Middle Eastern investors investing in Luxembourg and European real estate assets: the new tax standard

Middle Eastern investors investing in real EU assets, such as real estate and infrastructure, need to navigate the new tax standard when considering overseas investments and, in particular, how to organize their investment structures.

New regulations and tax reporting requirements have been adopted in EU countries, inspired by the OECD and its work on the BEPS project. Investors should pay attention to local EU compliance obligations, beneficial ownership (BO) rules and, in particular, substantive requirements.

Navigate the new standard

Business objectives and economic substance

As part of the BEPS project, the OECD developed the Multilateral Convention for the Implementation of Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). MLI quickly implemented a series of tax treaty measures to update international tax rules. To date, 95 countries have signed the MI, while others have expressed their intention to do so.

In the EU, the majority of Member States apply the MI provisions and the rest are in the process of implementing them. In the Middle East, MLI is already in force in Egypt, Israel, Oman, Qatar, Saudi Arabia and the United Arab Emirates and has been signed by Bahrain, Kuwait and Turkey. Lebanon has expressed its intention to sign it.

One of the key aspects of MLI is the introduction of anti-abuse provisions, such as the principal object test (PPT). The TPP allows tax authorities to prohibit the application of treaty benefits (such as relief or exemption from withholding tax) if it is reasonable to conclude that obtaining those benefits was one the main objectives of any transaction that directly or indirectly resulted in this benefit.

Thus, in order to pass the TPP, it is extremely important to be able to demonstrate the business objectives and economic substance of an agreement or transaction against which the benefits of the agreement are applied.

BO concept

In addition, there have also been substantial developments in the EU regarding the BO concept and the substantive requirements for holding companies.

These mainly follow the interpretation of the Court of Justice of the European Union (CJEU) in five cases (the so-called Danish cases). These are T Denmark (C-116/16) and Y Denmark ApS (C-117/16) concerning the interpretation of the parent-subsidiary directive, and the N Luxembourg 1 (C-115/16), X Denmark A / S (C-118/16), C Denmark I (C-119/16), and Z Denmark ApS (C-299/16) cases concerning the interpretation of the directive on interest and royalties.

For example, the Spanish Central Administrative Economic Court (CEAC) denied the application of the withholding tax exemption (WHT) on dividend payments made by a Spanish company to its Luxembourg parent company, which was owned by a Qatari investor (see the Court Decision of October 8, 2019).

The Spanish tax administration had determined that the Luxembourg holding company had no employees, that its registered office was the official address of its third-party service provider and that it had no third-party funding or relevant expenses with its sole shareholder. The ECAC considered that the Luxembourg holding company did not have sufficient substance and was not the BO of the income received, considering that the Qatari shareholder was the BO. It also rejected the application of the Luxembourg-Spain tax treaty for the same reasons. While this decision is not yet final and is subject to appeal, it is a clear example of the issues targeted by local EU tax authorities.

In another case, the Italian Supreme Court issued a decision (see Italian Supreme Court, decision no 14756) of July 10, 2020 in favor of the taxpayer in a situation where the Italian tax administration (ITA) attempted to refuse the application of Italian law. exemption from WHT interest because the Luxembourg shareholder did not have sufficient substance and was not the BO.

However, the court held that the mere fact that a Luxembourg shareholder was a holding company and carried out financial and treasury activities did not mean that it was an intermediary company. In addition, the Luxembourg holding held various investments and provided several loans to other EU subsidiaries. Therefore, the court held that the substance should be understood as proportionate to the activities carried out, and the fact that the holding company was an EU investment vehicle also supported BO’s position.

Hold on for impact …

EU tax authorities and regulators appear to be moving rapidly in a common direction, triggering real game-changing changes. An increase in tax audits is expected across the EU, given budget constraints in various countries resulting from the COVID-19 pandemic.

Indeed, the use of new technologies and innovative tools, as well as tax transparency and information exchange mechanisms within the EU, provide local tax authorities with an improved toolbox to do so ( for example, big data tools to analyze tax residency issues, automated risk assessment against transfer pricing policies).

EU countries such as Italy, Spain, France, Belgium and Germany have launched several tax audits against foreign holding companies investing in their countries. Investors in the Middle East are no exception to this trend.

Key points to remember

Each investment and structure must be weighed on its own merits. However, a clear trend seems to be that inauthentic arrangements and structures can be targeted by EU member states. A scheme or series of arrangements may be ignored by the tax authorities when one of the main objectives is to obtain a tax advantage.

There is a clear and growing emphasis on commercial rationale and economic substance. The criteria set out in the Danish cases have been followed by some tax authorities and national courts across the EU.

Given the changing tax landscape and the possibility of increased scrutiny due to budget constraints in the context of COVID-19, investors should:

  • Review their existing European investments to ensure they are aligned with best practice;
  • Correctly document the real business reasons for undertaking these investments; and
  • Examine and model the impact of potential challenges on their existing and future cross-border investments.

However, in these complex times, you should also see the silver lining. Investors should consider the expected post-pandemic economic boom and the unique opportunities that the EU funds for the next generation will bring to the real estate and infrastructure sectors.

Certainly the EU is, and will be, one of the most popular regions for investing in these asset classes. Therefore, it is essential to consider the issues discussed above to reap the benefits of tomorrow.

Marcell Koves

Director, Deloitte

Victor Sanlorien

Senior Advisor, Deloitte

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