On 24 October 2017, the European Union (EU) Code of Conduct group analyzed Liechtenstein’s tax system. Based on its review, the EU Code of Conduct group requested amendment of the country’s current corporate taxation regime in order to prevent the listing of Liechtenstein on the EU’s list of non-cooperative tax jurisdictions (tax havens).
Accordingly, in June 2018, the Liechtenstein Parliament (Landtag) debated in its second lecture over the draft bill for the planned revision of tax law. The proposed changes regarding the introduction of anti-avoidance rules, in particular for participation income, were widely supported and for this reason accepted by the Parliament.
The revised tax law entered into force on 12 July 2018 and generally applies as of tax year 2019.
Consequently, based on the changes to Liechtenstein’s tax legislation, the EU concluded on 27 September 2018 that Liechtenstein will not appear on the EU list of non-cooperative tax jurisdictions.
As described in EY Global Tax Alert, Liechtenstein releases consultation report on implementation of anti-avoidance rules into tax law, dated 20 March 2018, the impetus for this reform followed the tax review by the EU Code of Conduct Group. To prevent listing on the EU report of non-cooperative tax jurisdictions or the so-called black list, Liechtenstein agreed to adapt its tax law according to the recommendations by the EU by the end of 2018. Accordingly, a new draft bill regarding Liechtenstein’s tax law was drafted and published for consultation in February 2018. Although, several proposals from various parties were raised during the consultation process, only small adjustments were adopted for the proposed draft bill submitted for parliamentarian debate. The Parliament approved the proposed amendments on 7 June 2018. In September 2018, the EU Code of Conduct group concluded that Liechtenstein had completed the necessary reforms to comply with all the identified tax good governance principles. Consequently, Liechtenstein is no longer subject to being qualified as a non-cooperative tax jurisdiction.1
The specifications stated by the Government and Liechtenstein’s tax authorities after the consultation process are summarized below.
Implementation of anti-avoidance rules in connection with dividends and capital gains derived from participations in foreign entities
The new anti-tax-avoidance rule regarding dividend distributions restricts the tax exemption of dividend income derived from foreign entities. In addition to the already established exception from the participation exemption for dividend income from participations exceeding 25% of the voting rights which is regarded as a tax deductible expense at the level of the subsidiary, there are two new requirements which limit the application of the tax exemption. Based on the new anti-avoidance rule, Liechtenstein’s tax authorities will deny the participation exemption if more than 50% of the total gross revenue of the foreign legal entity is derived from passive sources and if the net profits of the foreign subsidiary are subject to overall low taxation. In the determination of low taxation, potential foreign withholding taxes are also considered.
The same restrictions on the participation exemption will apply for capital gains from sales, liquidations or unrealized appreciations of participations in foreign entities.
In the comments to the consultation process, the Government clarified that the new rules shall apply to any foreign subsidiary, regardless of its specific location, i.e., including subsidiaries located in an EU country (which should per se be in line with the Base Erosion and Profit Shifting (BEPS) and EU Code of Conduct requirements).
In order to determine the amount of a specific dividend from a foreign subsidiary that may benefit from the participation exemption, the reserves of the subsidiary have to be further analyzed. These reserves may derive from the following baskets:
(a) Income from (predominantly) active sources
(b) Income from (predominantly) passive, overall high-taxed sources
(c) Income from (predominantly) passive, overall low-taxed sources
If the reserves of a specific year predominantly (> 50%) derive from basket (a) or (b), the distribution of these reserves would benefit fully from the participation exemption at the level of the receiving Liechtenstein parent company.
If less than 50% of the reserves derive in a specific year from active sources and are overall low-taxed, the reserves are deemed to derive from basket (c) and its distribution does therefore generally not benefit from the participation exemption. Foreign taxes may be credited depending on the specific facts and circumstances. As a result, if part of the income of the subsidiary was subject to an effective tax rate of more than 12.5% (= ordinary Liechtenstein corporate income tax rate), the distribution of the reserves generated from that specific income may be exempt due to the tax credit system in Liechtenstein.
The analysis has to be separately performed for each year. If a dividend distribution derives from reserves of several years, it is assumed the dividend income is derived from the respective basket of each year proportionally.
The burden of proof for the origin of the distributing reserves is with the Liechtenstein taxpayer. If the origin of the reserves cannot be documented sufficiently, no participation exemption will be granted upon their distribution.
Implementation of anti-avoidance rules in connection with the notional interest deduction
Under Liechtenstein tax law, a notional interest deduction (NID) is granted which is calculated on the modified equity. The modified equity is based on the actual equity of a company from which certain deductions are made. These deductions refer, in particular, to assets which do not generate a taxable profit at the level of the Liechtenstein company, for example participations, foreign permanent establishments, and foreign real estate.
The revision of Liechtenstein’s tax law foresees new anti-avoidance rules regarding the NID in connection with intercompany relationships and transactions.
If a subsidiary, which is entitled for a NID, is debt-financed, the overall interest deduction under a consolidated view (i.e., debt interest at the parent company level and NID at the subsidiary level) would be high. According to the new anti-avoidance rule, interest payments for debt capital at the level of the parent company may not be fully tax deductible anymore, if the parent company invests such debt capital to acquire subsidiaries and if the respective subsidiary is entitled to a NID.
Furthermore, the NID will be restricted for certain intercompany transactions which are performed for the reason of tax avoidance only, such as cash/in kind contributions of related parties, acquisitions of businesses held by related parties and intragroup transfers of participations.
Generally, participations are not considered in the process of NID calculation. It should be noted that this principle remains unchanged besides the introduction of an anti-avoidance rule in connection with dividend income from participations in foreign entities. Therefore, if the dividend income of a specific participation does not benefit from the participation exemption under the mentioned anti-avoidance rule, the respective equity assigned to that participation may still not benefit from a NID.
Abolition of tax deductibility of depreciation or value adjustments on participations
According to the adapted tax law, losses derived from the revaluation of participations are no longer tax deductible. On the other hand, recaptured depreciation will not be subject to tax in the future. Losses on participation which were already declared as tax deductible under the old tax law would, however, in the case of a recapture still be subject to tax under the proposed regulation based on a transitional provision.
The illustrated amendments in connection with dividends and capital gains could be of great impact for Liechtenstein holding companies. In order to meet the new compliance requirements, the need for information regarding foreign participations, in particular, the kind of activity and taxation of the subsidiary, will increase.
It is highly recommended to track and document the origin of reserves for each subsidiary even if no dividend distribution is planned. Furthermore, it should be noted that the reserves in existence at the time of the introduction of the new rules should also be split into the respective baskets.
As these reserves in existing Liechtenstein structures may date back many years and are, therefore, difficult to track, suitable measures such as distributions or reorganizations may be further made until the rules apply (note that for existing structures, a transition period of three years applies; see below).
In addition, existing structures benefitting from the NID should be further examined with regard to potential limitations on interest deductions for tax purposes.
The new provisions of the revised law entered into force on 13 July 2018 with the reservation of transitional rules for certain adaptions. In general, the approved amendments will apply for the tax year 2019 (the tax year 2019 is usually the reporting period ending 31 December 2019).
A special transition period applies for the new anti-avoidance rule regarding the participation exemption on dividends and capital gains in structures existing before 1 January 2019. The tighter restrictions will be effective for these participations only from tax year 2022 onwards.
1. For a general overview of the proposed amendments, see EY Global Tax Alert, Liechtenstein releases consultation report on implementation of anti-avoidance rules into tax law, dated 20 March 2018.
EYG no. 012065-18Gbl
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