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How to manage substance in a home working environment

Alternative Universe

As the uncertainty continues over how long office closures and travel restrictions due to the COVID-19 pandemic will remain in place, the practical difficulties of holding physical board meetings in their required jurisdictions and other issues around substance have been brought into sharp focus. Notwithstanding some helpful guidance and/or latitude expressed by jurisdictions such as Luxembourg and the United Kingdom, action may be required to protect your structures from a loss of treaty benefits in investee jurisdictions on the basis of residence and substance.

Tax residence in Luxembourg

For Luxembourg domestic tax purposes, a collective entity (such as a company) is regarded as tax resident in Luxembourg if it has its legal seat in Luxembourg, or if its central administration is situated there.

Attention must also be paid, however, to the residence and substance requirements of the jurisdictions in which a Luxembourg company invests, particularly where important individuals for the relevant business are based in such jurisdictions. To this end, a set of general principles for maintaining tax residence and substance has evolved. These principles require a number of criteria to be met, such as:

  • The vast majority of board meetings are held in Luxembourg.
  • The chair and a majority of directors are physically present at board meetings in Luxembourg. 
  • The directors have their personal tax residence in Luxembourg. 
  • The directors have the appropriate skills and experience to manage the company’s business. 
  • Robust discussion and genuine strategic decision-making takes place during board meetings.
  • All material documentation is executed in Luxembourg.
  • Signatories on the company’s bank accounts are Luxembourg tax resident directors/individuals authorized to operate the bank accounts without requiring the approval of non-Luxembourg tax resident directors.
  • Books and records (including detailed board minutes) are held in Luxembourg.
  • Premises are owned/leased exclusively for the company (and its associated/group entities), and are appropriately equipped with office furniture and equipment and staffed with adequate personnel.

Challenges presented by the pandemic 

The pandemic has led to significant logistical issues, with most businesses in Luxembourg being closed since mid-March 2020, and restrictions on movement and congregating in force until further notice. Luxembourg’s airport has been closed for passenger flights since 23 March 2020 and the borders are closed to most road traffic. The physical presence of a majority of directors at board meetings has therefore been impossible or highly impracticable to achieve, while administrative and other functions carried on in Luxembourg have also been disrupted by work-from-home arrangements.

On 20 March 2020, Luxembourg introduced legislation to provide for remote attendance and deemed physical presence for the purposes of calculating the quorum and majority votes at shareholders’ meetings, board meetings and other meetings of a company’s decision-making bodies. It is not clear, however, whether these measures would affect another jurisdiction’s assessment of the tax residence and substance of a Luxembourg company.

In its COVID-19 guidance dated 3 April 2020, the OECD provided reassurance regarding the application of treaty tie-breaker provisions. Noting that the place of effective management (POEM) test should look to establish the “ordinary” or “usual” location of effective management, the OECD states that the temporary and extraordinary change in location of inter alia chief executive officers and other senior executives should not cause a change to an entity’s residence status under a tax treaty. Naturally, the question of a treaty tie-breaker does not arise unless competing taxing rights are being asserted. Below, we consider the case of a Luxembourg company with UK directors.

Case study: UK directors of a Luxembourg company

HMRC has confirmed that tax residence is to be assessed on a holistic and case-by-case basis and that—for non-UK incorporated entities—the central management and control (CMC) test should be applied. Importantly, there are no special rules to be applied while the pandemic is ongoing and, interestingly, HMRC considers its existing guidance to be sufficiently flexible to accommodate short-term changes to board meetings and decision-making. Accordingly, if board meetings are held in or attended from the United Kingdom for a short period only, the tax residence of a Luxembourg company would not necessarily move to the United Kingdom, since the occasional holding of meetings in or occasional attendance at meetings from the United Kingdom would not necessarily result in CMC moving to the United Kingdom. HMRC’s existing guidance provides a list of examples covering scenarios where it would not usually review tax residence, although these examples are narrowly drawn.

The new HMRC guidance states that it is “very sympathetic” to disruption caused by COVID-19 and reminds taxpayers that tie-breakers, such as the POEM test, may also need to be considered. In most cases, there may be no difference between the place where CMC is located and the POEM, but it is possible for the two tests to produce different results, as the factors to be considered do not line up exactly. As such, disruption to the broader Luxembourg functions of a company, rather than just the directors, may become relevant.

A “short” disruption to the normal operation of a Luxembourg company’s governance arrangements may not, therefore, pose material issues, especially where the company has a track record of being disciplined in complying with the measures described above and such practice resumes once the lockdown ends. The longer the lockdown, however, with an increasing number of important company decisions being made and documents being executed outside the normal framework, the greater the uncertainty as to whether the company can be regarded as maintaining tax residence and sufficient substance in Luxembourg to continue to be entitled to treaty benefits.

How can taxpayers seek to protect their position?

One option may be to review the membership of boards and committees and their governing instruments to determine whether amendments could ensure that decision-making and document execution can continue to take place in Luxembourg, even in the event of major business disruption such as in the current pandemic. Amendments of this type may require legal and structural changes and entail consequential impacts on internal risk controls. For these reasons, this solution may not be feasible or desirable where a targeted response to a temporary disruption is sought.

A simpler alternative to amending governing instruments or making changes to board membership may be to grant proxies or powers of attorney. A director who is physically absent may nevertheless be counted in the quorum of a meeting by granting a proxy to a fellow Luxembourg director to attend and vote on his or her behalf. A power of attorney may be used to ensure that documentation continues to be validly executed solely or primarily in Luxembourg. These solutions carry their own legal considerations and formalities that will need to be reviewed to ensure they are effective, but should be relatively simple to implement and could make a crucial difference between maintaining and losing treaty benefits.


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