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.
Who is concerned
Any company based in Luxembourg which does business abroad via a permanent establishment (e.g., a branch office) or a subsidiary must take into account the tax regime applicable to the income generated by this establishment.
How to proceed
A Luxembourg company's worldwide income is subject to Luxembourg tax.
However, once the tax rate has been set, Luxembourg will grant a tax credit equal to the tax charged in the foreign State.
This tax credit is, however, limited to the Luxembourg income tax due on the net foreign income.
- if the Luxembourg tax is more than the foreign tax, all the foreign tax may be offset;
- if the Luxembourg tax is less than the foreign tax, the credit is limited to the amount of Luxembourg tax payable on this income.
The surplus foreign tax (the uncredited portion) may nonetheless be offset against the taxable amount payable by the company in Luxembourg.
For opaque companies, ICC is not deductible from taxable profit.
The portion that can be offset is therefore determined as follows:
I (deductible foreign tax) =
(R = foreign income net of foreign taxes) x T (overall Luxembourg tax rate)) / (1-T)
Sole proprietorships and partnerships
For sole proprietorships and partnerships, ICC is deductible from taxable profit, and so the formula changes as follows:
I (deductible foreign tax) =
(R = foreign income net of foreign taxes) x T (overall Luxembourg tax rate)) / (1-T + ICC rate)
Companies established in more than one country
The tax credit calculation cannot be made in a single step: it must be done country by country.
If the Luxembourg company consists of several subsidiaries or branch offices located in different countries, it must therefore prepare, for each country concerned, a separate income statement enabling the relevant net income to be determined together with the corresponding Luxembourg tax charge.
SA Lux receives the following income:
- via its establishment in France:
- gross dividends from France: 100 (withholding tax payable in France: 15);
- other income: 70 (no tax withheld);
- costs related to this income: 80.
- via its establishment in Italy:
- income: 200 (withholding tax in Italy: 50);
- costs related to this income: 100.
The rate of income tax on Luxembourg corporate entities (IRC) is 21% (we are simplifying by using this rate for the purposes of this example).
The amount of foreign tax to be offset is calculated as follows:
- calculation of the amount of French tax to be offset:
(French net income on which Luxembourg tax is calculated: R= 100 –15 + 70 – 80 = 75)I = (75 x 21%) / (1-21%) = 11.5 / 0.79 = 19.94
The withholding tax of 15 can be fully offset;
- calculation of the Italian tax amount that can be offset:
I = [(200 – 50 – 100) x 0.21 / (1-21%) = 13.29
The Italian tax amount of 50 can be offset as 13.29.
The difference of 36.71 is, meanwhile, deductible from the Luxembourg taxable amount.