The Luxembourg law transposing Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market ("ATAD 1”) was recently published in the Luxembourg official gazette (the “Law”). The Law is generally applicable for financial years starting as from 1 January 2019 (with certain tax provisions being applicable as from 2020 only, e.g. exit tax provisions). The Law introduces interest deduction limitation rules that may apply to Luxembourg securitisation vehicles.
To limit tax avoidance strategies, new rules have been introduced by the Law, notably relating to (i) interest deductibility limitation, (ii) general anti-abuse principles, (iii) controlled foreign companies, (iv) hybrid mismatches and (v) exit taxation.
The limitation of interest deductibility, implemented with new article 168bis of the Luxembourg Income Tax Law (“ITL”), is particularly relevant as it directly affects Luxembourg companies, including securitisation vehicles.
This new article provides that, as a rule, a taxpayer’s borrowing costs are generally deductible within the limits of its taxable interest revenues and other economically equivalent revenues. However, it also makes it clear that, “excessive borrowing costs”, i.e. borrowing costs that are in excess of interest revenues, are now subject to an interest limitation rule and shall be deductible in the tax period in which they are incurred only up to the highest of (i) 30 percent of the taxpayer’s earnings before interest, tax, depreciation and amortisation (EBITDA) or (ii) EUR 3 million.
Article 168bis defines borrowing costs as interest expenses on all forms of debt and other costs economically equivalent to interest and expenses incurred in connection with the raising of financing and further (ii) includes a non-exhaustive list of elements viewed as borrowing costs:
Regrettably the Luxembourg lawmaker did not foresee a definition of interest revenues in the Law (whilst ATAD 1 left the opportunity to each national legislator to define such notion under its national law), as this would have shaped a clearer scope of application of the interest deduction limitation rules.
The Law exempts a number of entities from the application of the interest deduction limitation rules, notably financial undertakings and standalone structures.
Financial undertakings are meant to include credit institutions and investment firms (within the meaning of the law of 5 April 1993 on the financial sector as amended), alternative investment funds and undertakings for collective investment in transferable securities (UCITS), insurance undertakings, reinsurance undertakings, and pension funds.
Securitisation vehicles that are governed by Article 2 point 2 of Regulation (EU) 2017/2402 (the “Securitisation Regulation”), i.e. securitisation special purpose entities, also qualify as financial undertakings within the meaning of the Law and are thus exempted from the interest deduction limitation rules.
In practice, most Luxembourg securitisation vehicles subject to the Luxembourg law of 22 March 2004 on securitisation, as amended (the “Luxembourg Securitisation Law”) do not meet the criteria of securitisation special purpose entities and are moreover generally not set up in view of performing a securitisation transaction in the sense of the Securitisation Regulation. As a result, the vast majority of existing securitisation vehicles will not have the benefit of the financial undertaking exemption and will therefore be caught by the interest deduction limitation rules. Solutions exist however to remain out of the scope of this new regulation as detailed below.
As mentioned, the Law also foresees an exemption for standalone structures, which are defined as taxpayers that are not part of a consolidated group for financial accounting purposes and that have no associated enterprises. Pursuant to the new provisions of the Law, securitisation companies entirely held by single “orphan” entities such as Anglo-Saxon charitable trusts or Dutch stichtings will not be viewed as standalone entities and will thus be subject to the interest deduction limitation rules.
Pursuant to Article 168bis (8) of the ITL, grandfathering measures have been implemented for securitisation transactions carried out before 17 June 2016 and consequently the borrowing costs incurred by loans or securities issued before 17 June 2016 are excluded from the scope of the interest deduction limitation rules, except where such loans or the terms of such securities have been subsequently amended, e.g. increase of nominal amount or extension of maturity.
Safe harbour for transactions as at 17 June 2016
As mentioned, grandfathering provisions are applicable to securitisation transactions carried out before 17 June 2016, to the extent their terms are not amended after that date.
Transactions set up after 17 June 16
In respect of securitisation transactions carried out after 17 June 2016 (or whose terms have been amended after that date), the grandfathering provisions will not apply and such transactions will fall within the scope of the interest deduction limitation rules. It should thus be assessed on a case-by-case basis to what extent such rules will apply and whether exemptions set out in the revised ITL can be relied upon.
As a matter of principle, interest deduction limitation rules only become a concern to the extent revenues generated at the level of the securitisation vehicle do not qualify as interest income or economically equivalent income.
In practice, dividends, capital gains, equity distributions, proceeds from warrants and options, etc. and also arguably value appreciation and capital gains resulting from the purchase of receivables at discount or the sale of assets with a gain, may not qualify as interest income and thus fall within the scope of interest deduction limitation rules.
For securitisation vehicles whose transactions are expected to generate substantial non-interest income, the current legislative environment offers limited alternatives, one of which being the setting up of the issuing vehicle in the form of a securitisation fund within the meaning of the Luxembourg Securitisation Law. Indeed, securitisation funds are entities that are not liable to income taxes. Securitisation funds do not have legal personality, they consist of pools of assets managed by a management company, and are usually set up in the form of a co-ownership of assets (co-propriété). Although securitisation funds are not often seen in the Luxembourg securitisation environment, there is a good chance that a fair share of securitisation transactions will be structured around securitisation funds going forward further to the entry into force of the interest deduction limitation rules.
Another option will be to structure the issuing vehicle structured as an alternative investment fund (AIF) within the meaning of Directive 2011/61/EU on alternative investment funds managers; indeed, alternative investment funds qualify as financial undertakings in the sense of the Law and are thus exempted from the application of the interest deduction limitation rules.
In light of new framework described above and the fairly broad scope of application of the interest deduction limitation rules, it is strongly advisable for securitisation vehicles to run an assessment of their regulatory and tax situation to determine if and how they might be subject to the interest deduction limitation rules set out in the revised ITL.