Luxembourg Tribunal Classified an Interest-free Loan as a (Hidden) Capital Contribution: What Went Wrong?

On 23 September 2022, the Luxembourg Administrative Tribunal held its decision in a case that concerns an interest-free loan which has been granted by a Luxembourg company to its wholly owned Luxembourg subsidiary.

The IFL has been treated as a debt instrument by the borrower and the lender that, respectively, performed a downward adjustment (i.e. deemed interest expenses) and an upward adjustment (i.e. deemed interest income) in their corporate tax returns in order to reflect arm’s length conditions.

The Luxembourg tax authorities challenged this approach and considered that the IFL represented a hidden capital contribution and declined the tax adjustment (notional interest deduction) performed by the Luxembourg subsidiary (the taxpayer in the case at hand).
The Tribunal confirmed the position of the LTA and rejected the complaint of the taxpayer.

At the time this article is drafted, an appeal against the decision has been filed with the Luxembourg Administrative Court (Cour Administrative, which is the second instance jurisdiction). As IFLs are a wide-spread phenomenon in Luxembourg, this case is of paramount importance. However, were the LTA and the Tribunal right when concluding that the IFL was a (hidden) capital contribution?

This question will be analysed in detail in this ATOZ Report.