Position Paper: Classification of Interest-free loans (“IFLs”) for Luxembourg tax purposes

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Purpose of this position paper

Purpose of this position paper Interest-free loans ("IFLs") are a common feature of many Luxembourg investment structures and can be used in a variety of circumstances. IFLs are characterised by their flexibility (e.g. ease of implementation and repayment) and relatively light legal documentation. IFLs are generally qualified as debt instruments unless the IFL has specific equity features that result in its qualification as an equity instrument. However, in September 2022, the Tribunal in Luxembourg delivered its decision in a case concerning an IFL granted by a Luxembourg company to its wholly owned Luxembourg subsidiary. The Tribunal ruled that this IFL was an equity instrument.1 As such, it confirmed the position of the Luxembourg tax authorities that challenged the debt classification of said IFL. This engendered considerable legal uncertainty among investors and some tax advisors in Luxembourg. However, in November 2023, the decision of the Administrative Tribunal was overturned by the Luxembourg Administrative Court, which ruled that the IFL should be classified as a debt instrument.2 Given the widespread use of IFLs to finance companies in Luxembourg, the significance of this decision and its contribution to legal certainty cannot be overstated. In 2024, the Luxembourg Tribunal delivered its decision in another case involving an IFL. The court's ruling confirmed the reclassification of the IFL as an equity instrument, aligning with the position of the Luxembourg tax authorities.3 This decision has led to a resurgence of legal uncertainty regarding the classification of IFLs. This position paper analyses the features of financial instruments that need to be considered when classifying a financial instrument as either debt or equity and analyses specifically how IFLs should generally be classified for Luxembourg tax purposes. The purpose of this position paper is threefold:

• to analyse key features of financing instruments;

• to consider on which basis financing instruments are classified as equity or debt for Luxembourg tax purposes; and

• to determine how IFLs should be classified for Luxembourg tax purposes.