The evolving tax administrative cooperation to be on the radar of Private Equity houses

Between 2012 and 2022, the Luxembourg tax authorities (LTA) have witnessed a remarkable increase in exchange of information.

In 2022, the LTA handled 1,038 requests for exchange of information, spontaneous exchanges and notifications[1] from other jurisdictions compared to just 592 in 2012.[2] With requests almost doubling in 10 years, this highlights the expanding role of the LTA in administrative cooperation in the field of direct taxation. Clearly, this development has consequences for Private Equity houses establishing their holding platform in Luxembourg as they may find themselves affected by the various forms of administrative cooperation between States.

Luxembourg's adoption of laws, directives and conventions related to tax trsnsparency

At both the international level and within the European Union, Luxembourg proactively pursued measures to enhance tax transparency, notably through the implementation of Council Directive 2011/16/EU of 15 February 2011 on administrative cooperation in the field of taxation,[3] as subsequently amended. Furthermore, on 29 May 2013, Luxembourg signed the Convention on Mutual Administrative Assistance in Tax Matters and its Protocol.[4]

The procedures applicable to the exchange of information are laid down in the law of 25 November 2014, as amended.[5] The latter includes provisions related to the three types of exchange of information, that being exchange of information on request, automatic and spontaneous exchange of information. While automatic and spontaneous exchange of information occurs between the competent authorities of the Contracting States concerned, exchange of information on request is used when a Contracting State requires additional information from the LTA relating to a specific case. These requests often entail confidential information with respect to the substance and purpose of Luxembourg Private Equity platform (e.g., employment contracts, bank statements, lease agreements, assets owned) and failure to comply may result in an administrative fine. Therefore, understanding the procedures governing such requests, and the corresponding rights of the corporate entity or individual deemed to be in the possession of the information (so-called “information holder”) are of paramount importance.

Considering the significance and consequences of exchange of information on request, the following developments will focus on this particular type of exchange of information.

Understanding the 'Foreseeable Relevance' criterion in requests to the LTA

After receiving a request for exchange of information issued by a foreign tax authority, the LTA is obligated to verify whether or not the request meets the formal requirements. While the latter may vary depending on the concrete legal basis of the request of exchange of information, the key criterion to be assessed in a second step is the standard of “foreseeable relevance” that applies irrespective of the legal grounds of the request. This criterion ensures that the respective States do not engage in so-called “fishing expeditions” and request information that is unlikely to be relevant to the tax affairs of a taxpayer.

In the past, many disputes were brought before the administrative courts concerning the interpretation of the term “foreseeable relevance”, a concept that remained highly debated over years. However, since the implementation of DAC 7 (Council Directive (EU) 2021/514),[6] this concept is now defined in domestic law[7] where it states: “At the time the request is made, the requesting authority deems that (…) there is a reasonable likelihood that the requested information will be pertinent to the tax matters of one or more taxpayers, whether identified by name or otherwise, and be justified for the purpose of the investigation”. It remains uncertain whether this definition will indeed offer sufficient guidance to the LTA in their assessment of the relevance of the requested information.

Gathering the information

If the LTA concludes that the request is valid, they initiate the information gathering process. If the information is not already at the disposal of the LTA, they will issue an information request (décision d’injonction) to the information holder. This request must be precise, detailing the issuance date, the purpose of the request, and the deadline for providing the requested information. Although the usual deadline is typically set at one month, the LTA seems quite receptive to granting extensions.

Replying to the request

Upon receiving an information request, the information holder must carefully assess the rationale behind the request, the foreseeable relevance of the information sought as well as any potential tax consequences. While there is an obligation to comply with the request, it is crucial to understand that providing information and documentation without thorough examination may lead to unforeseen consequences. In practice, it is observed that foreign tax authorities often scrutinize the substance of Luxembourg holding platform when initiating such request, frequently aiming to challenge the application of benefits under a double tax treaty.

Therefore, it is strongly advised that the information holder promptly takes action by assessing whether to pursue legal remedies against the information request which can be done within one month of its notification. Additionally, seeking assistance in deciding to initiate legal proceedings or in responding to the information request is recommended.

The costly consequences of non-response

If the information holder fails to provide the information within the deadline, a tax administrative fine of up to EUR 250,000 may be imposed. The amount of the fine is determined taking into account objective and subjective criteria. The objective criteria for determining the fine for corporate entities not replying to the request relies on determined data, i.e., it is set at 10% of the total amount of the total balance sheet value as at 31 December of the preceding year. For individuals, the fine is equivalent to 10% of the adjusted taxable income of the year preceding the year of the fine.[8] Additionally, subjective criteria, such as the willingness of the information holder to cooperate, are considered in the assessment process.[9]

Furthermore, in case the initial injunction order is addressed to a company that does not respond, the LTA may issue a similar injunction order to the company's representative, thus transferring the obligation to respond to another person. Failure of the representative to respond within one month of receiving the information request could result in her/him being personally fined an amount of up to EUR 250,000.

Legal remedies for the information holder

Prior to the decision of the Court of Justice of the European Union (CJEU) in the Berlioz case,[10] the information holder was not able to contest the validity of the information request, in particular the assessment whether or not the information to be provided meets the criteria of “foreseeable relevance”. Following the decision of the CJEU and the subsequent amendment of the respective legislation in Luxembourg, the information holder now has the possibility to file a claim against the information request before the administrative tribunal within one month after its notification. Such claim has a suspensive effect, i.e., the information holder does not have to provide the information until the case is decided by the administrative tribunal.

Moreover, in instances where the LTA imposed an administrative fine, the same legal remedy applies. Drawing from both the consistent case law of the administrative tribunal and our own experience, it appears that if the information holder ultimately communicates the requested information, it is likely that the administrative tribunal may consider reducing the fine based on the demonstrated willingness to cooperate.[11]

Conclusion

It is evident that we have entered an era where tax transparency is now the international standard. The validity of this observation is reinforced by the evolution of the legal frameworks concerning exchange of information, alongside the active role of States and tax administrations in handling such requests.

Given this landscape, it is essential for Private Equity houses and their Luxembourg holding platform to take a proactive approach upon receiving an information request. As highlighted, providing requested information without a thorough review can have significant implications, and the window for challenging these decisions is brief. To mitigate potential risks, recipients are strongly encouraged to exercise caution. Anticipating the need and preparing ahead of time could be seen as a beneficial strategy for speeding up responses.

[1] Luxembourg direct tax authorities (Administration des contributions directes): Activity Report 2022, p. 121.

[2] Luxembourg direct tax authorities (Administration des contributions directes): Activity Report 202, p. 15.

[3] Law of 29 March 2013 transposing Council Directive 2011/16/EU of 15 February 2011 relating to administrative cooperation in the tax field and repealing Directive 77/799/EEC and amending 1. the general tax law ; 2. repeal of the amended law of 15 March 1979 concerning international administrative assistance in matters of direct taxes.

[4] Law of 26 May 2014 approving the Convention concerning mutual administrative assistance in tax matters and its amending protocol, signed in Paris, 29 May 2013 and amending the general tax law.

[5] Law of 1 March 2019 amending the law of 25 November 2014 providing for the procedure applicable to the exchange of information on request in tax matters.

[6] Council Directive (EU) 2021/514 of 22 March 2021 amending Directive 2011/16/EU on administrative cooperation in the field of taxation.

[7] Law of 16 May 2023 on the mandatory automatic exchange of information declared by platform operators and transposing Council Directive (EU) 2021/514 of 22 March 2021 amending Directive (EU) 2011/16/EU on administrative cooperation in the field of taxation.

[8] TA 13/08/2015, n°36452.

[9] TA 22/07/2020, n°44358 ; TA 15/11/2022, n°47988.

[10] CJUE, Berlioz Investment Fund, 16 May 2017, C-682/15.

[11] TA 05/07/2022, n°47471 ; TA 15/11/2022, n°47988 ; TA 22/11/2022, n°47971.