Guide of SOPARFI, The Luxembourg financial holding company

Discover why Luxembourg holding and finance company named SOPARFI (société de participations financières) is an interesting type of investment vehicle.

Luxembourg in a nutshell 

Luxembourg, located in the center of Europe, serves as a geographical and legal focal point within the European Union (of which it is a founding member). Luxembourg has a high degree of political, social, and fiscal stability, as indicated by AAA credit ratings from all major credit rating agencies.

Luxembourg has created a large sector of competent and multilingual financial service professionals due to its diversified population. English, French, and German are widely spoken in the Grand Duchy, boosting Luxembourg’s reputation as a financial hub.

The Luxembourg financial hub provides a wide variety of financial services that link investors and markets all over the globe.

Luxembourg is Europe’s most significant investment funds hub and the world’s second-largest. As a result, it is a preferred site for top private equity firms.

SOPARFIs as Luxembourg investment vehicles

Luxembourg has several investment instruments. It comprises several regulated and unregistered investment funds, securitization vehicles, partnerships, and SOPARFIs.

SOPARFI stands for SOciété de PARticipations FInancières. SOPARFIs are unregulated and fully taxed business organisations whose corporate purpose is holding and associated finance. Depending on the unique demands of the shareholder, SOPARFIs are often formed as private limited companies (société à responsabilité limitée, S.à r.l.), public limited corporations (société anonyme, S.A.), or partnerships limited by shares (société en commandite par actions, S.C.A.).

SOPARFIs are free from corporate income tax on dividends, capital gains, and net wealth on qualified investments. Moreover, dividends sent abroad to eligible shareholders are exempt from Luxembourg dividend withholding tax. In addition, SOPARFIs have full access to Luxembourg’s broad network of double tax treaties and EU directives.

Corporate taxation regime

Luxembourg resident corporations (such as SOPARFIs) are liable to Luxembourg corporate taxes on their international revenue (subject to applicable double tax treaties and exemptions).

Corporate Income Tax and Municipal Business Tax

SOPARFIs are subject to a 17 percent corporate income tax (CIT) and a 7 percent solidarity surcharge for the employment fund. In addition, Luxembourg imposes a municipal business tax (MBT) on the net income of Luxembourg enterprises, which varies by municipality. The MBT rate in Luxembourg City is set at 6.75 percent. Therefore, the aggregate combined CIT and MBT rate for SOPARFIs constructed in Luxembourg City in 2021 is 24.94 percent.

Net wealth tax and minimum net wealth tax

Luxembourg imposes an annual net wealth tax (“NWT”) on businesses based on their unitary value, which corresponds to the difference between assets (usually calculated at their fair market value) and liabilities as of a specific date (in principle, on January 1 of each year).

The NWT is assessed at a rate of 0.5% of the unitary value of a taxpayer. This rate is decreased to 0.5% for a fraction of a taxpayer’s net assets of more than €500,000,000. Moreover, Luxembourg imposes a minimum NWT.

Companies whose aggregate financial assets, transferable securities, and cash deposits exceed:

• 90% of their overall balance sheet and
• EUR350,000 will be subject to a minimum lump-sum NWT of €4,815. Companies that do not achieve the criterion mentioned above are liable to a minimum NWT ranging from EUR 535 to EUR 32,100, depending on their total financial sheet.

However, the Corporate Income Tax payable in the prior year reduces the minimum NWT.

Value-added tax (VAT)

Luxembourg now has four VAT rates:

• the standard rate (17%),
• the intermediary rate (14%)
• the reduced rate (8%),
• and the super-reduced rate (3%)

Luxembourg has the lowest standard Value-Added Tax (VAT) rate in the European Union. A SOPARFI shall not be considered a taxable person for Value-Added Tax (VAT) purposes as long as its operations are restricted to owning participation in other firms. As a result, a SOPARFI holding company will not be needed to register for VAT in Luxembourg.

When a SOPARFI provides other services in addition to its holding activity, it must establish its VAT status individually to determine if VAT registration is required and whether input VAT may be recovered.

The participation exemption regime

Inbound Dividends and liquidation proceeds

Following the Luxembourg participation exemption scheme, dividends and liquidation profits received by a SOPARFI from a subsidiary are free from CIT and MBT if the following requirements are satisfied.

The subsidiary responsible for distribution must be:

• Entities specified in Article 2 of the EU Parent-Subsidiary Directive 2011/96/EU (“PSD”);
• A Luxembourg-based limited liability corporation; or
• A non-resident company liable to a tax equivalent to the Luxembourg
• The SOPARFI must possess at least a 10 percent stake in the subsidiary (or, alternatively, a stake with an acquisition cost of at least EUR 1,200,000); and
• The SOPARFI must maintain qualified participation for at least 12 months without interruption.

Capital Gains

If costs associated with tax-exempt income exceed revenue generated by participation in a given year, the excess is tax-deductible. In other cases, the deductibility of costs related to tax-exempt income under the participation exemption regime is rejected during the year the dividend is distributed and received (dividend recapture rule).

If the following requirements are satisfied, capital gains earned by a SOPARFI on the selling of shares in a subsidiary are exempt from Luxembourg CIT and MBT:

• The subsidiary must meet the requirements for inbound dividend
• The Luxembourg SOPARFI must have a participation of at least 10% (or participation with a purchase price of at least EUR 6,000,000); and
• SOPARFI has had such qualifying participation for at least 12 months.

The exemption does not apply to the number of connected costs and value adjustments that have reduced the tax result for the current or previous years (capital gains recapture rule).

Net Wealth Tax

SOPARFI participations are excluded from the 0.5 percent NWT if the following requirements are met:

• the subsidiary must meet the same requirements as for the inbound dividend exemption; and
• The SOPARFI must own at least 10% of the subsidiary (or a share with an acquisition cost of at least EUR 1,200,000).

A minimum holding time is not required under the NWT participation exemption system.

Anti-abuse regulations for the dividend participation exemption regime

Luxembourg has included an anti-hybrid and general anti-abuse rule (GAAR) in its domestic participation exemption provisions due to the updated European Union Parent-Subsidiary Directive (“PSD GAAR”).

As a result of this:

• Participation exemption does not apply to dividends/profit distributions that are tax-deductible in the hands of the subsidiary; and
• Dividends/profit distributions do not qualify for the participation exemption if they are the result of an arrangement or series of arrangements put in place with the primary goal of obtaining a tax advantage that defeats the object or purpose of the participation exemption regime and is not genuine in light of all relevant facts and circumstances.

It should also be emphasized that the PSD GAAR only applies to inward and outward dividend exemptions, not capital gains or NWT exemptions.

Withholding taxes

Outbound Dividends

Dividends paid by a SOPARFI to a resident or non-resident shareholder are subject to a withholding tax of 15%. Under relevant double tax treaties, exemptions or lower rates may apply. The Luxembourg participation exemption system allows for a 100% withholding tax exemption if the SOPARFI is owned by:

• corporation (or its permanent establishment (“PE”)) listed in article 2 of the PSD, or
• a Luxembourg-based limited liability corporation, or
• a non-resident company (or a PE thereof) entirely liable to a tax comparable to Luxembourg CIT and residing in a state with which Luxembourg has a double tax treaty, or
• an European Economic Area (EEA) member state (other than Luxembourg); and
• its corporate shareholder has held minimum participation of 10% in the capital of the SOPARFI (or an acquisition cost of at least EUR 1,200,000) for a continuous period of at least 12 months.

Under the PSD GAAR, the withholding tax exemption may be rejected.

Interest

Interest payments made by a SOPARFI are generally exempt from withholding tax. However, a 15% withholding tax may apply to interest paid on profit participation bonds/notes or interest payments, which would not be at arm’s length.

The Liquidation Proceedings

No withholding tax exists on a SOPARFI’s complete or partial liquidation, regardless of its shareholder’s tax residence/tax status.

Royalties

There is no withholding tax on payments of royalties by a SOPARFI.

Finance-related activities

In addition to holding operations, it is typical for a Luxembourg SOPARFI to engage in group financing. Luxembourg has completely incorporated the OECD model tax convention’s arm’s length concept into its domestic tax law.

The Luxembourg tax authorities (“LTA”) released Circular L.I.R. n° 56/1 – 56bis/1 (the “Circular”) on December 27, 2016, which applies to all entities engaging in intra-group financing operations. The Circular follows the OECD to transfer pricing guidelines:

A SOPARFI with a funding operation that is within the scope of the Circular will, in theory, need to:

• achieve an arm’s length margin on such intra-group funding activities (if the arm’s length concept is used then a comparability study will be necessary);
• have adequate equity to bear the risks associated with its financing operations; and
• have enough substance to limit the hazards associated with its activities.

SOPARFIs subject to the Circular must develop and maintain relevant transfer pricing paperwork.

Double Tax Treaty Network

By the end of 2021, Luxembourg will have more than 80 DTTs in effect, and further DTTs are currently being negotiated. 

In addition, Luxembourg has become a signatory to the Multilateral Convention (MLI) of the OECD.

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General

A corporation (such as a SOPARFI) is regarded as a Luxembourg resident under Luxembourg tax legislation if its registered office or central management is based in Luxembourg. The Luxembourg tax authorities (LTA) may provide residence certificates (for domestic and DTT purposes) to the SOPARFI on simple demand, providing the SOPARFI is in good standing.

Luxembourg tax law does not specify particular content criteria for entities covered by the Circular. On the other hand, other countries may have specific content criteria to provide the advantage of a double tax treaty, an European Union (EU) regulation, or a specific exemption under national tax legislation. As a result, maintaining an adequate amount of substance should reduce the danger of foreign tax authorities refusing to apply treaty advantages, eligibility under EU Directives, or other domestic benefits/exemptions to the SOPARFI.

When it comes to substance, the most important factor is ensuring that the SOPARFI is successfully managed and critical decisions are made in Luxembourg.

Group Financing Companies: Specific Substance Rules

According to the Circular, SOPARFIs participating in intra-group financing transactions must explicitly comply with the following substantive requirements:

• The majority of board members, directors, or managers with authority to bind the SOPARFI must be Luxembourg residents (personally or professionally);
• It must take significant management decisions in
• The SOPARFI must have competent people who can control the funding transactions that are carried out. However, the SOPARFI may outsource operations that have no significant influence on risk management; and
• The SOPARFI cannot be a tax resident in any other country except for Luxembourg.

BEPS Measures

The OECD has prepared 15 action plans to combat multinational corporations’ tax base erosion and profit shifting (“BEPS”) methods. Over 135 nations and jurisdictions are working together to develop steps to combat tax evasion, strengthen the coherence of international tax regulations, and create a more transparent tax environment.

Luxembourg has been a pioneer in adopting BEPS-related policies, providing a tax environment entirely consistent with OECD norms.

Multilateral Instrument

Luxembourg has signed the OECD’s Multilateral Convention on Trade and Development (“MLI”). The MLI went into effect in Luxembourg on August 1, 2019. Luxembourg, like other countries, has chosen the “principal purpose test” (“PPT”), under which a treaty advantage may be refused if it was one of the major aims of the arrangement or transaction that resulted in such benefit.

Anti-Tax Avoidance Instructions

Directive 2016/1164 of 12 July 2016 (“ATAD 1”) and Directive 2017/952 of 29 May 2017 (“ATAD 2”) were approved at the EU level to implement specific BEPS measures relating to interest deduction restriction rules, controlled foreign firms, general anti-abuse rules, and hybrid mismatch rules. ATAD 1 and ATAD 2 were incorporated into Luxembourg domestic legislation and were effective on January 1, 2019, and January 1, 2020, respectively.

The following are the essential ATAD measures for SOPARFIs:

• Interest Limitation Rule

The interest deduction limitation rule (“IDLR”) limits the deduction of a SOPARFI’s excess borrowing costs3 (if any) to the greater of EUR 3 million or 30% of the SOPARFI’s EBIDTA. The IDLR does not affect a SOPARFI’s interest deduction capability if it primarily realizes tax-exempt income (exempt dividends or capital gains under the participation exemption).

Furthermore, if a SOPARFI is involved in intra-group financing, the IDLR should not affect the SOPARFI’s interest deduction capabilities.

• Foreign Controlled Company Regulations

The primary goal of controlled foreign corporation (“CFC”) legislation is to prevent taxpayers from moving earnings to low-tax countries. A subsidiary or Permanent Establishment (PE) of a SOPARFI may qualify as a CFC. Undistributed profits of a CFC resulting from fraudulent arrangements may be included in the SOPARFI’s tax base if:

• The SOPARFI, along with connected firms, directly or indirectly owns more than 50% of a foreign entity’s voting rights, capital, or earnings (“Control Test”); and
• The foreign entity is subject to an effective tax rate of less than 50% of the Luxembourg CIT payable in Luxembourg (“Effective-Tax Test”).

Subsidiaries or PEs having accounting profits of less than i) EUR 750,000 or (ii) 10% of their operational expenses for the tax period are excluded from the CFC requirements.

The tax authorities may ask the Luxembourg taxpayer to submit documentation proof of CFC taxes and payment.

• Anti-hybrid regulations

The anti-hybrid regulations target numerous types of hybrid mismatches that take advantage of variations between tax regimes. Hybrid mismatches may occur when two (or more) countries treat an entity, a financial instrument, or a Permanent Establishment (PE) of an entity differently for tax purposes, resulting in so-called deduction/non-inclusion or double deduction consequences.

The hybrid mismatch rules’ applicability is roughly restricted to mismatches occurring between:

• related businesses (as defined in the anti-hybrid rules)
• ahead office and its PE,
• two or more PEs from the same organization, or
• as part of a structured arrangement.

Luxembourg may be compelled to refuse the deduction of payments, costs, or losses, include payments as taxable income or deny relief from double taxation to offset these mismatches.

• Rules for Mandatory Disclosure

The Luxembourg legislation of March 25, 2020 (the “DAC6 Law”) implemented EU Directive 2018/822 of May 25, 2018, on the required automatic exchange of information in the sphere of taxes concerning reportable cross-border arrangements (“DAC6”).

The DAC6 Law requires intermediaries and, in certain situations, the taxpayer to notify potentially tax aggressive cross-border arrangements to the LTA. A cross-border agreement may be reportable if it fulfils one of the DAC6 Law’s trademarks.

Legally privileged intermediaries (such as attorneys, auditors, and accountants) are free from reporting responsibilities under DAC 6.

The Luxembourg Tax Authorities (LTA) will immediately send the information to other EU member states. Non compliance with the DAC6 Law may result in penalties of up to EUR 250,000.

SOPARFIs should carefully monitor if any transactions they engage in are reportable under the DAC 6 Law.

Tax compliance for a SOPARFI

• Tax return filings

A SOPARFI must file yearly tax returns for CIT, MBT, and NWT. Corporate tax returns (CIT, MBT, and NWT) for a particular, fiscal year (“year T”) must be submitted online by May 31 of the following calendar year (“year T+1”). SOPARFIs may need an extension to file their business tax filings.

Late submission of company tax returns may result in fines. SOPARFIs that purposefully file a false or incomplete corporate tax return or intentionally fail to submit direct tax returns may face further penalties.

• CIT, MBT, and NWT advance payments

A SOPARFI must make advance tax payments depending on the most recent tax assessment (or the estimated taxable profit for the corresponding year).

During the first several years of a corporate taxpayer’s existence, no advance payments are often sought.

The following deadlines must be met for advance tax payments:

CIT: March 10th, June 10th, September 10th, and December 10th; and

NWT and MBT: February 10th, May 10th, August 10th, and November 10th.

The amount of each advance payment may be changed if the SOPARFI makes a valid claim. Tax advances not paid on time will accumulate interest at a monthly rate of 0.6 percent (on the unpaid balance).

• Tax evaluations

The LTA issues final tax assessments on company tax return five years after the fiscal year’s conclusion.

In reality, the LTA provides a tax assessment (a self-assessment notice) based on the tax returns without evaluating the records themselves. This notice of self-assessment is not final, and the LTA is entitled to evaluate the return at any moment until the end of the fifth year after the relevant fiscal year. Following an inspection of the tax returns filed, they may, if required, provide a final tax assessment. If no additional or final tax assessment is supplied before the conclusion of the five years, a self-assessment notification will eventually become final.

• Statute of limitation

The domestic law of Luxembourg allows for a statute of limitations that prohibits the collection of any taxes (including any penalties, interest for late payments, and so on) beyond the fifth year after the appropriate tax period. This term may be extended to 10 years if a SOPARFI has failed to file a return or submitted an incomplete or incorrect return (with or without fraudulent intent).