Entrepreneurs wishing to grow their business must consider the consequences of the two following choices:
- structure of establishment: subsidiary or branch office;
- location of establishment for this new activity: in Luxembourg or abroad.
These two options have consequences from a tax standpoint, in terms of profit generated by these establishments and the parent company's total income and in terms of the place of taxation.
Who is concerned
Any entrepreneur wishing to grow his/her business geographically can set up a subsidiary or a branch office.
A business is free to decide where to set up its subsidiary or branch office.
- in the event of setting up in Luxembourg, communal business tax (ICC) varies from commune to commune;
- in the event of setting up abroad (any host country, country covered by a tax agreement or 'tax haven' is legally admissible), the country of taxation varies depending on the form of establishment.
The choice of form of establishment is also open (representation office, coordination centre, branch office, subsidiary, etc.):
- a branch office is an establishment which enjoys a degree of independence vis-à-vis the founding company or firm, while not being legally separate from it;
- a subsidiary is a local company that is legally independent from the parent company which has a majority holding in the subsidiary.
If the entrepreneur decides to set up in a host country other than Luxembourg, he/she will need to pay attention:
- to the tax regime (rate and base) offered by the host country with respect to the set-up structure chosen;
- to 'transfer pricing' and proper application of bilateral tax treaties in conjunction with the applicable EU Directives;
- to national sanctions (for the Luxembourg parent company) in the case of structures used for tax optimisation purposes (abuse of rights, tax evasion, 'anti-treaty shopping' provisions, etc.).
How to proceed
- a subsidiary can choose whether or not to distribute its profits;
- it can repatriate or distribute net profits with low or no withholding tax on the dividends (application of the parent/subsidiary directive or the tax agreement from which the parent company may benefit);
- the amounts invoiced by a parent company to its subsidiary are deductible;
- management fees, loan interest and royalties paid to associated companies are also deductible provided all the following conditions are met:
- they relate to services actually provided;
- transactions are invoiced at market prices;
- the application of the European Interest and Royalties Directive enables all interest or royalty payments between associated companies to be completely exempt from all withholding tax;
- under certain conditions the subsidiary and its parent company can benefit from the tax consolidation regime allowing profits to be netted against losses in the same tax year.
A Luxembourg subsidiary is a separate legal entity from the parent company: its profits are therefore subject to income tax in Luxembourg.
While the Luxembourg parent company is in principle subject to tax on profits which the subsidiary pays to it in the form of dividends or interest, in most cases, these dividends are exempt from tax at parent-company level.
A foreign subsidiary is a separate legal entity from the Luxembourg company: the latter's profits can therefore only be subject to tax abroad.
However, the Luxembourg parent company is subject to tax on profits paid to it by the subsidiary in the form of dividends or interest (even if in most cases, dividends from abroad are exempted from tax at parent-company level in Luxembourg).
Potential foreign withholding tax on these dividends or interest can either: be offset against the portion of tax payable in Luxembourg, or: be deductible from the taxable amount.
- profits are immediately taken by the head office;
- a branch office must, on an annual basis, provide the Luxembourg Inland Revenue with financial data, sometimes confidential, on the parent company;
- a branch office is not really in a position to conclude agreements (transfer or franchising of a patent, operating licence, procedures, etc.) with the parent company as they are one and the same legal entity. It cannot therefore take advantage of any resulting tax deductions;
- the host country for the branch office may examine the accounts of the company in its entirety in the event of a tax audit.
Luxembourg branch office
A Luxembourg branch office is not a separate legal entity from the company itself: its results are therefore immediately included in the parent company's accounts.
Branch office abroad
A foreign branch office is not a separate legal entity from the company itself: its profits are therefore immediately included in the parent company's accounts.
However, according to most tax treaties signed by Luxembourg, its profits are non-taxable and non-deductible in the Grand Duchy, and are therefore taxable in the branch office's host country.
Where there is no international tax agreement, income generated by the branch office is subject to Luxembourg tax, with a tax credit for the foreign tax.