In a judgment handed down on 12 November 2019, the Luxembourg Lower Administrative Court (Tribunal administratif) ruled in favour of the disallowance of interest expenses paid under bonds held by a family wealth management company, a société de gestion de patrimoine familial ("SPF"), on the grounds of abuse of law. In the case at hand, a tax transparent entity, a société civile immobilière ("SCI"), whose purpose was the acquisition and renovation of real estate located in Luxembourg, was financed by bonds held by a related SPF. Both, the SCI and the SPF were held by the same Luxembourg resident individuals. As a result of said structure, the SCI was treating the interest payments made to the SPF as tax deductible while the corresponding income was not subject to direct taxes in the hands of the SPF. Due to this outcome, the Luxembourg tax authorities refused the deductibility of interest paid under the bonds, primarily on the basis that an SPF is prohibited from granting interest-bearing loans. In the course of litigation, the government’s representative claimed the existence of an abuse of law, as defined under §6 of the Luxembourg Steueranpassungsgesetz. In their decision, the judges assessed exclusively the existence of an abuse of law to deny the deductibility of the interest payments.
As a reminder, the existence of an abuse of law requires the fulfilment of the following conditions: (i) the use of private law forms or institutions; (ii) a tax saving resulting from the bypassing or reduction of the tax burden; (iii) the use of inappropriate means; and (iv) the absence of any non-tax related reasons that might justify the means chosen.
In the case at hand, the Lower Administrative Court considered that all those conditions were fulfilled and that the tax authorities were therefore entitled to refuse the deductibility of the interest paid under the bonds. One point to reflect on, however, is whether the "tax saving" criteria was effectively met in the present case. Indeed, when comparing the structure put in place with the one that the judges deemed appropriate (i.e. where the taxpayer would have directly lent the funds to the SCI and which would not have been tax deductible due to the tax transparency of the SCI), one can wonder whether this comparison should not be pursued until the end, where one would have to take into account the taxation of the distributions that would need to be made by the SPF to the taxpayer in order to arrive to the same economic result than in case of a direct loan by the individual. In this scenario, interest income would in the end also be fully taxable in the hands of the Luxembourg resident partners of the SCI, thus significantly weakening the tax savings aspect. The judges simply deemed the taxation of future distributions by the SPF to be irrelevant.
Given the particular fact pattern of the present case as well as the possibility to appeal the judgment in front of the Higher Administrative Court (Cour administrative), no broader reaching conclusion should be drawn at this stage. However, this should serve as an important reminder to taxpayers generally that the existence of non-tax related reasons to structure an investment in a certain way (and the supporting documentation) should not be an afterthought, but rather the initial jumping-off point for any investment structure.
Abuse of Law in Relation with Use of SPFs
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ARTICLE24 January 2020