The two cases discussed in this three-part blog series concern Luxembourg companies that had branch offices in foreign jurisdictions, namely the United States (“U.S.”) and Malaysia. The foreign branches were set up for the exclusive purpose of holding and administering equity investments. In each instance, a manager was allocated to the branch to undertake the day-to-day management of the relevant investment portfolio. The recognition of the foreign branches as Permanent Establishments (“PEs”) by the Luxembourg tax authorities (“LTA”) was critical for availing exemptions in respect of the annual net wealth tax (“NWT”).
In Luxembourg, resident companies are subject to an annual NWT, levied at a rate of 0.5% on the company’s worldwide net worth as determined on 1 January of each year. Where a foreign PE is recognised under Article 5 of the applicable tax treaty, Luxembourg must grant relief in respect of the income attributable to, and assets allocated to that PE. In the cases at hand, the Luxembourg companies operated branches in Malaysia and the U.S. that held substantial investments. Thus, recognition of the Malaysian and U.S. branches as PEs under the Malaysia Luxembourg and U.S.-Luxembourg DTAAs was critical. Absent such treaty-based PE recognition, the assets held through those branches would not qualify for the exemption from Luxembourg NWT, resulting in the value of these investments being included in the tax base for NWT in Luxembourg.
In both cases, the Luxembourg Administrative Court (“the Court”) ruled in favour of the LTA, concluding that the U.S. and Malaysian branch offices did not constitute PEs within the meaning of Article 5 of the applicable tax treaties. Although both cases deal with the issue of (foreign) PE-recognition and the impact on the Luxembourg NWT, the recognition of the (foreign) PEs by the LTA would also be relevant for exempting income from Luxembourg CIT by virtue of the Luxembourg participation exemption. It is conceivable that, had the Luxembourg taxpayer held the investments in the Azerbaijani companies (Case #1) and the Cayman Islands company (Case #2) directly, the Luxembourg companies might not have qualified for the benefits of the Luxembourg participation exemption regime.
Hence, it is plausible (but cannot be said for certain) that the branch offices in Malaysia and the U.S. were set up to allocate the equity investments (i.e., in the Azerbaijan companies and the Cayman Island company) to the respective PEs in order to (i) avail the exemption from Luxembourg NWT; and (ii), avail the benefits of the Luxembourg participation exemptions (i.e., effectively exempting dividends received and capital gains realised under Luxembourg CIT).
This blog is the first in a three-part series discussing the two Luxembourg court cases described above. This blog outlines the factual background and summarises the Court’s reasoning in Case #1 concerning the recognition of a PE in Malaysia. It also provides our general observations and comments on the burden of proof. The second part of this series, Case #2, concerns the recognition of a PE in the U.S. In the third part of this series, we present our observations and key takeaways from the two decisions.
