments, responding to one of today’s most important preoccupation of stakeholders. By offering tax incentives for projects that meet ESG criteria, either through direct ecological and environmental transition or digital transformation, the scheme lowers financial barriers and encourages a broader range of companies to adopt sustainable practices. 

The link between tax policy and ESG is a vital aspect of fostering a more sustainable economic environment. Luxembourg’s latest investment tax credit scheme exemplifies how strategic tax incentives can promote ESG principles and contribute to a more sustainable future.