Infrastructure tax updates: ELTIF, investment tax credits, Pillar 2, German tax reforms and substance

Since the onset of 2024, Luxembourg has seen significant changes in its tax landscape, impacting players in the infrastructure sector. Known for its stability amidst global economic fluctuations, infrastructure as an asset class is gaining even more prominence under the new coalition agreement, which includes numerous actions directly linked to fostering this sector. Relevant tax updates are summarized below.

ELTIFs: Exemption from subscription tax

The revision of the 2015 European Regulation, effective since January 2024, marks a shift in the Luxembourg’s financial landscape through the comprehensive overhaul of the European Long-Term Investment Funds (ELTIFs) framework. The revised framework - referred to as ELTIF 2.0 - addresses the original framework’s rigidity by broadening the scope of eligible assets and relaxing investment thresholds. Notably, it eradicates the €10,000 minimum entry fee for retail participants and introduces fund of funds strategies, enhancing flexibility for portfolio composition and distribution. Another advancement introduced at the Luxembourg level is the exemption of ELTIFs from subscription tax, which forms a critical part of Luxembourg's strategy to modernize its financial toolbox, aiming to bolster capital inflow from both institutional and retail investors. With over 60% of all ELTIF registrations located in Luxembourg,  this figure further solidifies the country’s status as a leading European hub for investment funds. The ELTIF 2.0 now also permits redemptions (semi-liquidity), making the funds more attractive and accessible to retail investors, simplifying product development, and softening restrictive conflicts of interest provisions. This regulatory revision presents a new, appealing option for long-term infrastructure investment opportunities.

Revamped investment tax credit

In December 2023, the Luxembourg Parliament enacted a significant reform of the Investment Tax Credit (ITC) system, targeting investments in digital transformation, and the ecological and energy transition. Starting from the 2024 tax year, companies can benefit from an 18% ITC on certain investments and related expenses, while tangible depreciable assets receive a 6% rate (also leading to 18% ITC if they qualify for the 12% global ITC rate). 

For investments and expenses to be eligible for the new ITC, they need to meet specific objectives established by law. For example, in the case of digital transformation, objectives include a substantial improvement of productivity or of energy efficiency, a new value creation for the company’s stakeholders or better identification and mitigation of digital risks of the company’s business activity. For the ecological and energy transition, achieving certain targets is required for energy efficiency in a production process and its decarbonization or renewable energy production and storage for own consumption.

Qualifying investments include depreciable tangible assets (excluding buildings) and software or patents acquired from third parties. Qualifying expenses include costs for the use or right to use software or patents acquired from third parties, external providers’ fees for consultancy, diagnostic and technical services which are not related to the company’s ordinary business operations, staff costs & training associated with the company’s digital transformation or ecological and energy transition.

This new regime not only incentivizes modernization across various sectors but also aligns Luxembourg’s tax policy with the EU’s goals for sustainable growth. By enhancing tax credits for strategic investments, Luxembourg is bolstering its commitment to supporting eco-friendly and socially responsible business practices. This reform is designed to catalyze significant advancements in technology and infrastructure, driving both economic growth and environmental sustainability within the region. 

Pillar 2 implementation: Strategic tax planning for infrastructure

Effective for fiscal years starting after 31 December 2023, the Global Minimum Tax Directive or Pillar 2 rules impact multinational groups with consolidated revenues of at least €750 million. The Pillar 2 rules aim at ensuring that multinational groups in scope calculate and pay a 15% minimum tax in each jurisdiction where they operate. The top-up tax is calculated as the difference between 15% and the actual tax rate per jurisdiction. It is generally due by the ultimate parent entity unless the low tax jurisdiction opted to implement a qualified domestic minimum top-up tax.

Infrastructure groups may be in scope of Pillar 2 rules if they meet the consolidated revenue threshold. Infrastructure investment funds should also consider Pillar 2 rules even if there is no consolidation at fund level but: (i) there is a consolidation of the target group, (ii) an investor has a controlling interest in the fund and consolidates it in its financial statements, or (iii) the fund invests with a co-investor in scope of Pillar 2 and their co-investment vehicle is consolidated in the financial statements of the co-investor. Infrastructure fund managers are now tasked with a rigorous examination of their existing fund structures to identify if their funds or underlying entities are in scope. If so, a top-up tax could impact projected returns, requiring a review of their financial models. Appropriate investor and co-investor due diligence should be considered to identify potential exposures. 

The implementation of Pillar 2 is intricate, involving various layers of compliance and strategic planning. Infrastructure funds must navigate the complexities associated with seed capital and ownership percentages, which could inadvertently lead to a controlling state, triggering further compliance requirements. 

The impact of German tax reforms on intragroup financing to Germany

The German Federal Council recently enacted the revised Growth Opportunities Act, ushering in a set of changes with potential implications for Luxembourg infrastructure fund structures, particularly in the realm of cross-border intra-group financing into Germany (as the investment jurisdiction). Effective retroactively from 1 January 2024, this legislation imposes stricter rules on the amount of new and/or existing cross-border intra-group debt to German entities. The debt must be supported by a debt capacity analysis/cash flow test and business needs. Moreover, the interest rate on that debt should be determined based on the group’s credit rating, unless it could be specifically justifiable to apply a deviating credit rating (still deriving from the group’s credit rating) that remains in line with the arm’s length principle. Excessive interest expenses would become non-deductible and could be reclassified into hidden dividends, potentially subject to German withholding tax (WHT). These changes are part of a broader modification in the German tax law.

Luxembourg entities engaged in cross-border financing to German group entities must navigate these changes with strategic foresight. As shareholder loans from a Luxembourg company to a German subsidiary are often an effective and swift mechanism for tax-free repatriation of funds, the new requirements should be considered when determining the amount of debt to be lent to the German group entity by demonstrating debt serviceability and the business necessity of funds. For existing intercompany loans, it is also recommended to run an assessment of the maximum level of debt that can be supported under the new rules and, if necessary, take actions to maintain efficient investment flows and ensure compliance. 

ATAD 3, substance and beneficial ownership issues

It is unclear when the Anti-Tax Avoidance Directive 3 (ATAD 3) will be approved. However, challenges on the basis of lack of substance or absence of beneficial ownership continue to be brought up by tax authorities leading to litigation in investment jurisdictions and, in some cases, revised domestic legislation.

In general, infrastructure investments are held on a long-term basis to provide regular returns during their lifecycle. Withholding (“WHT”) discussions on dividends (and therefore effective beneficiary tests either under a double tax treaty or EU directive) paid up the structure may arise. In addition, there could be discussions on interest WHT, anti-hybrid rules and possibly general anti-abuse rules.

Recent court cases from several EU jurisdictions have focused on substance and beneficial ownership to determine the availability of tax relief under treaties or directives. Key aspects usually analyzed include: whether the shareholder is the beneficial owner of the funds (i.e., funds received and immediately distributed vs. reinvested), whether the shareholding company performs management functions, has a commercial purpose or sufficient material and human resources, the place of effective management of the shareholder and the level of taxation of income received by the shareholder. 

On the other hand, a look-through approach allowing the ultimate beneficial owners to claim tax treaty relief even where an intermediary holding company is denied relief may be supported by courts and even followed by certain tax authorities. 

Some jurisdictions have already updated their tax legislation to enhance substance requirements when making payments to group companies in other jurisdictions - for example, by requiring that the recipient is an “active management holding company” able to demonstrate effective decision making and significant payroll costs. 

Luxembourg's infrastructure sector is navigating a complex tax landscape shaped by domestic innovations and international regulations. The adaptability of fund managers and investors to these changes will define the success of Luxembourg as a continuing leader in global infrastructure investments. It is imperative for stakeholders to proactively engage with tax professionals and regulatory bodies, ensuring that their investment strategies remain robust and compliant under the evolving tax regimes.