In the current COVID-19 context, the Luxembourg Ministry of Finance announced several tax measures on October 14 as part of the budget accounting for the tax year 2021 (“Budget bill”). The Budget Bill aims to increase fiscal and social equity as well as economic sustainability. It includes new tax measures related to the Luxembourg real estate sector, such as the taxation of income from Luxembourg-resident real estate held directly by Luxembourg investment funds and an increased real estate transfer tax on stock transactions, as well as certain personnel changes to income taxation such as the introduction of an employee participation bonus and an improved system inpatient taxation. The existing tax rates remain unchanged.
1. New income tax derived by Luxembourg funds from domestic real estate assets
Luxembourg investment funds such as Specialized Investment Fund (SIF), Collective Investment Companies (UCI) and Reserved Alternative Investment Funds (RAIF) (the “medium”) Are exempt from income tax and withholding tax and are only subject to annual subscription tax between 0.05% and 0.01% of their net asset value.
If funds that are opaque for tax purposes directly hold Luxembourg real estate assets, this leads to the unusual result that rental income and capital gains from such assets are tax-free both at the fund level and when distributed to the fund’s investors.
This differs from the tax treatment in other EU countries, where income from domestic real estate assets is usually taxable at a certain level in the holding chain. Most countries have regulations that allow taxation of real estate income generated by resident and non-resident real estate owners. Some countries have introduced special real estate investment instruments that benefit from a tax exemption on real estate income (e.g. SOCIMIs in Spain or OPCIs in France). However, such vehicles are usually still subject to withholding tax on the distribution of income to their investors and must be distributed regularly.
This advantageous tax treatment has historically been of little importance as it was rather unusual for Luxembourg real estate funds to acquire domestic real estate due to the small size of the Luxembourg real estate market. However, after decades of strong growth in the real estate market, the appetite for Luxembourg assets has increased in recent years.
It has also been shown that Luxembourg residents have been able to combine the fund-level tax exemption with general tax rules on capital gains on movable assets (gains made by UK residents on the sale of shares held for more than 6 months , and A stake of 10% or less is tax free, for example if the fund redeems its units after the six month holding period it can benefit from a full direct real estate investment tax exemption.
This has now prompted the government to look into the situation, almost two years after it made a relevant announcement in the coalition agreement presented on December 3, 2018.
In order to adapt the Luxembourg tax system to the regulations applicable in other EU countries, the Budget Act is therefore introducing a new special tax of 20% (Prélèvement immobilier), which will apply from January 1, 2021 on all income from tax-opaque Luxembourg funds from domestic real estate assets .
It is important to note that Luxembourg funds that do not invest in Luxembourg real estate will not be affected by this change at all and those that invest in Luxembourg real estate will only be subject to the new tax for part of their income from Luxembourg real estate assets.
The exact tax implications of this measure are unknown, but are expected to be relatively limited, as confirmed by the head of the indirect tax authorities of the Budget Commission at a recent meeting.
2. Contributions from real estate
The contribution of real estate to the share capital of Luxembourg civil or commercial companies is tripled in order to better ensure a similar tax treatment of stock transactions (i.e. transactions related to the acquisition of shares in a real estate company) compared to asset transactions (i.e., direct sale of the property) and will then increase from 1.1% to 3.4%.
3. Other measures
The Budget Act also provides for more specific measures that might be of interest to asset managers, such as introducing a reduced subscription tax on sustainable investments to encourage mutual funds to actively participate in the ecological transition of the economy and climate change.
Finally, the draft budget contains certain measures to tax personal income. The current option and stock option programs will be abolished with effect from January 1, 2021 and replaced by a “participation bonus”, which will be paid to employees under certain conditions. The inpatient tax system will also be adjusted and will benefit from a tax exemption of 50% to 25% of the annual income generated from inpatient income, with this system being available for 8 years.
The above is a brief description of some of the new tax measures announced by the Treasury Department for 2021 and is therefore not intended to be exhaustive.