How to keep pace with evolving tax legislation and its impact on business and operations

Evolving tax landscape  

In 2022, reducing taxation was considered the top priority for improving Luxembourg’s competitiveness in the global economy, but in 2023, it has dropped to 6th place, according to research from the EY Luxembourg Attractiveness Survey (2023).  

Despite this positive shift, sentiment can change overnight, especially given that the pace of tax

change seems never to have been this fast! It is therefore crucial for asset servicers to keep track of and adapt to tax regulations, which are evolving at a rapid pace globally and even more at the European level. Responding appropriately to new requirements and complexities, like the automatic exchange of information, Pillar 2, the ATADs, Transfer Pricing Directive, BEFIT, and ESG (among others) is therefore necessary for them to maintain their competitive edge.

The evolving tax landscape triggers significant challenges for Luxembourg based asset servicers and the

way they operate and serve clients. On one hand, new tax regulatory requirements necessitate tax governance to be adapted. This is mainly due to the higher complexity of the routine services provided and the significant degree of professional liability connected to such services. On the other hand, with new tax compliance and accounting obligations for Luxembourg taxpayers, these changes may positively impact and create new opportunities for Luxembourg corporate or fund services providers.

Greater tax transparency and more data

Transparency on private investor data is materialized through the DAC(1) mechanisms. Among them, DAC 2 (Automatic Exchange of Information on Financial Accounts), DAC 6 (Mandatory Disclosure Regime (MDR) of cross-border tax aggressive transactions), and recently DAC 7 (obligation, starting 1 January 2023, for certain online platform operators to report on certain sellers that use their digital platforms), increase the requirements in terms of tax transparency and exchange of information. 

While only 37 intermediaries have been controlled under DAC 6 in 2022,(2) the topic remains high on the list of tax challenges for asset servicers, who have to demonstrate robust governance (training, internal policy and process, and appropriate controls). The main purpose of DAC 6 is to increase transparency by providing tax authorities with early information regarding potentially aggressive or abusive tax planning schemes and to identify the promoters and users of those schemes. The reporting responsibilities under DAC 6 generally rest with the so-called intermediaries based on the MDR Law definition (that can be, among others, tax advisors, lawyers and other service providers involved in the design or implementation of crossborder arrangements). 

Luxembourg alternative administrators(3) frequently assist investors and fund managers with respect to the implementation and management of international investments. Therefore it is imperative to consider potential reporting obligations and help clients to comply with their obligations under DAC 6 in Luxembourg. Asset servicers should clearly identify their responsibilities in each new transaction, and any access to information that could trigger a reporting obligation. 

On top of that, the recent DAC 7 Law(4) strengthens the obligations of reporting entities which should annually notify reportable investors about their reportable data. This new obligation should be performed in a reasonable timeframe before the annual CRS declaration. The same is applicable to DAC 6 reporting. 

This mandatory tax reporting is a subject that continues to be a daily reality for asset servicers and an area of control for Luxembourg tax authorities: on top of the 37 intermediaries controlled for DAC 6 mentioned before, 184 controls were also performed in the field of FATCA and CRS in 2022.

(5) And while this number has not increased much compared to the previous year, the amount of penalties (in euros) has doubled, increasing from EUR 441,000 to EUR 950,000. 

Unshell Directive and its impact on asset servicers

ATAD 3 (or the “Unshell Directive”) and its potential implications are undeniably the biggest risk to date for the Luxembourg asset servicers’ model. Under a draft version for two years, the Directive reshuffles the cards on the asset servicing industry. If voted in its final version, the consequences of this directive would mean the denial of certain tax benefits (such as the access to Double-Tax Treaties, the Parent-Subsidiary or the Interest Royalty Directives) or the denial of a tax residency certificate for EU companies that are deemed to have no or minimal substance. 

Since the substance criteria could be assessed based on, among other things, the existence of own premises or premises available for the companies’ exclusive use, and on the board composition (where individuals would be limited in the number of board mandates they have), this could have a very significant impact on the asset servicer business model. While today there is limited visibility on its implementation date, it is certain that ATAD 3 will materialize in the coming years.

Harmonization of the taxable base and minimum effective tax rate for multinationals with Luxembourg based entities 

Pillar 2 is probably the biggest and most complex recent tax change as it introduces a minimum effective tax rate for multi-national enterprises (MNEs) with global revenues above EUR 750 million at a rate of at least 15%, calculated based on very complicated rules.

On top of this, entry into force is 1 January 2024 (with some provisions being deferred until 2025), meaning that there is no more time to prepare.

Asset servicers must draw their attention to many areas within Pillar 2: First there is the need to identify clients that are falling within the scope of Pillar 2 and to ensure these clients fulfil their obligations on the provisioning of a potential Luxembourg top-up tax, be it on the filing of annual notification and/or tax re-turn for Luxembourg entities in scope. Being on the board of those clients is, of course, adding some personal liability component to that risk. This additional level of compliance offers an opportunity for asset servicers to adapt their service offering, such as providing annual Pillar 2 tax compliance. 

On top of Pillar 2, the draft Directive Proposal on “Business in Europe: Framework for Income Taxation” (BEFIT) came to light on 12 September 2023, and introduces a common framework for corporate income taxation in the European Union, with the aim of replacing the current various ways used by Member States to determine the taxable base for groups of companies that have annual combined revenues exceeding EUR 750 million. 

The BEFIT proposal would also apply to non-EU-headquartered groups exceeding specific thresholds.  The principle is to simplify the life of EU companies (and to reduce their tax compliance costs), by putting in place a one-stop shop that will allow one member of a group complete the group’s tax returns with the tax administration of one Member State. BEFIT concrete application remains unclear for the time being and there are some concerns that this initiative may actually lead to increased complexity and additional administrative costs for both the taxpayers concerned and the national tax authorities.

From the asset servicers’ point of view, this will require sufficient investment in training and knowledge but will also give rise to some new service opportunities, if Luxembourg is chosen as the central filing location by their clients.

New incentives for digital, energy and ecological investments

The Law modernizing the existing tax credit for investments is perceived as a big step for Luxembourg. There is a strong push for Luxembourg taxpayers to invest in digital transformation and the ecological and energy transition in order to benefit from an 18% tax credit computed both on the investment cost but also on the expenses in relation to the investment as from the year 2024. Luxembourg has become, as of today,the only EU jurisdiction having implemented a tax advantage promoting ESG investments (excluding the already existing Italian EcoBonus that applies to individuals rather than corporations). The Law is applicable as from 1 January 2024 and will constitute a significant tax incentive for asset servicers themselves and for their clients.

How to stay the course with tax

In this fast changing and demanding tax environment, asset servicers must demonstrate transparency and strong governance to remain best-in-class and competitive actors. Tax will continue to influence assets servicers’ operating and digital models, so they must be able to stay the course on sound management of tax matters applicable to the entity and its clients, which will require more active and extensive monitoring. 

Using a tax management dashboard and matrix is essential, with an equilibrium needing to be found between the use of qualified internal resources, resources intended to train more, or choosing to outsource in order to allow the asset servicer to concentrate on its core business. New tax regulations often seem tedious but we should not lose sight of the that they are likely to improve internal processes enrich the current service offering, thereby earning the appreciation of international clients.

1) Directive on Administrative Cooperation

2) Rapport d’activité de l’administration des contributions directes

3) Alternative administrators within the meaning of this position paper provide a wide range of services to alternative investment funds and international investors, may have a PFS licence and do not render tax advisory services

4) Loi du 16 mai 2023 relative à l’échange automatique et obligatoire des informations déclarées par les Opérateurs de Plateforme 

5) Rapport d’activité de l’Administration des Contributions Directes