According to the Luxembourg Administrative Court (the Court), which on March 31, 2022 upheld a decision of the Administrative Tribunal (the Tribunal) (case no. 46067C), contributions made by a Luxembourg company to a “115 account” of another Luxembourg company cannot be considered in the determination of the acquisition price of the participation when applying the Luxembourg dividend withholding tax exemption.
This decision—which is final—is particularly relevant for the Luxembourg market, as it goes against the commonly accepted practice of including contributions to a “115 account” in the assessment of whether the minimum participation acquisition price of 1.2 million euros ($1.25 million) has been reached under the participation exemption regime.
What Are Contributions to a 115 Account?
A 115 account contribution, or “capital contribution without issue of shares,” is an accounting classification included in the Luxembourg Standard Chart of Accounts group 11 equity accounts called “share premium and similar premiums.”
Contributions to a 115 account have been developed by Luxembourg practitioners to ease equity injections essentially in intra-group situations. Such equity injections can be made repeatedly without requiring the formalities and costs associated with notarial deeds.
Conditions for Application of WHT Exemption Regime
Dividends distributed by a Luxembourg company are, in principle, subject to a 15% withholding tax. A withholding tax exemption applies where the conditions of article 147 of the Income Tax Law are met. In particular, the Luxembourg recipient company must, as of the date on which the income is made available, hold or commit itself to hold, directly and for an uninterrupted period of at least 12 months, a participation of at least 10% or with an acquisition price of at least 1.2 million euros in the share capital of the entity paying the dividend.
Article 149 of the Income Tax Law also provides that, in the absence of a commitment by the recipient to hold the participation for at least 12 months, the paying entity must declare and pay the withholding tax within eight days after the dividend has been paid or made available for payment.
The recipient may claim a refund as soon as it proves that the holding period has been fulfilled and that during the entire holding period the participation has not fallen below the 10% threshold, or the acquisition price below 1.2 million euros.
Background of the Case
As the participation held by a Luxembourg company (the Parent) in another Luxembourg company (the Subsidiary) was below the 10% threshold, it was key to determine whether the acquisition price of the participation in the share capital amounted to at least 1.2 million euros.
On April 10, 2014, the Parent acquired shares in the Subsidiary and, on the same day, made contributions to the 115 account of the Subsidiary. In September 2015, the Parent acquired additional shares in the Subsidiary. The Parent considered that it had a participation with an acquisition price of at least 1.2 million euros when the consideration paid for the acquisitions and the 115 account contributions were added.
In January 2016, the Parent received dividends from the Subsidiary. As the 12-month holding period criterion was not met, a withholding tax of 15% was levied by the Subsidiary upon distribution. In October 2017, the Parent applied for a refund of the withholding tax based on article 147 of the Income Tax Law as it considered it had satisfied all the conditions required to benefit from the withholding tax exemption.
The Luxembourg tax authorities denied the refund of the withholding tax, arguing that the criterion of a holding threshold of 10% or the 1.2 million euro acquisition price was not met. Simplifying the argument, they considered that 115 account contributions are only informal contributions and cannot be considered as a direct holding in the share capital of the Subsidiary unless there is a clear link demonstrating that the acquisition price would be composed of the contributions.
The Tribunal upheld the position of the Luxembourg tax authorities in a judgment of May 11, 2021 and rejected the claim for a refund of withholding tax on dividends. The Parent then lodged an appeal before the Court (no. 42417).
Decision of the Court
The Court upheld the decision of the Tribunal and confirmed that, in the case at hand, 115 account contributions could not be taken into account when assessing whether the participation acquisition price met the threshold of 1.2 million euros for the purpose of benefiting from the withholding tax exemption.
To reach this decision, the Court followed the reasoning below, which calls for comment.
Did the Parent have a direct participation in the share capital of the Subsidiary?
Although the Court considered that the Parent had a direct participation in the share capital of the Subsidiary, it adopted a very narrow—too narrow in our view—interpretation of this concept.
The Court recalled that article 147 of the Income Tax Law as well as article 166 of the Law (which deals with the inbound dividend exemption regime at the level of the Luxembourg parent company) use the same criteria to determine what constitutes a direct participation in the share capital, and both originate from the Parent-Subsidiary Directive (Council Directive 2011/96/EU of Nov. 30, 2011). The Court referred to case law of the Court of Justice of the European Union to interpret the concept of direct participation in the share capital which refers to the “legal relationship between the parent company and the subsidiary.”
Under the Luxembourg law of Aug. 10, 1915 on commercial companies, the share capital of companies is composed of contributions made to the capital by the shareholders and the capitalized reserves. As a result, the Court concluded that the concept of participation in the share capital for the application of article 147 of the Income Tax law refers to the holding of shares in the share capital of the distributing entity within the meaning of the law of 1915, since it is only the holding of these shares that places the company in a direct legal relationship with the subsidiary.
The reference made by the Court to the Parent-Subsidiary Directive is not accurate, in our view, as the Directive considers the percentage of the participation held in the share capital of the subsidiary to be the sole relevant criterion and does not offer the possibility of using a test linked to the acquisition price. The acquisition price must be autonomously interpreted based on the economic approach of Luxembourg tax rules.
Furthermore, the Court’s reference appears contradictory when it subsequently writes, correctly this time, that a hidden contribution (which, by definition, will never be made in accordance with the provisions of the law of 1915) can increase the acquisition price of a participation.
How should the “acquisition price” of a participation be determined?
The Court indicated that the acquisition price must be determined as per article 25 of the Income Tax Law, according to which the acquisition price of an asset is the total expenses incurred by the taxpayer for the asset to materialize. Incidental costs are thus part of the acquisition price.
However, according to the Court, an expense can only be considered as part of the acquisition price of a participation if it (i) increases the number or nominal value of the shares held, or (ii) is incidental to such an increase.
This assertion appears incorrect in our view, as the acquisition of a participation can result from either (i) a direct subscription of shares issued by the subsidiary, or (ii) an acquisition of already issued shares from a third party. In the latter scenario, the price paid to a third-party seller will never entail an increase in the number or in the value of the shares acquired or be directly ancillary to such an increase.
There will often be no correlation between the price paid to a third party for acquiring shares and the value of the shares acquired or even the accounting value such shares represent in the net assets of the issuing company.
Can contributions to a 115 account be part of the acquisition price of a participation?
The Court considered that contributions to a 115 account can be treated as informal contributions to the subsidiary’s equity. However, as such contributions are realized without issuance of shares or an increase of the nominal value of the shares, the Court ruled that in the case submitted to its review, such 115 account contributions were not sufficiently linked to the participation in the share capital. As a result, the Court considered that such contributions could not be taken into consideration for the determination of the minimum acquisition price of 1.2 million euros.
According to the Court, 115 account contributions might nevertheless be taken into consideration for determining the acquisition price of a participation where such contributions are made with the intention of increasing the participation’s value, and the subsidiary’s articles of association provide that the amount paid by the parent in the form of a “contribution to account 115” is to be allocated exclusively to the parent, in particular in the event of repayment of the said “contribution.”
This might also be possible where contributions to a 115 account could be assimilated to hidden capital contributions, which would in turn be assimilated, for the purposes of the parent-subsidiary regime, to a formal contribution, the amount of which would increase the acquisition price of the participation in the subsidiary.
As detailed above, 115 account contributions have been developed by Luxembourg practitioners to facilitate capital contributions and equity injections in intra-group situations. Where a parent company increases the equity of its 100%-held subsidiary via a 115 account contribution, there is no doubt that such a contribution increases the acquisition price of the participation of the subsidiary.
In the same way, when all the shareholders make a 115 account contribution to their subsidiary on a pari passu basis, the said contribution should also increase the acquisition price of the participation in the hands of the respective shareholders. In the above scenarios, the contribution should therefore always result in a value increase of the shares and have a sufficient link with the participation itself.
The Court referred to the “nominal value” of the shares where it should, in our view, have referred to the “intrinsic value” of the shares. Some companies may have their share capital expressed by shares without nominal value, with such shares having only an accounting par value being equal to the amount of the share capital divided by the number of shares issued.
Furthermore, any kind of contribution made to a company—formal or informal, open or hidden—will always result in an increase of the intrinsic value of its shares. Here again, a reference to procedures foreseen by the law of 1915 is irrelevant when it comes to determining the acquisition price of shares.
The facts in this case combine an acquisition of shares (corresponding to a minority interest of less than 10% of the share capital) with a 115 account contribution decided on the same day. From the factual elements contained in the published decision, it seems that all shareholders had agreed to make 115 account contributions on a pari passu basis, which necessarily resulted in an increase of the intrinsic value of all their shares.
Applying the Court’s reasoning to the facts as summarized in the decision, it seems obvious to us that such contributions were made with the intention of increasing the value of the participations held by the respective shareholders.
Furthermore, we are of the view that contrary to what the Court writes, the articles of association of the subsidiary did not have to provide that the amount paid by the Parent in the form of a “contribution to 115 account” was to be allocated exclusively to the Parent. When contributions are made pari passu by all shareholders of a company, such contributions are repayable pari passu to all shareholders, ultimately at the time of liquidation.
In other words, any 115 account contribution will be allocated exclusively to the shareholder having made such a contribution, assuming such a shareholder has kept unchanged its percentage held in the share capital.
In addition, it is surprising that neither the litigant nor the Court made reference to German case law. The latter is often referred to in Luxembourg, given the German origins of Luxembourg direct tax legislation and the similarities of many key tax concepts in Germany and Luxembourg.
The German Supreme Court actually considered that if the shareholder of a company makes a contribution to the assets of the company, this economically increases the acquisition price of its participation. This also applies if the contribution consists of an allocation of funds to a capital reserve (like a 115 account).
In particular, in this case the shareholder does not acquire an independent asset (like a “participation in the capital reserve or account 115") (BFH judgment on 27.4.2000 (I R 58/99) BStBl. 2001 II S. 168).
We cannot follow and agree with the Court’s reasoning when it concluded that the 115 account contributions made by the litigant did not increase the acquisition price of its participation in the subsidiary.
The position adopted by the Court is totally unexpected and raises numerous practical questions.
Corporate taxpayers are strongly advised to assess the tax impact of any transactions involving 115 accounts. Particular attention should be paid where contributions to a 115 account have been made and the application of the participation exemption regime is assessed using the minimum acquisition price threshold requirement of 1.2 million euros.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Thierry Lesage is a Partner and Marie Demmerlé is Senior Associate, Tax Law, with Arendt & Medernach.