Tax News Alert

Luxembourg Administrative Tribunal judgment on the tax treatment of share class redemption

By:
Jean-Nicolas Bourtembourg,
Mélina Rondeux
09 Mar 20234 min read
insight featured image
On 27 January 2023, the Luxembourg Administrative Tribunal (the “Tribunal”) pronounced its judgment in case n° 42432 relating to the tax treatment of redemption of a share class. In this landmark decision, the Tribunal dealt with the issue of whether the repurchase of such a class of shares, followed by their cancellation and a reduction in the share capital, triggers Luxembourg withholding tax (“WHT”). Based on the decision of the Tribunal, the redemption should qualify as a capital gain at the level of the shareholder up to the amount corresponding to the fair market value of the redeemed shares.
Contents

Summary

On 27 January 2023, the Tribunal ruled that a repurchase of shares followed by their cancellation should not qualify as a distribution of profits, generally subject to Luxembourg WHT at the rate of 15%.

However, if the repurchase price of the shares exceeds their fair market value, the excess should be classified as a hidden dividend distribution, subject to WHT.

 

Facts of the case

The case concerned a Luxembourg limited liability company (“LuxCo”) with a share capital consisting of ordinary shares and 10 classes of alphabet shares (classes from A to J). The shares were held by a single shareholder – a company resident in the Cayman Islands (“CaymanCo”).

In the articles of association of LuxCo, it was noted that said classes would be redeemed in reverse alphabetical order, starting from class “J”. The redemption of class “J” by LuxCo took place in 2014, and was followed by the cancellation of the shares and a reduction in its share capital.

LuxCo classified the payment made to CaymanCo further to the redemption and cancellation of the “J” class of shares as a payment pursuant to a partial liquidation of the company. Therefore, such payment was not subject to WHT in Luxembourg.

Tax treatment of the share class redemption

Arguments of the parties

In order to support its position before the Tribunal, LuxCo referred to, among other, the decision of the Administrative Court dated 23 November 2017 (case n° 39193C). According to this decision, the proceeds received by the shareholder upon the redemption of shares (not followed by a cancellation) should be treated as income from the realisation of profit (i.e. capital gains) and not as income from capital (i.e. dividends).

LuxCo further argued the existence of different economic rights of the classes of shares on the grounds that their redemption takes place in reverse order, which results in the classes redeemable last having a much lower economic value than those redeemable first.

The Luxembourg tax authorities (“LTA”) refuted tax treatment of a capital gain, mainly on the grounds that the classes of shares lacked differentiated economic rights. Moreover, they qualified the operations at hand as an abuse of law within the meaning of paragraph 6 of the Tax Adaptation Law. In their view, the payment following the redemption should be wholly qualified as a hidden dividend distribution, on which 15% WHT should be due.

Decision of the Tribunal

The Tribunal noted that all transactions between the shareholder and the company affecting the substance of the shares, including the redemption of shares and subsequent capital reduction, fall under article 101(1) of the Luxembourg income tax law (“LITL”) as “proceeds from the disposal of the participation”.

Consequently, and in line with previous case law, the proceeds derived by the CaymanCo from the redemption of class of shares “J” should qualify as capital gains, not subject to WHT in Luxembourg.

The Tribunal further clarified that the general characterization of the proceeds as a capital gain does not prevent their partial qualification as a hidden dividend distribution, for the part of the redemption price exceeding the fair market value.

This part of the payment should be subject to WHT at the rate of 15% (unless reduced by a double tax treaty or exempt under the WHT exemption regime). Such treatment would apply where the price paid by the company is not justified by a valid economic reason, and is sustained solely by the existence of the shareholder relationship.

In this regard, it should be noted that the Tribunal itself did not decide on the fair market value of the shares at hand. Instead, it referred this question back to the LTA without specific guidance on the valuation methodology, neither in the present decision, nor in previous case law.

With regard to the abuse of law invoked by the LTA, the Tribunal did not provide any clarifications as to whether this concept may apply to the use of alphabet shares and deemed this analysis unnecessary in the situation at hand.

Finally, the Tribunal did not find LuxCo’s argument on the different economic rights of alphabet shares convincing. Namely, class “J” was redeemed at a value that corresponded to almost the entirety of the monetary assets of the LuxCo, when in fact the shares in question only represented approximately 5% of the share capital.

Our observations

As an appeal to Administrative Court can be filed within 40 days of the judgment, it remains to be seen whether there will be further clarity and legal certainty on the points the Tribunal did not elaborate extensively in this judgment – the abuse of law and the valuation of classes of shares.

To conclude, we recommend that Luxembourg companies are particularly wary when implementing classes of alphabet shares in their articles of association and make sure they have well-defined economic and legal rights. As an alternative to alphabet shares, implementing tracking shares may be considered.

 

For more information, you may contact:

TAGS  
Authors
  • Jean-Nicolas Bourtembourg
    Jean-Nicolas Bourtembourg Partner, Head of Tax & Transfer Pricing
  • Mélina Rondeux
    Mélina Rondeux Partner, International Tax