Luxembourg 2021 Budget bill – changes for personal tax and domestic real estate investments

In the on-going COVID-19 context, the Luxembourg Ministry of Finance has disclosed, on 14 October, several tax measures as part of the budget bill for the tax year 2021 (“Budget Bill”). The Budget Bill aims at increasing tax and social equity as well as economic sustainability. It contains new tax measures related to the Luxembourg real estate sector, such as the taxation of income derived from Luxembourg-based real estate directly held by Luxembourg investment funds and an increased real estate transfer tax on share deals, as well as certain changes to personal income taxation such as the introduction of an employee participation bonus and an improved inpatriate taxation regime. The existing tax rates remain unchanged.

1. New tax on income derived by Luxembourg Funds from domestic real estate assets

Luxembourg investment funds such as Specialised Investment Fund (SIF), Undertakings for Collective Investments (UCI) and Reserved Alternative Investment Funds (RAIF), (the “Funds”), are exempt from income taxes and withholding tax and are only subject to an annual subscription tax ranging from 0.05% to 0.01% on their net asset value.

If tax opaque Funds directly hold Luxembourg real estate assets, this leads to the unusual outcome that rental income and capital gains on such assets are tax exempt both at Fund level and upon distribution to the Fund’s investors.

This deviates from the tax treatment in other EU jurisdictions, in which income derived from domestic real estate assets is typically subject to tax at some level in the holding chain. Most countries have provisions that allow for the taxation of real estate income realized by resident and non-resident property owning companies. Some countries have introduced special real estate investment vehicles that benefit from a tax exemption on real estate income (eg, SOCIMIs in Spain or OPCIs in France). However, such vehicles are typically still subject to withholding taxes upon income distribution to their investors and they are required to make regular distributions.

This beneficial tax treatment was historically of little consequence as it was fairly uncommon for Luxembourg real estate Funds to acquire domestic real estate assets due to the tiny size of the Luxembourg real estate market. However, appetite for Luxembourg assets has increased in recent years, following decades of strong growth of the real estate market.

It has also become apparent that, where Luxembourg resident individuals were able to combine the tax exemption at Fund level with the general tax provisions on capital gains on moveable assets (gains derived by resident individuals from the disposal of shares held for more than 6 months and representing a participation of 10% or less are tax exempt), for instance by having the Fund redeem their shares after the 6 months holding period, they could benefit from a full direct tax exemption on real estate investments.

This has now prompted the government to address the situation, almost two years after having made a relevant announcement in the coalition agreement presented on 3 December 2018.

In order to align the Luxembourg tax regime with the regimes applicable in other EU countries, the Budget Bill therefore introduces a new special 20% tax (prélèvement immobilier) which will apply as of 1 January 2021 on all income derived by tax opaque Luxembourg Funds from domestic real estate assets.

It is important to note that Luxembourg Funds which do not invest in Luxembourg real estate will not be affected by this change at all and those which do invest in Luxembourg real estate will only be subject to the new tax for the portion of income derived from their Luxembourg real estate assets.

The exact tax impact of this measure is unknown but expected to be fairly limited, as was confirmed by the Head of the indirect tax authorities to the budget commission in a recent meeting.

2. Contributions of real estate

The contribution of real estate to the share capital of Luxembourg civil or commercial companies will be tripled in order to better ensure similar tax treatment of share deals (ie, transactions related to the acquisition of shares of a property company) compared to asset deals (ie, direct sale of the property) and will then increase from 1.1% to 3.4%.

3. Other measures

The Budget Bill also provides for more specific measures that could be of interest to asset managers, such as the introduction of a reduced subscription tax for sustainable investments to encourage investment funds to actively participate in the ecological transition of the economy and climate change.

Finally, the Budget Bill contains certain personal income taxation measures. The current warrant and stock option schemes will be abolished with effect from 1 January 2021 and replaced by a “participation bonus” paid to employees under specific conditions. The tax regime for inpatriates will also be adapted and benefit from a 50% tax exemption up to 25% of the annual income generated by the inpatriate, this regime being made available for 8 years.

The above provides for a brief description of some of the new tax measures announced by the Ministry of Finance for the year 2021 and is therefore not exhaustive.