Luxembourg - Tax

On 17 April 2025, the Luxembourg Administrative Court delivered an important judgment in case no. 50602C, requalifying Interest Free loans as Equity instruments under the substance over form principle.

The case involved a Luxembourg limited liability company ("LuxCo") that had received two interest-free loans from an indirect shareholder to finance the acquisition of foreign participations. These loans were treated by LuxCo as debt instruments for tax and accounting purposes.

However, the Luxembourg tax authorities challenged the debt classification, arguing that the loans were, in substance, equity contributions. They also denied the existence of a Malaysian permanent establishment. The Administrative Tribunal confirmed the tax authorities' position, and LuxCo appealed against the decision to the Administrative Court.

The Administrative Court confirmed the Tribunal’s ruling, concluding that the interest-free loans should be requalified as equity under the substance over form principle. The key factors that influenced the Court’s decision included:

1. The absence of interest payments;
2. The lack of repayment guarantees comparable to an arm’s length situation;
3. The lack also of repayment schedule, mentioned by the Court as an essential criterion for debt qualification;
4. The use of the funds to finance long-term assets;
5. An excessive debt-to-equity ratio.

Regarding the excessive debt-to-equity ratio, LuxCo tried to argue that at least the long-standing administrative practice of an 85/15 debt-to-equity ratio should be accepted, by presenting a transfer pricing study supporting the widely spread use of this ratio. The Court, however, dismissed this argument by stating that it is a non-binding administrative practice. Furthermore, the Court argued that the transfer pricing study was supposed to establish a correct debt-to-equity ratio to be applied and not if other companies followed the administrative practice.

This decision serves as helpful guidance on the qualification of funding instruments and, more importantly, stresses the need for proper transfer pricing analyses rather than relying on (long-standing) administrative practice.