Draft Bill 8676: Establishing a unified tax class and scale

At a glance

The Luxembourg government has released the long-awaited draft Bill n°8676, which proposes a comprehensive reform of individual taxation. The introduction of a single tax class and a unified tax scale has been discussed by successive governments since 2013. Although the legislative process is still in its early stages and the measures are expected to take effect only from the 2028 tax year, we believe it is important to anticipate the potential impact of the reform, given the significant shift in the underlying philosophy of individual taxation.

Below is a summary of the main changes expected, subject to potential comments and amendments that may be introduced and debated during the legislative process.

A closer look
 

Tax Alert: Draft Bill n°8676 individual tax reform published as the government moves toward a single tax class and unified tax scale for 2028

The Luxembourg government has published the much-anticipated Draft Bill n°8676, setting out a major overhaul of individual taxation. The concept of a single tax class and unified tax scale has been under discussion by successive governments since 2013.

Although the legislative process is only just beginning and the proposed measures are not expected to take effect until the 2028 tax year, it is already useful to consider the potential implications of the reform, given the significant shift in the principles underlying individual taxation.

What follows is an overview of the key anticipated changes, which may still be subject to revisions and amendments during the parliamentary debate.
 

Individual taxation: What you need to know

• A single tax class will be introduced as from 2028. The new individualized tax system is expected to be particularly beneficial for taxpayers currently taxed under tax class 1, slightly beneficial for those in tax class 1a, and potentially less advantageous for certain taxpayers in tax class 2. Individualization also implies the end of tax solidarity for couples between spouses or partners, except where joint taxation continues to apply during the transitory period.
  
  The table below illustrates the estimated impact of the single tax class and the new rates (U-rates), compared with the current tax classes, taking into account different levels of taxable revenues and various income-sharing scenarios between spouses or partners in class 2 (with 100% meaning that only one earns the entire taxable income of the household).

• A 25-year transitory period will be introduced (covering tax years up to and including 2052) to mitigate the impact of the reform on taxpayers currently in tax class 2, as shown above. The impact may be particularly adverse for jointly taxed couples where there is a significant discrepancy in taxable income between spouses or partners.

• The application of either the new unique tax class (U-rate) or the transitory regime (T-rate) may, in certain cases, be subject to proactive requests by the taxpayers, subject to specific deadlines.  This may affect whether the chosen regime is applied directly through payroll withholding or only upon tax assessment following the filing of a tax return. Once exercised, the option for the individualised tax system is definitive.

• The annual adjustment (“décompte”) will be abolished and replaced by a tax assessment upon request, based on the filing of a voluntary tax return.

• Going forward, the government will be required to propose updated tax brackets and rates more frequently in order to reflect inflation in a timelier manner.

See below a summary of main changes.

A change of philosophy

• As a consequence, former provisions regarding the “pure” individualised taxation or the individualised taxation with reallocation of income are repealed.
  The allocation of income will follow the legal title of the asset generating the revenue, except where contrary documentary evidence is provided. The same principle will apply to the deduction of certain expenses. Nevertheless, the Draft Bill provides for specific exceptions, such as the possibility to deduct contributions made for a voluntary pension on behalf of a spouse or partner as special expenses.

• The 25-year transitory period will apply automatically in particular to
  • (i) married tax resident taxpayers before 1 January 2028; and
  • (ii) married taxpayers before 1 January 2028 who are wholly or partially non-Luxembourg tax residents and subsequently, as from the beginning of the 2028 tax year, become Luxembourg tax resident taxpayers, provided they have been jointly taxed since 2028.

In the above cases, taxpayers may still opt for the new individualized taxation system by submitting a request (which will be irrevocable) by 30 November of the concerned tax year. A specific form will have to be used, and the adjustment will be carried out through an assessment based on a tax return. In order for the individual taxation to apply in the payroll as from 2028, the request must be submitted by 30 November 2027.

The transitory period will also be available to taxpayers in civil partnerships upon request provided the partnership is declared before 1 January 2028 and the request is submitted before 31 December of the concerned tax year. Even if no request is made, they will be taxed on an individual basis, though a request is required to opt for the individualized taxation system.

Married taxpayers where one of the two is a Luxembourg resident as from the beginning of the 2028 tax year and realises at least 90% of the professional revenues of the household could also benefit from the transitory regime upon request.

Tax savings but not for all situations

• The new brackets and individualized progressive tax rates are referred to as U rates, whereas the rates applied during the transitional regime, under which joint taxation continues as described above, are referred to as T rates.

The number of brackets has been reduced in the new U rates, and the progressivity appears to accelerate for certain amount of revenue. Nevertheless, according to the Luxembourg government, no taxpayer should pay more under the new individualized tax system. This is expected to hold true at least for those previously taxed in tax class 1 or 1a.

The main beneficiaries are clearly those in tax class 1, who could see significant tax savings, ranging from approximately 3.5% up to 100%, depending on income level, with the largest benefits realised for taxable incomes up to around EUR 75,000.

For taxpayers previously taxed jointly (tax class 2), the situation differs. Government simulations indicate that the new tax system is likely advantageous only if the lower-earning partner or spouse contributes at least 25% of the household’s total income. An example for a household with a taxable income of EUR 100,000 is provided below, although the potential benefit in such cases is modest.

With the same total taxable income, tax savings amount to approximately 33% if both household members earn equally (50% each). However, if a single household member earns the entire EUR 100,000, applying the U rates would result in a 66% increase in taxes compared with joint taxation.
 

Additional details

• Children and individual taxation
  Children will continue to impact individual taxation, even though the system is designed to be independent of household composition. A moderation will still be granted, and children will continue to increase the cap of certain deductions. The table relating to extraordinary expenses has been updated (e.g. taxable income considered up to EUR 105,000 instead of EUR 60,000). The rebate for children not residing in the household will increase from EUR 5,424 to EUR 5,928. Additionally, the tax credit for children will be slightly adjusted: the full amount will now be granted up to EUR 76,600 of adjusted taxable income (previously EUR 67,400), assuming a maximum of five children.

• Single parent tax credit (CIM)
  The CIM will increase from EUR 3,504 to EUR 4,008, while the taxable income limit to benefit from the full amount remains at EUR 60,000. The credit will continue to be adjusted based on the income, with a minimum of EUR 750 applied when adjusted taxable income reaches EUR 105,000. The threshold of subsidies affecting the CIM will increase from EUR 2,712 to EUR 2,964.

• New early childhood allowance
  A new allowance for early childhood (children under three at the start of the tax year) will be introduced, amounting to EUR 5,400. This allowance can be apportioned between parents or allocated fully to one parent, depending on how the moderation for children is applied. Specific technical requirements may apply, including a formal request in certain cases. Taxpayers may also request the full allowance even under individualised taxation system if the other parent/spouse lacks sufficient taxable income to benefit from it. This allowance will not apply to non-Luxembourg tax resident who cannot be assimilated to Luxembourg residents.

• Increases in deduction ceilings
  • The maximum annual deductible amount of debt interest, insurance premiums and contributions will increase from EUR 672 to EUR 900.
  • The ceiling for annual payments to home savings contracts will be increased respectively from EUR 1,344 to EUR 1,500 for taxpayers aged 18-40, and from EUR 672 to EUR 900 for others.
  • The lump-sum rebate for household employees, nursing and care expenses, and after-school childcare costs will increase from EUR 5,400 to EUR 6,000 (via Grand-Ducal decree to be issued).

• Indexation for inflation
  Increases in income due to inflation will result in a better adaptation of the tax scale to avoid automatic tax increases due solely to price growth. The government will have to propose a draft bill to adjust brackets and the tax scale each time there are three adjustments to the sliding salary scale terms.
• The annual adjustment (“décompte”) is repealed and will be replaced by the possibility to introduce a tax return to be taxed by assessment on demand (i.e. even if filing a tax return is not mandatory given the situation). The new system of assessment on demand is supposed not to be detrimental to the taxpayer by comparison to the current system of annual adjustment. One specific feature of the annual adjustment is indeed not to generate additional taxes for the taxpayer (except in very specific cases). The Tax Authorities could also decide to tax by assessment (and thus request additional taxes if need be) the taxpayer in certain situations supposed to cover the same situations than those which should have previously led to a special annual adjustment.
• Widowers, divorced taxpayers, and civil partnerships
  Widowers and divorced taxpayers were previously able to benefit from tax class 2 for three years following the death or divorce. This period will be extended to five years before being subject to the U-rates. The reform also clarifies that taxpayers in civil partnerships cannot benefit from tax class 1a during the three years following the death of a partner or the end of the partnership.