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Luxembourg tax authorities release circular on the use of foreign functional currency for tax purposes

In a recent circular the Luxembourg tax authorities have defined the rules applicable when corporations with share capital and accounts in the same foreign currency wish to determine their taxable income by simply converting their commercial result in foreign currency into EUR. The release of this circular was motivated by the fact that strict application of the Luxembourg valuation rules may create artificial taxable exchange profits, which appear when preparing a tax balance sheet in EUR, and therefore do not reflect the economic reality. To avoid this kind of situation the tax authorities have defined the rules and conditions to apply the foreign functional currency for tax purposes. Taxand Luxembourg presents the main aspects.

Who can use its foreign functional currency for tax purposes?
The possibility to use the functional currency applies, upon request, to undertakings with share capital and accounts in the same foreign currency. Once an undertaking has opted for the regime it will have to use its functional currency as long as its share capital remains denominated in this currency.

What about undertakings which are consolidated for tax purposes?
Consolidated entities will all have to determine their taxable result in the same currency, meaning that the functional currency regime will apply to a consolidated entity only to the extent that the other consolidated entities also opt for this regime.

What are the formal requirements to benefit from the regime?
A request has to be filed with the Luxembourg tax authorities at the latest 3 months before the end of the tax year in which the undertaking intends to benefit from the regime (ie 30 September at the latest if the tax year corresponds to the calendar year). For new undertakings which become subject to corporate income tax in the course of the tax year in which they intend to benefit from the regime, the request has to be filed before the end of the related accounting period.     

Computation of the taxable profit
To obtain the taxable result in EUR, the commercial result the in foreign currency is increased by the amounts which are not deductible for tax purposes (in foreign currency), decreased by the amounts exempt (in foreign currency as well) and then converted into EUR based on exchange rates determined by the European Central Bank.

The exchange rate to be used can be either the year-end rate or the average rate of the year. It is up to the taxpayer to choose one between the two but once the choice has been made the taxpayer will have to apply the rate chosen to all future tax years. This exchange rate will apply to all amounts in foreign currency as well as to tax losses of previous years, which are carried forward and will be converted at the rate of the tax year for which they are taken into account - ie not at the historical rate. The determined amounts in EUR are then reported in the tax returns of the undertaking and the related tax assessments issued by the tax authorities are in EUR as well.

Specific issues:

Participation exemption regime
To check whether a shareholding qualifies for the so-called participation exemption regime - according to which related dividends, liquidation proceeds and capital gains can be exempt under certain conditions - the value of the participation (which has to reach a certain value in EUR for the exemption regime to apply) has to be converted into EUR by using the historical exchange rate (ie rate as of the date of acquisition of the participation). This approach is justified as the participation might otherwise qualify for the participation exemption regime in 1 tax year and no longer qualify in another, if the exchange rate varies significantly from 1 year to another.

Minimum amount of corporate income tax (CIT)
To determine the amount of minimum CIT due by Luxembourg companies, reference has to be made to the total balance sheet and converted in EUR by using the exchange rate applicable to the related tax year (year-end exchange rate or average rate of the year).

Municipal business tax (MBT)
The same principles as above apply for municipal business tax (MBT) purposes.

Net wealth tax (NWT)
NWT is levied on the so-called unitary value of the company as of 1 January. In practice this value is determined based on the closing balance sheet of the preceding tax year, which is in principle the value as of 31 December.

Companies which have a tax year corresponding to the calendar year have to convert all their assets and liabilities by using the exchange rate as of the closing date of the preceding year, ie as of 31 December.

Companies which have a tax year differing from the calendar year can either convert their assets and liabilities, by using the exchange rate as of the closing date of the preceding tax year, or they can apply the exchange rate as of 31 December of the preceding tax year. As far as shares and other similar securities are concerned the exchange rate as of 31 December of the preceding tax year must always be applied.

Other issues
Lastly the circular clarifies the implications on the determination of the amount of NWT reduction which is available under certain conditions to taxpayers. Furthermore it expands the rules which apply during the transitory year for a taxpayer who until now has prepared a tax balance sheet in EUR and now opts for the future use of the functional currency for tax purposes.

Your Taxand contact for further queries is:
Samantha Merle
T. +352 26 940 235

Taxand's Take

To attract foreign investors Luxembourg has always been committed to putting in place a legislative arsenal adapted to the specific needs of multinationals. The fact that Luxembourg companies can have a share capital and prepare their accounts in a foreign currency illustrates this quite well. However, this remains an attractive tool only in cases where these companies do not realise artificial taxable profits when preparing tax balance sheets in EUR. The aim of the circular is a positive one - to provide solutions to this potential issue and to define the related rules and conditions.

Taxand's Take Author