TAX ALERT

BALANCE SHEETS IN FOREIGN CURRENCY

JULY-2014

©2014

INTRODUCTION While most Luxembourg companies prepare their annual accounts in Euro (EUR), they remain free to have their share capital and annual accounts in any other lawful currency. If so, given that taxes are necessarily assessed in EUR, a tax balance sheet in EUR has to be prepared to determine their Luxembourg taxable income. Traditionally, fixed assets, long-term liabilities and equity were converted using a historic exchange rate, whereas current assets and short-term liabilities were converted using the year-end exchange rate. Consequently certain foreign exchange movements might result in taxable gains and deductible losses unrelated to the operations of the company. Under the pre-existing practice, companies could file an advance tax clearance request to be authorized to determine their taxable base solely in a foreign functional currency. Then they only have to convert such final tax base into EUR so as to avoid having to prepare a full EUR-denominated tax balance sheet for filing purposes, thus eliminating foreign exchange translation results having no economic cause.

I. THE NEW CIRCULAR The Circular L.G.-A n° 60 issued on June 16, 2014 by the Luxembourg tax authorities, formalises this practice as follows: •

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When a Luxembourg company decides to establish its balance sheets in another currency than EUR, it has to introduce a written request to the direct tax authorities at least three months before the end of the first financial year from which it wishes to determine its business profit in a foreign currency. New companies can file the request until the end of their first financial year. The company will be engaged for future tax years. The choice for a foreign currency is irrevocable, except if the company decides to change the currency of its share capital. For the companies which choose to determine their taxable income in a foreign currency, the taxable base will be defined based on the profit as indicated in the balance sheets established in the foreign currency, increased by any non deductible amounts and decreased by any non-taxable amounts or amounts deducted as special expenses. For purposes of calculating the tax due, the amounts in a foreign currency are converted into EUR using either the weighted average exchange rate of the corresponding tax year, or the year-end exchange rate for such year, at the choice of the company. This choice is irrevocable and binds the company for the coming tax years. For the conversion from the foreign currency into EUR or conversely, the company shall use the exchange rates published by the European Central Bank.

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II. HOW ARE FOREIGN CURRENCY POSITIONS CONVERTED? OVERVIEW OF THE DIFFERENT RULES A. Corporate income tax Position

Conversion rate

Business profit of the year (including additions and deductions) Balance sheets total used to determine the minimum tax and the attributable withholding tax

Weighted average exchange rate or year-end exchange rate of the tax year at the choice of the company

Losses carried forward expressed in foreign currency until they are used Amounts taken into account to calculate the exempted capital gains of disposal

Weighted average exchange rate or year-end exchange rate of the tax year in which they are used at the choice of the company

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Amounts in foreign currency in the commercial balance sheets used as basis to determine tax credits in EUR

Weighted average exchange rate or year-end exchange rate of the tax year at the choice of the company

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Acquisition price in foreign currency of a participation, used to determine if it reaches the minimum acquisition price (1.200.000 EUR) in order to be eligible for the participation exemption regime (article 166 of the Luxembourg tax law and the Grand-Ducal Degree of 21 December 2001)

Historical exchange rate

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B. Municipal business tax Position •

Business profit

Conversion rate Weighted average exchange rate or year-end exchange rate of the tax year

C. Net wealth tax Position In case the financial year corresponds to the calendar year: • Unitary value of operating assets

Conversion rate Exchange rate on December 31 of the year 1 preceding the fixation key date for tax purposes

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Since January 1, 2002, the net wealth has to be established every three years (i.e. fixation key date). It follows that the next fixation key date will be on January 1, 2017. This period can be shortened (i) when the wealth value on the beginning of a civil year varies by more than one-fifth or more than EUR 75,000 compared to the value at the last key date; (ii) in case of modification of the determining circumstances for the granting of tax relief or for the collective taxation, implementing an increase by more than one-fifth or more than EUR 75,000 of the wealth value compared to the value at the last key date; (iii) in case of reduction or increase of the net wealth tax rate on the key date following the reduction or increase year, implementing an increase by more than one-fifth or more than EUR 75,000 of the wealth value compared to the value at the last key date.

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In case the financial year does not correspond to the calendar year: • Unitary value of financial assets in case of non-calendar financial year

Exchange rate prevailing at the closing date of the last financial year preceding the fixation key date for net wealth tax purposes or Exchange rate on December 31 of the year preceding the fixation key date for tax purposes (irrevocable choice)

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Stocks, shares and similar instruments in capital companies

Exchange rate on December 31 of the year preceding the fixation key date for tax purposes

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Acquisition price in foreign currency of a participation, used to determine if it reaches the minimum acquisition price (1.200.000 EUR) in order to be eligible for the participation exemption (paragraph 60 of the law concerning the valuation of assets and values (BewG))

Historical exchange rate

In case the financial year corresponds to the calendar year: • Reserve constituted to be eligible for a tax reduction (paragraph 8a of the law concerning the net wealth tax (VStG)) • In case of a part or total distribution of the reserve before the five-year period, amount of the tax increase

Exchange rate on December 31 of the year preceding the fixation key date for tax purposes

In case the financial year does correspond to the calendar year: • Reserve constituted to be eligible for a tax reduction (paragraph 8a of the law concerning the net wealth tax (VStG)) • In case of a part or total distribution of the reserve before the five-year period, amount of the tax increase

Exchange rate prevailing at the closing date of the last financial year preceding the fixation key date for net wealth tax purposes or Exchange rate on December 31 of the year preceding the fixation key date for tax purposes

III. TRANSITION TO FOREIGN CURRENCY REPORTING Companies, which, historically, were preparing full tax balance sheets in EUR while having their share capital in a foreign currency, now have the option to apply the new method implemented by the Circular. When it decides to switch its tax balance sheets from EUR into another currency, it must convert its tax balance sheet at the end of a tax year. The assets shown in the tax balance sheets in EUR of the first financial year, from which the business profit is determined in a foreign currency, must be converted into the foreign currency using the transition exchange rate, i.e. the exchange rate at the closing date of the first financial year from which the business profit is determined in a foreign currency (the "Transition Exchange Rate"). The same exchange rate is used for the amounts in EUR relating to previous tax-years with an impact on the taxable income of the transition year or of the coming years, i.e. the profit carried forward. In the tax balance sheets, the short-term assets are ordinary evaluated at the closing exchange rate whereas the long-term assets are evaluated at the historical exchange

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rate. Consequently the translation of assets in the tax balance sheets from EUR into the foreign currency using the Transition Exchange Rate is likely to cause value differences in the assets whose corresponding value in EUR was not initially established at the closing exchange rate. Due to these differences, which cannot be integrated in the profits from the transition financial year, the company must continue to establish a tax balance sheet in foreign currency. The difference appears during the first year after the transition. To ensure avoiding it during the following years, the company must apply the same method in the future.

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Transition foreign exchange gains and losses

The gains and losses resulting of the conversion of the amounts receivable and the debts denominated in the foreign currency are related to the transition financial year. They are taxable or deductible under the tax year, in which the transition financial year finishes. •

Amortization

The net book value in the tax balance sheet in EUR converted into the foreign currency using the Transition Exchange Rate constitutes the basis for the depreciation of such assets for tax purposes. The annual amortisation in foreign currency is established by dividing the conversion result by the customary duration of use. This approach is mandatory to ensure that the transition from the determination of the taxable income in EUR to the determination in the foreign currency has no effect on the amortisation period. •

Investment tax credit

From the transition tax-year, the determination of tax credit for investments is based on amounts in the foreign currency as in the balance sheets, converted into EUR. When calculating the tax credit for complementary investments for the transition tax year and for future tax years, the amounts in EUR relating to prior financial years for which the determination of the financial profit was done in EUR, are converted using the Transition Exchange Rate. The tax credit denominated in a foreign currency is then converted into EUR at the weighted average exchange rate or year-end exchange rate of the tax year according to the choice of the company for the conversion of its business profit.

IV. NEXT STEPS As the Circular now codifies the pre-existing practice with significantly greater precisions, functional currency agreements previously obtained via an advance clearance should no longer be valid due to the specific regime now introduced by the new Circular. It follows that also companies, which had an advance tax analysis in place, are obliged to file a new formal request to the Luxembourg tax authorities under the new circular, bearing the newly introduced deadlines in mind.

For further information feel free to contact the following persons: LIONEL NOGUERA [email protected]

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ANNE SELBERT [email protected] KATHARINA MÜLLER [email protected] PATRICK ANDERSSON [email protected]

*** BONN & SCHMITT JULY 2014

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