Useful Luxembourg court case on interest free loans

Interest free loans – new Luxembourg court case provides useful clarifications regarding their qualification as debt or equity.

On 23 November 2023, the Luxembourg Court of Appeal (“LCA”) ruled on the debt or equity qualification of an interest free loan (“IFL”) granted by a Luxembourg shareholder to its Luxembourg subsidiary.

This decision is not only very helpful as at it provides very useful clarifications regarding the debt of equity qualification of financial instruments but also welcoming as overturning the decision by the Luxembourg administrative tribunal (“LAT”) of the equity qualification of the IFL. Indeed, the LAT confirmed the approach of the Luxembourg tax administration (“LTA”) to consider the IFL as equity and as such, refusing the deduction of notional interest by the Luxembourg subsidiary based, among others, on the relationship between the parties involved, the subordination of the IFL and a (considered) long maturity date.

The LCA first recalls (i) the application of an economic analysis to motivate the reclassification of an IFL from debt into equity by analysing its financial characteristics and (ii) that none of such financial characteristics is decisive, although the presence of a repayment obligation and interest are key elements for the qualification as a debt instrument.

In the case at hand, the LCA ruled in favour of the taxpayer, quashing the LAT decision, at the light, among others, of the below financial characteristics:

• The IFL agreement (“IFLA”) gave no right to the profit, liquidation profits, nor voting rights to the lender. The LCA stated that such analysis should be assessed by looking at the terms and conditions of the IFLA and would not be altered by the fact that the lender would also be the shareholder of the borrower.
• The IFLA did not include a provision whereby the borrower could convert the loan into equity.
• The IFLA did not include a stapling clause.
• The maturity date of 10 years, which was not considered too long for a debt qualification.
• Although the IFLA expressly stipulated the absence of interest payments, the borrower made use of the notional interest mechanism and such interests were included at the level of the lender.

The absence of a guarantee provided to the lender under the IFL, or a subordination as regards other third-party lenders, were not considered sufficient to alter this qualification.