On 14 May 2020, the European Commission sent a letter of formal notice to Luxembourg with respect to the exemption from the recently implemented EU interest barrier rules which certain securitisation undertakings can resort to under Luxembourg legislation. The letter of formal notice is based on article 258 of the Treaty on the Functioning of the European Union, which allows the European Commission to initiate infringement proceedings whenever it is of the opinion than an EU Member State has breached EU law.
As a future second step in the afore-mentioned infringement proceedings the European Commission can send a reasoned opinion to the Luxembourgish authorities should Luxembourg not adapt its domestic legislation within four months as discussed in the letter of formal notice. If Luxembourg fails to do so, the European Commission could take the case to the Court of Justice of the European Union.
Background to the letter of formal notice
In the present context the European Commission is of the opinion that the respective provisions of applicable domestic Luxembourg legislation exceed the range of the allowed exemptions under Article 4 of the 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″). These provisions are set out in the Luxembourg law of 21 December 2018 on implementing ATAD and modifying several Luxembourg tax laws (the "Luxembourg ATAD Law").
The European Commission takes the view that the current Luxembourg provision permitting, in essence, unlimited deductibility of interest for certain securitisation undertakings is not in line with the framework set out in ATAD as such securitisation undertakings do not qualify as ″financial undertakings″ as defined under ATAD and should therefore not benefit from a complete carve-out. Accordingly the European Commission requests Luxembourg to implement an amended version of the EU interest barrier rules which would be compliant with the provisions set out in ATAD.
EU interest barrier rule
In line with the framework of ATAD , the Luxembourg ATAD Law has introduced a limitation of interest tax deductibility to 30% of EBITDA or EUR 3,000,000 (whichever is higher) to the extent the taxpayer has ″excess borrowing costs″ (the so-called EU interest barrier rule). In other words, the limitation rule always allows for a tax deduction of up to three million Euro if such amount is higher than 30% of the actual EBITDA of the taxpayer in question, precluding the taxpayer to resort to the deduction of any amount of "excess borrowing costs" exceeding such barrier.
In this respect, excess borrowing costs are generally considered to be the amount of tax-deductible borrowing costs which exceed taxable interest income and other economically equivalent income. Broadly speaking, borrowing costs can generally include interest expense on all forms of debt and other economically equivalent costs incurred with respect to financing.
Carve-out under the Luxembourg ATAD Law
However, ATAD in its article 4 (7) contains the option for EU Member States to specifically exempt certain "financial undertakings" from the afore-mentioned interest barrier rule. The Luxembourg legislator made use of this exemption option by including under the definition of financial undertakings securitisation special purpose entities (an "SSPE") within the meaning of article 2 (2) of Regulation (EU) 2017/2402 of 12 December 2017 (the "Securitisation Regulation").
In other words, securitisation undertakings incorporated under Luxembourg law which qualify as an SSPE are not subject to the above-discussed tax deductibility limitation.
In this respect, it is important to note that Luxembourg incorporated securitisations undertakings only qualify as an SSPE if they carry out securitisation transactions falling under the scope of the Securitisation Regulation. In order for them to do so such securitisation entities would primarily need to engage in transactions which fulfil the notion of "securitisation" as set out in article 2 (1) of the Securitisation Regulation.
This means that such securitisation undertakings would have to set up a transaction or scheme whereby the credit risk associated with an exposure or pool of exposure is tranched (i.e. by the issuance of "tranched securities"). Luxembourg incorporated securitisation undertakings which however do not engage in such "tranched" securitisation transactions would therefore only be subject to the Luxembourg law of 22 March 2004 on securitisation (i.e. the general Luxembourg domestic securitisation framework) and should not benefit from the carve-out under the Luxembourg ATAD Law.
Consequently, with respect to a lot of Luxembourg securitisation transactions the removal of the exemption should be of no practical impact. However, those SSPEs which currently rely on this exemption should seek further guidance from their tax and legal advisor in order to take the necessary measures if the Luxembourg legislator is to remove the exemption from the Luxembourg ATAD Law.
Author: Markus Waitschies
