When a Luxembourg-law company conducts business abroad, it is necessary to know whether the company is subject to tax:
- only in its country of establishment, i.e. Luxembourg, or;
- also in the source country for its foreign operations.
In the event of tax being payable abroad, how it will be treated in Luxembourg will also need to be determined by taking the following into account:
- whether or not a permanent establishment exists in the source country;
- whether or not there is a tax treaty between Luxembourg and the foreign State.
Mechanisms to avoid double-taxation are used to ensure fair tax treatment.
Any Luxembourg company with foreign operations via a permanent establishment must take into account the tax regime applicable to the income generated by this establishment.
There is no universal definition of a permanent establishment. Each State uses its own different range of criteria to define it.
However, a growing number of treaties use the framework-definition handed down by the OECD tax treaty model (article 5), namely 'a fixed place of business by means of which a company conducts all or a part of its business'.
Fixed place of business
The notion of a permanent establishment includes, among other things:
- a management head office;
- a branch;
- an office;
- a factory;
- a workshop;
- a mine, quarry or any other place of extraction of natural resources;
- a construction or assembly site lasting more than 6 months (12 months according to the OECD convention).
Representatives of the company
A permanent establishment can also consist of a person who:
- acts on behalf of a company;
- has the authority to enter contracts in the c ontracting State on behalf of the company;
- exercises these powers on a regular basis.
According to the treaty model, there is no permanent establishment if:
- the premises in question is used solely for the purpose of storage, display or delivery of merchandise belonging to the business;
- merchandise belonging to the business is kept in said premises solely for the purpose of storage, display or delivery;
- merchandise belonging to the business is kept in said premises solely for the purpose of processing by another business;
- a fixed place of business is used by the company solely for the purpose of advertising, providing information, scientific research or similar activities which are of a preparatory or ancillary nature.
There is no permanent establishment if the company conducts its business through the intermediary:
- of a broker;
- a general commission agent;
- or any other intermediary with the status of self-employed worker, provided that such persons are acting in the normal course of their business.
Taxable amount of the permanent establishment
The taxable amount of a company's permanent establishment consists of the sum of the turnover and margin generated by the establishment, from which all costs (direct, indirect, proportional) borne by the establishment in order to generate this profit are deducted.
Taxable amount of the permanent establishment =
turnover + margin – costs (direct, indirect, proportional) of the establishment
There are two methods for determining the profit attributable to the permanent establishment:
- separate assessment method: based on separate accounts covering only the assets and liabilities relating to the permanent establishment;
- unit-based assessment method: based on the company's total income broken down between the permanent establishment and the head office using criteria such as turnover, personnel costs, the number of staff employed, etc.
Tax treatment in Luxembourg
In practice, all income generated by taxpayers is subject to exactly the same treatment from a tax standpoint, regardless of where the income was generated. Therefore, foreign income is treated in the same way as national income.
Foreign income is taken into account when determining the tax payable in Luxembourg using the foreign tax credit mechanism.
Luxembourg's tax treatment of a permanent establishment abroad varies based on whether or not an international tax treaty exists.
Where there is no international tax treaty
Income generated by a foreign permanent establishment in a non-treaty country is subject to Luxembourg tax, with the foreign tax being offset.
As the amount taken into account is limited to the corresponding Luxembourg tax, the surplus foreign tax will be deductible from the Luxembourg taxable amount.
Where there is an international tax treaty
In accordance with most tax treaties signed by the Grand Duchy of Luxembourg, income from permanent establishments located abroad is exempt from tax in Luxembourg.
However, to calculate the amount of income tax payable in Luxembourg (national) by the taxpayer, Luxembourg can apply the same tax rates as if the foreign income was not exempt. This is why Luxembourg Inland Revenue determines the rate applicable to worldwide income (national + foreign) and then applies it only to national income.
Losses incurred abroad reduce the rate of tax and in this way reduce the amount of tax payable (on the Luxembourg taxable amount).
Examples (countries with treaties)
SA Lux has the following income:
- income generated in Luxembourg: 600;
- profit from a permanent establishment abroad: 400.
Its worldwide income corresponds to a net book profit before tax of 1,000 (600 + 400).
As the country has entered a tax treaty with Luxembourg, profits from the permanent establishment abroad are tax-exempt in Luxembourg.
=> The taxable profit in Luxembourg is 600 (= 1,000 – 400).
SA Lux has the following income:
- income in Luxembourg: 50,000;
- loss incurred by a permanent establishment abroad: 40,000.
Its worldwide income corresponds to a commercial profit of 10,000 (50,000 – 40,000 = 10,000).
The 40,000 loss incurred by the permanent establishment abroad is a tax-exempt in Luxembourg, the corporate income tax rate is therefore 20 % on a profit of 10,000.
=> Luxembourg income (national) is 50,000 and the maximum total Luxembourg tax expense for SA Lux is 28.22% (20 % corporate income tax and 8.22 % of additional charges) on 50,000, i.e. EUR 14,110 for 2013.
SA Lux has the following income:
- income in Luxembourg: 40,000;
- loss incurred by a permanent establishment abroad: 50,000.
Its worldwide income does not show a profit but instead a business loss of 10,000 (40,000 – 50,000 = -10,000).
The 50,000 loss incurred by the permanent establishment abroad is tax-exempt in Luxembourg, the corporate income tax rate is therefore 0% on a loss of 10,000.
=> National income (Luxembourg) is 40,000 and the maximum total Luxembourg tax expense for SA Lux is 0 % on 40,000, i.e. EUR 0. Loss carry forward: 0
- for Bodies & Administrations whose registered office or central Administration is in Luxembourg (subject to certain conditions) and;
- for companies:, based on their balance sheet.