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LEX MUNDI INTERNATONAL TAX DESKBOOK EDITORS: John R. Barsanti, Jr. and Robert Lewis Jackson Armtrong Teasdale LLP One Metropolitan Square St Louis, Missouri 63102

LUXEMBOURG TAX DESKBOOK PREPARED BY

BONN SCHMITT STEICHEN

44, rue de la Vallée L-2661 Luxembourg

Updated July 2002

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LEX MUNDI

INTERNATIONAL TAX DESKBOOK

LUXEMBOURG CHAPTER BONN SCHMITT STEICHEN Tel. (+352) 45 58 58 44, rue de la Vallée Fax (+352) 45 58 59 L-2661 Luxembourg mail@bsslaw.net www.bsslaw.net

INTRODUCTION

1. Types of taxes imposed

The different tax authorities and the main types of taxes administered by these are as follows:

A. Direct taxes: Administration des Contributions Directes

- Corporate income tax (Impôt sur le revenu des collectivités); - Individual income tax (Impôt sur le revenu des personnes physiques); - Municipal business tax (Impôt commercial communal), which is collected by the State on behalf of municipalities; - Net worth tax (Impôt sur la fortune).

B. Indirect taxes: Administration de l'Enregistrement et des Domaines

- Value added tax (taxe sur la valeur ajoutée) - Annual registration tax (taxe d'abonnement) - Registration and stamp duties (droits d’enregistrement)

C. Customs and excise duties: Administration des Douanes et Accises

- Excise duties on gasoline products, tobacco and alcohol; - Import duties.

D. Municipalities

- Land tax (Impôt foncier- Grundsteuer)

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2. Sources of tax law

The Luxembourg system of direct taxation is quite similar in some points to the German system and tax decisions given by German Courts are a useful guide to the interpretation of Luxembourg tax law. Indirect taxation shares common features with the French and Belgian tax systems. The diversity of sources is largely the result of historical accidents. In 1839, the Treaty of London established Luxembourg's independence. Luxembourg adopted The Netherlands’ direct tax legislation. As far as indirect taxation is concerned, Luxembourg maintained the French system, inherited from the French Revolution. In 1921, Luxembourg concluded with Belgium the Belgian-Luxembourg Economic Union (BLEU) which created a customs union and established common excise duties on certain products. During World War II, German legislation replaced the domestic laws. In September 1944, the Luxembourg legislator reinstated certain elements of the pre-war tax legislation such as those relating to the BLEU. The German direct tax law was temporarily maintained, and is still applicable today. For personal income tax and corporate income tax the original German statutes were replaced by the Law of 4 December 1967 on income tax. But the underlying concepts remain those of German tax law. Under the Law of 5 August 1969, VAT replaced the old turnover tax in compliance with EC directives. No official tax code exists. However, the various tax administrations cooperate to publish a loose-leaf compilation of the tax laws which is regularly updated and which is referred to as "Code Fiscal".

3. Tax administration structure

All principal national taxes other than VAT are assessed and collected by the direct tax authority, the Administration des Contributions Directes (“ACD”). This department also recovers the municipal business tax on behalf of the municipalities. The indirect tax authority, the Administration de l'Enregistrement et des Domaines (“AED”), a separate department of the Ministry of Finance, is responsible for VAT and registration duties. The municipalities themselves levy local taxes on real estate. The ACD is prepared to give advance opinions on the tax implications of a specific proposed transaction. Although such an opinion is a mere confirmation of the interpretation of the law, the tax authorities will stand by it in practice when the transaction is actually carried out.

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INCOME TAXES AS APPLIED TO BUSINESS ENTITIES AND INDIVIDUALS

Corporate income tax ("CIT") is levied on worldwide profits realized by: • all commercial companies organized under Luxembourg law, except 1929 holding

companies and investment funds; such commercial companies include stock companies ("sociétés anonymes" - S.A.), limited liability companies ("sociétés à responsabilité limitée" - S.A.R.L.), "sociétés en commandite par actions" (S.C.A) ;

• cooperative companies ("sociétés coopératives" - S.C.) • non-profit associations ("associations sans but lucratif" - a.s.b.l.) and foundations

("fondations"); • all organizations created under private law which present a collective character; • Luxembourg permanent establishments of foreign companies. Partnerships, like a "société en nom collectif " (S.E.N.C.) or a "société en commandite simple" (S.E.C.S.), have legal personality but are exempt from CIT. These are tax transparent entities: the profit is computed at the level of the partnership but it is taxed directly in the hands of the partners.

I. CORPORATIONS (S.A., S.A.R.L., S.E.C.A. & S.C.)

1. What tax returns must be filed

Tax returns have to be filed with the ACD at the latest on March 31st of each year following the calendar year during which the income was earned. The tax year usually corresponds with the calendar year. However the ACD can approve a different fiscal year. Quarterly advance payments are due on March 10th, June 10th, September 10th and December 10th of each fiscal year. The amount of these tax advances is notified to the taxpayer by the authorities. It usually corresponds to one quarter of the previous yearly tax assessment but may be modified on request if appropriate. Any amount outstanding after deduction of the quarterly payments on account is due within one month of the issue of the annual notice of assessment. Positive balances and excess credits are refunded or carried forward to the next year.

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2. Calculation of income/profit taxes

A. Determination of the taxable base

(1) Revenues included

Business profits are calculated as the difference between closing and opening net asset values, capital contributions being deducted and distributions being added back. Capital gains are taxable as ordinary income. Gains on the sale of buildings or of land held for more than five years may be rolled over, provided the proceeds are reinvested within two years in other fixed assets used by the business in Luxembourg. Interest is fully taxable. Most dividends, in kind or in cash, enjoy a 50% exemption; a full exemption may also be available if the equity stake generating the dividends qualifies under the SOPARFI regime (see below). Non taxable income includes: 1. Dividends and capital gains covered by the important participation exemption Also called the SOPARFI regime, this exemption is available to all regular commercial companies in Luxembourg. Dividends and capital gains on equity stakes held by such a company can be earned tax-free provided these stakes fulfil certain size and holding duration requirements:

Dividends

• The parent company holds at least 10 % of the share capital of the paying company, or the price of acquisition of the participation amounted to at least EUR 1.2 million.

• At the time of payment of the dividend, the parent company holds or undertakes to hold its participation during a continuous period of at least 12 months and during this period the participation does not fall below 10% or EUR 1.2 million.

• The company paying the dividends must be: - a fully taxable Luxembourg limited company (SA, Sàrl, SCA), or - a non-resident limited company fully liable to a tax equivalent to the Luxembourg

IRC, or - a company resident in a EU member State and listed under Article 2 of the EU

Parent-Subsidiary directive of 23 July 1990.

The equity stake can be held directly or through a tax transparent entity.

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A foreign corporate income tax will be considered equivalent to the Luxembourg IRC if it imposes on the paying corporation an effective tax rate of at least 15 %.

Dividends from non-qualifying participations

Since 1.1.2002, dividends earned by a Luxembourg resident company from a participation held in any of the entities listed under (3) above enjoy an automatic 50 % income tax exemption in the hands of the beneficiary.

The breadth of this exemption is such that only very limited types of dividends, such as those paid by companies incorporated in tax havens (with no or nominal taxation, or no tax treaty with Luxembourg), remain fully taxable.

Capital Gains

The exemption is extended to capital gains realised upon the disposal of such stakes.

If the parent company sells shares held in another limited company, the capital gain is exempt if the following conditions are met: § The shares sold are part of a participation held during an uninterrupted period of

twelve months before, after or including the date of the sale. § During this period, this participation has constantly remained above the minimum

threshold of 10 % of the capital of the subsidiary, or the participation has been acquired for at least EUR 6 million.

§ The subsidiary is: - a fully taxable Luxembourg limited company (SA, Sàrl, SCA), or - a non-resident limited company fully liable to a tax equivalent to the Luxembourg IRC, or - a company resident in a EU member State and listed under Article 2 of the EU Parent-Subsidiary directive of 23 July 1990. 2. Income from permanent establishments and real property abroad exempted by double tax treaties; 3. Interest from certain Luxembourg State bonds.

(2) Deductions allowed

In general, all expenses which have an economic connection with business income are deductible. Correspondingly, the deduction of expenses economically related to nontaxable income is disallowed. To ensure deductibility the expenses must be properly documented and supported by adequate accounting records. Common deductions include: • depreciation of fixed assets; • lease payments; • interest incurred; • royalties and service fees paid;

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• employee salaries; • insurance premiums; • inter-company charges (assessed at arm’s length) by a foreign parent or affiliate for

management services, research and development or general and administrative expenses;

• non-creditable foreign taxes; - repairs and maintenance for normal upkeep of assets (improvements must be

capitalized)

(3) Major non-deductible expenses

Non-deductible items include: • Hidden distributions to shareholders/partners • Gifts, except those to certain organizations of general interest, to special institutes and

to funds for scholarships and scientific research. • Administrative and legal penalties imposed for noncompliance with laws or

regulations. • Directors’ fees (tantièmes). • Deducted losses suffered by a permanent establishment of the company situated in a

country with which Luxembourg has a double tax treaty. • Provisions for self- insurance; • Provisions for deferred business expenses; • Non-deductible taxes, including:

- Corporate income tax; - Tax withheld on income from capital; - Net worth tax; - Interest on taxes in arrears; - Foreign withholding taxes on income from capital.

B. Rates applicable

All items of income not covered by an exemption will be subject to the Luxembourg corporate income tax at the rate of 22 %, and to the municipal business tax at the rate of 7.5 %. Due to the calculation mechanism, and with an additional 1% contribution (Employment Fund), this will lead to a total effective tax rate of 30.38 %. There is no separate capital gains tax in Luxembourg. Capital gains are broadly treated as ordinary profits, unless exempt as described above (cf. the SOPARFI regime).

C. Losses

Losses recorded for accounting periods ending after December 31, 1990 may be carried forward and deducted from the taxable profits of subsequent years without any time limit. A branch of a nonresident company may carry losses forward, provided these are connected with the activities of the branch and the branch keeps its books within Luxembourg.

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Losses cannot be carried back.

D. Transfer pricing

It is a firmly established principle that prices applied in intra-group transactions should be the same as those obtained by arm’s length dealing between unrelated parties. Under Article 56 of the Income Tax Law (Loi de l’Impôt sur le Revenu, hereinafter “LIR”), the tax authorities may rectify prices when these have made a transfer of profits possible in any type of transaction between a Luxembourg resident and a directly or indirectly related non-resident party. The transaction at stake may then be re-characterized as a hidden distribution of profits or a hidden capital contribution, depending on the facts of the case.

E. Consolidated returns for affiliated corporations

Consolidated returns may be submitted for a minimum period of five years by resident corporate taxpayers, together with their resident corporate subsidiaries, as long as 95% of the subsidiary's capital is directly or indirectly held by the parent company. A joint request must be filed by the parent company and the subsidiaries before the end of the first year of the consolidation period. The parent company and the subsidiaries falling under the consolidation must file individual tax returns, in addition to the consolidated tax return. Tax is computed on the consolidated result and paid by the parent. Tax losses that occurred before the consolidation period must be set off against profits of the company that incurred the loss. Losses arising during the consolidation period are attributed to the parent company.

3.Territorial Rules

A. The Corporation's residence

A company is considered resident in Luxembourg if its registered seat or its principal place of management is located in Luxembourg. The registered seat is the office mentioned in the articles of incorporation; the principal place of management is the place where decisions are taken and supervised.

B. Taxation of worldwide income

A resident company is liable for corporate income tax on its worldwide profits, including capital gains, subject to the provisions of any relevant double tax treaty taxation agreement.

C. Branch income

A non-resident company is liable to corporate income tax only on items of income and capital gains from sources within Luxembourg. These typically encompass business profits of a branch or other permanent establishment of the company in Luxembourg,

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interest from loans secured on Luxembourg real estate and rental income from real estate situated in Luxembourg. In general, income attributable to a fixed place of business constituting a permanent establishment under the relevant tax treaty (i.e. the treaty between Luxembourg and the country of residence of the foreign corporation that created the permanent establishment in Luxembourg) or, absent any treaty, under Luxembourg law, will be taxable in Luxembourg. A permanent establishment requires a material fixed place of business through which the foreign corporation operates all or part of its activity; as a result, the sole entering into, or performance of, contracts may not result in any party to such contracts being treated as having a fixed place of business in Luxembourg. However, if any of those parties does already have a fixed place of business in Luxembourg, then the profits derived from such contracts may be taxable here, to the extent these are attributable to such fixed place of business.

D. Controlled Foreign Corporations

There are no CFC rules in Luxembourg, but some tax-driven legal structures involving CFCs may be vulnerable to the abuse of law theory. Broadly, the tax authorities may resort to the abuse of law concept in order to disregard actions performed by the taxpayer in conformity with the letter of the law but which do not have any real economic purpose. An abuse of law exists where:

- there is no reason to the taxpayer’s acts other than the avoidance of tax, and

- the sole purpose is to bypass an adverse tax rule, and

- the object and the intention of the law invoked by the taxpayer would be disregarded if he were permitted to place himself in a position where he could escape taxation.

When those conditions are fulfilled, the authorities are able to re-characterize the acts of the taxpayer as if a normal, straightforward legal construction had been chosen, in line with the nature of the economic transaction. Taxation will then be assessed based on the results of such re-characterization.

The abuse of law theory can be applied to virtually any factual situation, but the strict requirements to meet in order to establish the artificiality of the taxpayers’ construction ensure that it does not become a factor of legal insecurity.

E. Tax credits

In many cases, Luxembourg domestic law grants credits for foreign taxes on a stand-alone basis, i.e. even absent a tax treaty with the foreign country.

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(1) Country-by-country method

By default, foreign tax credits are imputed on a country-by-country basis, i.e. the credit for each country’s taxes is calculated and imputed separately on Luxembourg tax. Typically, the gross foreign income (i.e. including any foreign tax thereon) is added to the Luxembourg taxable base. Luxembourg will then credit the foreign tax paid on such item of income against Luxembourg tax on the same item. Some double tax treaties provide for tax sparing clauses whereby the tax credit is calculated at a fixed rate superior to the real foreign tax rate. The total creditable amount remains capped to the fraction of Luxembourg tax corresponding to the income paid in the foreign country. Corporate taxpayers may only use foreign income tax credits to offset their corporate income tax liability, but not the municipal business tax.

(2) Global method

A Grand-Ducal regulation of 26 May 1979 grants the taxpayer an option to have all foreign-source income from capital and the corresponding foreign withholding taxes (“WHT”) accounted for globally, without any distinction between the source States.

The advantage of this method is that the total creditable amount will be capped to the fraction of Luxembourg WHT corresponding to the entire foreign source income from capital, no matter whether it has borne foreign WHT or not. The cap will therefore allow for greater creditable amounts if some items of income included in the calculation have not borne any WHT, while others have borne higher WHT than could be credited under the country-by-country approach.

The global method has limits of its own: only the foreign WHT effectively paid can be credited. Additional tax sparing credits granted by a treaty become unavailable. Each credit for foreign WHT is capped to a WHT rate of 25 %, any excess being only deductible as a business expense. The global credit is limited to 20 % of total Luxembourg tax.

4. Withholding taxes

A. Dividends

A withholding tax of 20% applies to dividends paid by a Luxembourg company, but the important participation exemption can apply. The dividend is exempt from WHT if it is paid to: • a fully taxable Luxembourg limited company (SA, Sàrl, SCA), or • a company resident in a EU member state and listed under Article 2 of the EU Parent-

Subsidiary Directive, or • the Luxembourg permanent establishment of a company from a double tax treaty

country.

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In all cases the shareholder must also hold or undertake to hold at least 10% of the share capital in the Luxembourg paying company, or the acquisition value of his share must remain above EUR1.2 million (US$1,178,540), during a minimum period of 12 months.

B. Royalties

IP royalties are subject to a 12% WHT if the patent or trade mark is used in Luxembourg through a permanent establishment or if it is registered in Luxembourg.

C. Interest

As a matter of principle, there is no WHT in Luxembourg on payments of all items of income from capital other than dividends. In particular, Luxembourg does not apply any WHT on interest paid by one of its residents to either a resident or a non-resident. In some instances, interest on profit participating loans may, however, be re-characterised as a dividend.

II. PARTNERSHIPS (S.E.N.C. & S.E.C.S.)

1. What tax returns must be filed

Tax returns have to be filed with the ACD at the latest on March 31st of each year following the calendar year during which the income was earned.

2. Calculation of income for income tax purposes

Partnerships are not taxable for corporate income tax purposes. Each partner is taxed on his share of the profits, regardless of whether such share has actually been distributed or not. This amount must be reported in the partner’s personal income tax return. For net worth tax purposes, the partners are also taxed individually on their respective share of the partnership's net assets. Partnerships with business income are a taxable entity for municipal business tax purposes. They are also treated as an entity if they are liable to VAT. There is no restriction on companies being partners.

III. OTHER ENTITIES SUCH AS JOINT VENTURES, ASSOCIATIONS AND FOUNDATIONS

1. Joint ventures

Whenever the joint venture takes a form in which the company is legally and fiscally recognized as an entity distinct from the participants, it is taxed according to the regime applicable to corporations (cf. supra).

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In other cases, the income is taxable in the hands of the individual venturers, along with the rules applicable to partnerships (cf. supra). This is in particular the case for a European Economic Interest Grouping (Groupement Européen d’Intérêt Economique, GEIE). The profits are allocated on the basis of the joint venture agreement.

2. Associations and foundations

Associations and foundations are taxed according to the regime applicable to corporations (cf. supra). Exemptions are available for organizations pursuing cultural or charitable purposes and other aims of general interest. But such organizations remain subject to taxation as far as the commercial part of their activity is concerned. The Minister of Finance may grant a complete exemption if the general interest is particularly strong and if the association does not distribute any material gains to its members.

IV. INDIVIDUALS

1. What tax returns must be filed

Tax returns have to be filed with the ACD at the latest on March 31st of each year following the calendar year during which the income was earned. The tax year is identical to the calendar year. Quarterly advance payments are due in respect of income not subject to withholding tax on March 10th, June 10th, September 10th and December 10th of each fiscal year. The amount of these tax advances is notified to the taxpayer by the authorities. The tax authorities will issue a final assessment notice on basis of the return. Any amount outstanding after deduction of the quarterly payments on account is due within one month of the issue of the annual notice of assessment.

2. Calculation of income taxes

A. How is the taxable base determined

(1) What revenue is included

For the purposes of individual income tax, income is classified into 8 separate categories which are:

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1. Business profits Income from business and trade: entrepreneur's profits, including those earned as a partner of a business enterprise. 2. Income from farming and forestry Farming, forestry, wine growing, stock breeding, hunting, fishing, etc. 3. Income from independent professions Fees of statutory auditors, accountants and lawyers, director's fees, and proceeds from independent scientific, artistic, literary, educational and medical activities, etc. 4. Income from dependent professions It includes all benefits in cash or kind received by the employee. These benefits include: salaries, wages, bonuses, profit participations, lump-sum living expenses and other remunerations or benefits for services rendered in public office or private employment, unemployment indemnities, payments from sickness and accident insurance schemes in place of salaries, as well as pensions and the compensation or benefits in consideration of past services rendered. 5. Pension income Pensions and arrears on annuities paid to pensioners, usufruct and all kind of annuities, periodic advantages, etc. 6. Income from capital Dividends and profit splits received from business companies, interest on bonds and loans, dividends from holding companies, interest on savings accounts, etc. 7. Rental income 8. Miscellaneous income. This category most relevantly includes capital gains. The tax treatment depends on the type of property sold and on the length of time it has been held by the owner. Real property gains are taxable when the sale giving rise thereto occurs within two years of the purchase. Gains on the sale of the main dwelling of the owner are exempt. Personal property gains are taxable when the sale giving rise thereto occurs within six months of the purchase. However, capital gains made by shareholders in a commercial or cooperative company are taxable if such shareholders have owned, together with their family, an equity stake of at least 10 % in the company during the preceding five years. Finally, in Luxembourg homeowners are liable to income tax on the estimated annual rental value of their home. The estimates are based on value assessments dating back to 1941, so that in the end this does generally not lead to a significant tax liability.

(2) What deductions are allowed

Deductions may be divided into three groups: business, non-business and personal allowances.

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• Business expenses In general, all expenses arising in connection with income from fa rming or forestry, business or trade or an independent profession are deductible as long as there is an economic relationship between the expense and an activity generating taxable income. Expenses incurred in acquiring, securing and maintaining income from employment, pensions and annuities, capital and investments, rents and royalties, and other revenues are deductible only if incurred directly for that purpose. There are no flat minimum allowances applicable to rental or royalty income. Significant expenses (i.e. repairs and renewals) may be spread over a maximum of five years if these are related to income received over more than one tax year. Spouses who both earn salaried income benefit from a double allowance. The minimum deductions are increased in the case of handicapped employees. • Non-business expenses Special expenses that are not related to income of a particular source may be deductible from the taxpayer's total net income from all sources when expressly allowed by the law. Examples of such deductible expenses are: - the flat rate minimum allowance of 480 EUR, which is doubled when both spouses earn salaried income; - interest payments on loans contracted for the acquisition of assets unrelated to any professional activity; - insurance premiums (life, sickness, accident, civil liability); - contributions to certain recognized medical or social organizations; - mandatory social security contributions; - excess losses incurred in the course of independent activities (business, trade, farming, forestry, independent professions) that cannot be offset against the individual's other sources of income; these may be carried forward during the following five years. Most of the above expenses are subject to statutory ceilings. • Personal allowances A variety of personal allowances have been created by statute. Typically, such allowances are designed to alleviate the burden on taxpayers depending on their economic or social situation (children, child support payments, pension allowance, single parent allowance…).

(3) What exemptions are allowed

A number of specific exemptions have been granted by the legislator over the years. Many are aimed at employees; these cover, for example: - certain special indemnities to personnel for expenses such as clothes, tools and equipment, traveling expenses, etc. ; - gifts to personnel after a number of years (25-50) of employment or at the time of retirement, with certain limits; - severance pay and indemnities for unfair dismissal, within specified limits; - family allowances and similar grants; - social security payments for sickness and accidents;

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- luncheon vouchers issued by employers (under conditions). A few exemptions cover certain items of income from capital. These include: - 50% of dividends paid by resident companies or by companies resident in a double tax treaty country, if the paying company is fully taxable to corporate income tax; - the first 1,500 EUR in interest on Luxembourg savings accounts and on public or semi-public bonds.

(4) What major expenses are not deductible

The main non-deductible expenses are: • all household expenses as well as those related to the support of the family members,

including lifestyle expenses in relation with the social or economic position of the taxpayer, even if they are realized with the aim to benefit to his profession;

• any gifts, donations, subsidies, including allowances granted to persons entitled to alimony from the taxpayer under the Civil Code;

• the individual income tax, the net worth tax, the inheritance tax as well as personal foreign taxes;

• the VAT due in relation with the private use of a company asset; • criminal and administrative fines, seizures, transactions and any other fines to be paid

by the taxpayer in case of non-compliance with statutory and regulatory provisions, even if the fines are connected to one ore more categories of his net income.

(5) Stock options and employee benefits

• Stock options belong to the taxable base only when such options are freely negotiable by the employee on the market. In that case the market value of the options will be added to the employee’s taxable income. Other types of stock options (such as those including an unavailability clause, a blocking period or other restrictions) are not considered a taxable benefit in and of themselves. These will only give rise to a taxable gain when exercised.

• Pension benefits are included in the taxable base, subject to certain allowances. • Social Security benefits are typically not included in the taxable base.

(6) Benefits in kind

Broadly, any benefit, in money or in kind, is taxable as income from salaried employment if it is granted to the employee in connection with the salaried employment relationship and if the employee has the power to dispose of it. • Benefits such as a dwelling or an automobile must be assessed and included in the

taxable base. The employee may however exclude part of the value of the dwelling if he can establish that a portion thereof is reserved for the use of the employer company (storage, conference rooms, etc.)

• Health and life insurance provided belong to the taxable base as well, but due to the exemptions covering insurance premiums (cf. supra) this is unlikely to increase the employee’s tax liability.

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B. What are the applicable rates

Income tax is determined on the basis of progressive rates applicable to income bands, ranging from 8% on taxable income exceeding 9,750 EUR up to 38% on income exceeding 34,500 EUR. An additional 1 % of the tax due is added as a contribution to the unemployment fund. Rates are the same for all classes. Taxpayers are divided into three classes: • class 1: default class for all taxpayers not qualifying under class 1a or class 2; • class 1a: - widows,

- persons over 64 years old at the beginning of the tax year, - persons benefiting from the children allowance, ⇒ and who do not belong to class 2

• class 2: - spouses, - widowed, divorced or separated spouses, for the three years following the date of the death/divorce/separation. Divorced and separated spouses will however belong to class 1 or 1a if they have already benefited from this extension of class 2 status during the past five years.

Class 1 taxpayers are taxed by direct application of the rate table to their taxable income. Class 2 taxpayers benefit from the so-called splitting, i.e., the income of both spouses is aggregated, then divided by two. The tax rate is then applied to such figure and the tax so calculated is multiplied by two in order to determine the final tax burden. This has the effect of significantly decreasing income tax progressivity. Class 1a taxpayers have an intermediate regime, less favourable than class 2, but more favourable than class 1 taxpayers.

C. How are losses handled

As a principle, losses in one income category may be set off with income in another income category, except otherwise provided by law. In particular, a net loss in the miscellaneous income category may not be cleared against income in other categories. Furthermore, losses that occurred during the tax years closed after December 31, 1990 in the categories income from business and trade, income from farming and forestry and income from independent professions may be carried over without any limitation in time.

3. Territorial Rules

If an individual is resident in Luxembourg, he will be liable to tax on his worldwide income. Double tax relief is likely to be available under a tax treaty or may be given unilaterally by the Luxembourg tax authorities. Under Luxembourg domestic law, a taxpayer is considered to be a resident of Luxembourg for tax purposes if he has a dwelling at his disposal here in conditions

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allowing to assume that he will maintain it and use it, or if he has an habitual place of abode within Luxembourg. An individual has an habitual place of abode if his stay on Luxembourg territory exceeds six months in a tax year. A non-resident is subject to tax on income from sources within Luxembourg but double tax relief may be available under tax treaties or the domestic law of the State of residence of the taxpayer.

Expatriates

An employee is taxed in Luxembourg on income arising from employment that is undertaken within Luxembourg. Income generated by an employee of a foreign company working in Luxembourg is taxed at the same rates and conditions as the income of other residents. Double tax treaties concluded by Luxembourg may depart from this principle. Typically, under treaties following the pattern of the OECD Model Tax Convention, an employee seconded to Luxembourg for less than 183 days in a 12-month period is likely to be exempt from Luxembourg income tax if his salaries remain effectively paid and borne by the foreign employer company.

4. Withholding taxes on salaries

The income tax of salaried employees is withheld at source by their employer. The withholding tax rate is assessed on gross income less social security contributions and any permitted expenses If the employee is a resident taxpayer, the tax withheld at source is treated as a prepayment on account of his personal income tax as finally assessed. If the tax assessed proves to be lower than the amounts withheld, the employee is entitled to a refund. In case of unmarried individuals whose only income is their salary or wage, and who claim no deductions other than the standard deductions, the withholding represents the final tax. If the employee is a non-resident taxpayer, the tax withheld at source may represent the final tax in a limited number of cases, depending on the total amount and nature of such taxpayer’s income from Luxembourg sources. Else the treatment is similar to that of residents.

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ALL OTHER TAXES, CONTRIBUTIONS OR TRANSFER REGIMES OTHER THAN INHERITANCE

AND GIFT TAXES AND LEVIES

I. REGISTRATION DUTIES

1. Capital contribution duties

Capital contribution duties are registration duties applicable to equity contribut ions to companies, no matter whether these are made upon incorporation or upon subsequent increases of capital. As a general rule, contributions to civil and commercial companies having their seat of effective management in Luxembourg are subject to the 1% capital contribution duty by virtue of Article 2(1) of the law of 21 December 1971. The capital contribution duty is assessed on the net value of the contributed assets. The taxes have to be paid at the time of the registration of the deeds. The competent authority is the Administration de l'Enregistrement et des Domaines. Capital contribution duties are also due for • the establishment of a branch office or a permanent establishment in Luxembourg by

civil or commercial companies whose seat of effective management and registered office are located outside of the EU; and

• the transfer of the seat of effective management or of the registered office of a civil or commercial company which has not been subject to a capital contribution duty in a EU Member State.

Under Articles 4(1) and 4(2) of the law of 21 December 1971, no such duty is levied on the contribution of a corporation’s whole business, of economically autonomous parts of its business, or of shares representing at least 65% of its capital to one or more companies, if the contributions are paid with shares of the beneficiary corporation (and no more than 10% of the value of such shares in cash) and if the companies parties to the transaction have their statutory seat or their seat of effective management on the territory of an EU Member State.

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Increases of capital by incorporation of reserves do not bear any capital contribution duty either. No registration duties are due in case of transfer of company shares.

2. Annual registration tax

Luxembourg 1929 holding companies and investment funds are subject to an annual registration tax (taxe d’abonnement) as described below. For 1929 holding companies, the tax is levied on the value of paid-up share capital at a rate of 0.2%. There are specific regimes available for “billionaire” holding companies (i.e. those with a capital of at least 1 bn. Luxembourg Francs, i.e. approx. 24.8 mio. EUR). For investment funds, the tax is levied on total net asset value at the last day of each quarter at a rate of 0.06% per annum. Institutional funds (i.e. funds the shares of which are not intended to be placed with the public) benefit from a reduced rate of 0.01%. Fund assets invested in other funds already subject to such tax are exempt in order to avoid double taxation.

II. OTHER TAXES ON CAPITAL AND ASSETS

1. Net worth tax

Companies and individuals are subject to net worth tax at the yearly rate of 0.5% on their total net assets (total assets minus total liabilities). Corporate and individual taxpayers benefit from specific allowances and exemptions in respect of their status. Taxable values are determined in accordance with the valuation law and other applicable regulations. The basic standard of value is fair market value. For real property and investments in companies, special values must be applied. The taxable value of real property in force at the moment is based on values dating back to 1941 and thus far below current market values. Shares and securities are assessed at market value. If no important changes in the annual net asset value take place, a basic assessment is generally applicable for a period of three years. It is made on January 1st of the first year in each three-year period. Where a company's accounting year-end is other than December 31, the assessed value may be based on the accounts of the company immediately preceding the fixed date.

B. Land tax

Land tax is payable by any owner of real estate to the municipality where such piece of real estate is located.

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The basis for land tax is the standard va lue of real estate, as determined by tax authorities according to the valuation law, by application of a base rate ranging from 0,7% to 1%. On the resulting base amount, the municipalities apply their respective communal tax rate to arrive to the final amount of tax due.

III. TURNOVER TAX: VAT

VAT potentially applies to all deliveries of goods and provisions of services made for consideration by a taxable person acting as such, i.e. within the scope of its independent economic activities. Deliveries of goods encompass all operations consisting in a transfer of ownership of movable goods. All other transactions fall under the broad definition of provisions of services. Taxable persons have a right to deduct the VAT they paid on their own purchases of goods or services from the one they collect on their sales to their clients. The standard VAT rate is 15%. It applies to all deliveries of goods and supplies of services unless they are subject to a reduced rate. The following transactions are subject to a reduced rate of VAT: - a super-reduced rate is applicable to certain basic products and services such as food, medical fees, prescription drugs, books and newspapers. - a reduced rate (12%) applies to certain services and goods including most professional services (e.g. lawyers, accountants), unleaded gasoline and electricity. Exports are exempt (but the exporter’s right to deduct the VAT he incurred is maintained). VAT is administered by the AED. VAT returns are filed and payment of the tax is made on a monthly basis. The returns and payments are due before the fifteenth day of the following month. Each taxpayer must file an annual return no later than May 1st of each year, reporting all taxable and exempt transactions of the preceding year in aggregate form, including any information necessary to adjust the monthly returns (accounting and invoicing errors, discounts and allowances, unpaid claims, etc.).

IV. MISCELLANEOUS

A. Mortgage and transfer tax

A mortgage tax of 0.05% is due upon mortgage registration (and renewals thereof) based on the principal amount of the debt.

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At transfer of real estate, a transfer tax of 1% reduced to 0.5% in certain cases, is levied on the price or market value at the real estate. In addition, such transfers are subject to a registration duty of 6% (9% in Luxembourg City). These taxes are administered by the AED.

B. Insurance tax

The insurance tax is levied on most insurance premiums at rates of 2 to 10%. There are exemption (social security contributions for instance). A supplemental fire service tax is due on premiums received by private fire insurance companies, at the rate of 6%.

C. Stamp duties

Stamp duties (droits de timbre) are due on the issuing of certain private or public deeds. Fixed stamp duties are levied on the issue of certain official documents, such as passports, driver’s licenses, etc. These duties are administered by the AED.

D. Import duties

Goods imported from outside the EU may be subject to customs duties. The basis and the rates vary according to the classification of goods. Within the EU, imports and exports are not subject to customs duties.

E. Other taxes

Excise taxes, taxes on gambling and betting, and taxes on premises licensed to sell drinks are also levied.

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INHERITANCE AND GIFT TAXES

I. GIFT TAX

Most gifts must be made by registered notarial deed, and gift tax is payable upon registration. It is administered by the AED. Rates vary from 1.8% to 14.4% depending on the relationship between the donor and the recipient. Gifts to municipalities and public bodies are taxed at a rate of 4.8%, versus 7.2% for those made to charities and churches. Some municipalities levy an additional tax on gifts of real property. Gift tax is payable by the recipient on the gross market value of the assets received. Unregistered gifts (for example, gifts of cash) and gifts of real property located abroad are exempt.

II. INHERITANCE TAX

Estates of Luxembourg residents bear inheritance tax, which is payable on the value of all property inherited from such resident. The deceased is considered a resident if, at the time of his death, he had established his domicile in Luxembourg. For non-residents, the inheritance tax is replaced by a transfer tax applicable only to the gross value of real estate located in Luxembourg. Rates vary from 2.5% to 15 % depending on the relationship between the deceased and the heir. The inheritance tax is assessed on the net assets received by each beneficiary from the estate after deduction of all liabilities other than the inheritance tax. Real estate located abroad is not subject to the tax; it is however taken into account, at market value, for the purpose of offsetting liabilities in the computation of the total net assets. Gifts and donations made in the year preceding death that have not borne gift tax are considered part of the inheritance.

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The part of each child’s share of the parental estate that is granted to him by virtue of law (and not by special bequest of the deceased over and above such legal share) is exempt from inheritance tax. Typically the conveyance of the estate from one spouse to another is also exempt if the spouses have common children. There are a number of other exemptions (bequests to scholarship funds, to charities…).

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OTHER MATTERS

I. TAX INCENTIVES

A wide array of tax incentives is available in Luxembourg for different kinds of investments and activities. The most relevant are the partial corporate income tax exemption for new businesses and the allowance for investment in venture capital structures. Other incentives cover, for example, investment in audiovisual production companies, corporate investments in certain amortizable assets, the hiring of people who were unemployed for more than three months, and sea shipping companies.

Exemption for new businesses

New undertakings, or existing undertakings introducing new productions in Luxembourg, may benefit from a reduction of their corporate income tax burden for 8 accounting years. The reduction amounts to 25% of the tax due on profits generated by the new undertaking or production. The total 8-year reduction is capped to a pre-set percentage of the investments allocated to such undertaking or production.

Venture capital investment

Natural and legal persons who invest in a venture capital financing company may be entitled to a specific tax allowance. Those investors must be residents of Luxembourg for tax purposes, and the company must be a fully taxable resident entity having as its exclusive purpose the provision of venture capital financing. The investment must be made in the form of a cash contribution to the company upon its incorporation or in a subsequent increase of capital. Shares issued to the investors may only be in registered form. The Luxembourg Government will then issue investment certificates to the investors, stating the date and amount of the contribution made. These certificates are in registered form, and may be transferred once by way of endorsement. They may not be split. Upon request, each certificate holder obtains an allowance for venture capital investment representing up to 30% of his total taxable income. The amount of the allowance is based upon the investor’s contribution to the company, multiplied by the rate of venture capital investments made by the company in proportion to its total paid-up share capital.

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II. 1929 HOLDING COMPANY STATUS

The Law of July 31, 1929 gave certain Luxembourg holding companies a tax-exempt status. such companies must meet strict corporate purpose and activity requirements. They are limited to acquiring, managing and selling debt and equity stakes in other companies, but they cannot conduct any commercial or industrial activities. They may not have facilities open to the public and may not own land or real estate except the offices necessary to conducting their bus iness. If those requirements are met, the 1929 holding status has the effect of exempting the company from all direct taxes. In fact, the company is even removed from the jurisdiction of the ACD; it is monitored by the AED. This is consistent with the fact that it is only liable to registration duties: - 1% capital contribution duty upon incorporation and capital increases; - 0.2% annual registration tax on the current value of the holding company shares. There are different valuation mechanisms depending on whether the company is listed or not. There are specific regimes available for “billionaire” holding companies (i.e. those with a capital of at least 1 bn. Luxembourg Francs, i.e. approx. 24.8 mio. EUR). As an exempt entity, the 1929 holding company is excluded from tax treaties. By contrast, a regular commercial company holding equity stakes covered by the SOPARFI regime (important participation exemption, cf. supra) will benefit from the treaties although it may not be liable to direct taxes if the holding of such qualifying stakes is its sole activity.

III. INVESTMENT FUNDS

Due to their nature, investment funds have tax exempt status. They are only liable to: - a fixed capital contribution duty of 1,200 EUR at creation; - an annual registration tax of 0.05% levied on the value of the total net assets of the fund on the last day of each quarter. Lower rates apply to money market funds (0.01%), institutional investor funds (0.01%). Funds of funds are exempt.

IV. EXCHANGE CONTROL AND ANTI-DEFERRAL REGIMES

There is no exchange control in Luxembourg. There are no anti-deferral regimes either; legal structures created in the sole purpose of deferring tax liability might only be vulnerable to the abuse of law theory.

V. TAX TREATIES

As of August 1st, 2002, the Luxembourg network of double tax treaties is as follows. For the reader’s convenience, the normal withholding tax rates applicable under domestic law

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are also mentioned. The figures reflect the lower rates applicable, under the Treaty and Luxembourg domestic tax law, on payments made by a Luxembourg resident. It should however be borne in mind that, in every case, dividend income may be fully exempt under the Luxembourg important participation exemption, regardless of whether the corresponding equity stake is considered a “substantial holding” under the applicable treaty.

RECIPIENT DIVIDENDS

PORTFOLIO SUBSTANTIAL HOLDINGS

INTEREST ROYALTIES

Resident corporations 20 0 0 0

Resident individuals 20 20 0 0

Non-resident corporations and individuals :

w Non-treaty 20 20/0 0 12 w Treaty

Austria 15 5 0 0 Belgium 15 10/0 0 0 Brazil 20 15 0 12 Bulgaria 15 5 0 5 Canada 15 5 0 10 China, P. R. 10 5 0 10/6 Czech Republic 15 5 0 0/10 Denmark 15 5/0 0 0 Finland 15 5/0 0 0/5 France 15 5/0 0 0 Germany 15 10/0 0 5 Greece 7.5 7.5/0 0 5/7 Hungary 15 5 0 0 Indonesia 15 10 0 12/10 Iceland 15 5 0 0 Ireland, Rep. of 15 5/0 0 0 Italy 15 15/0 0 10 Japan 15 5 0 10 Korea, Rep. of 15 10 0 10/12 Malta 15 5 0 10 Mauritius 10 5 0 0 Mongolia 15 5 0 5 Morocco 15 10 0 10 Netherlands 15 2.5/0 0 0 Norway 15 5 0 0 Portugal 15 0 0 10 Poland 15 5 0 10 Romania 15 5 0 10 Russia 15 10 0 0 Singapore 10 5 0 10 Slovak Republic 15 5 0 0/10 South Africa 15 5 0 0 Spain 15 5/0 0 10 Sweden 15 5 0 0

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Switzerland 15 5/0 0 0 Thailand 15 5 0 12 Tunisia 10 10 0 12 Ukraine 15 5 0 5/10 United Kingdom 15 5/0 0 5 United States 7.5 5 0 0 Uzbekistan 15 5 0 5 Vietnam 10/15 5 10 10