A recent decision by the lower administrative court in Luxembourg (case n° 45759) has brought to light the importance of providing valid economic justifications and proper documentation when using "alphabet shares" in corporate transactions.
The case involved the tax treatment of a Luxembourg company's redemption of alphabet shares, leading to a crucial ruling that may impact similar situations in the future.
Facts & background
The case revolved around a company that migrated its registered office from Cyprus to Luxembourg.
Following the migration, the Luxembourg company (LuxCo) held an investment in a Dutch company (DutchCo).
In a series of transactions, LuxCo converted its ordinary shares into twenty classes of shares, all having the same economic rights as the initial ordinary shares.
Later, LuxCo redeemed and canceled two classes of shares using distributable reserves, considering the transaction as a partial liquidation eligible for a 15% withholding tax exemption.
However, the Luxembourg tax authorities recharacterized the transaction as a dividend distribution and applied the 15% withholding tax, citing abuse of law.
Decision of the Lower Administrative Court
The lower administrative court highlighted that the legal form of a transaction is not decisive for tax purposes. Instead, the economic substance and true intention behind the transaction are crucial factors in determining its tax treatment.
An inappropriate path?
The court confirmed that the redemption of shares could be considered as a partial liquidation under tax treatment.
However, in this case, the court focused on the economic analysis of the transaction to ascertain whether LuxCo used an inappropriate path.
The short timeframe between the share conversion, receipt of dividends, and redemption raised suspicions, leading the court to conclude that the shareholders did not intend to exit from LuxCo. As a result, the transaction was deemed a dividend distribution subject to the 15% withholding tax.
Valid non-tax reasons?
Regarding the absence of non-tax reasons justifying the chosen path, LuxCo's arguments were considered insufficient by the court.
Merely stating economic reasons without concrete proof was inadequate to shift the burden of proof.
Consequently, the court found that the condition of abuse of law due to the lack of valid economic reasons was met.
This case highlights important considerations for businesses using alphabet shares in their transactions.
While redemption and cancellation of alphabet shares may qualify as a partial liquidation under tax rules, it can be recharacterized as a dividend distribution if economic reasons are not adequately documented.
To avoid potential tax challenges, taxpayers must ensure they have concrete evidence justifying the use of alphabet shares and adequately record such reasons in board minutes or related documentation.
As such, companies in Luxembourg must take care when employing alphabet shares in their transactions and must be prepared to provide well-documented economic justifications to avoid potential tax implications.
If you have any queries about this article on alphabet shares, or Luxembourg tax in general, then please do get in touch.
The content of this article is provided for educational and information purposes only. It is not intended, and should not be construed, as tax or legal advice. We recommend you seek formal tax and legal advice before taking, or refraining from, any action based on the contents of this article