Legal Update: Share Premium Repayment Without Capital Reduction: Withholding Tax Risk Confirmed

Share Capital Means Share Capital – Nothing More

The Court appears to adopt a strict, literal interpretation of the concept of share capital as used in Article 97(3) b) of the Luxembourg Income Tax Law (“LITL”), aligning it with its meaning under company law. Article 97(3)b) LITL excludes from taxable distributions/repayments “allocations that are the consideration for a reduction of the share capital constituted by the contributions of the shareholders,” provided that such reduction is motivated by “serious economic reasons”.

The Court held that the notion of share capital does not extend to share premium, defined as the excess of the issuance price over the nominal value of shares, and which does not contribute to the formation of share capital. This distinction is further supported by the Luxembourg standard chart of accounts, which separately classifies “capital” (account 10) and “share premiums” (account 11) within equity, the latter forming part of equity in a broad sense but remaining distinct from share capital.

The parliamentary works underlying Article 97(3) b) LITL leave little room for ambiguity. They indicate that “the only case where a capital repayment does not constitute a taxable advantage for the shareholder is where such repayment has a counterpart in a reduction of share capital” and that “it must be a reduction of share capital carried out in accordance with the laws governing capital companies”. The Court further emphasized the semantic distinction between share capital, contributions, and allocations, concluding that these concepts are not synonymous: the fact that a share premium may constitute a contribution does not necessarily mean it forms part of the share capital whose reduction is required to trigger the exemption.

Importantly, the Court’s reasoning appears to leave open the possibility that a share premium repayment carried out together with a concurrent reduction of share capital could fall within the scope of Article 97(3) b) LITL. However, the precise mechanics of such a combined operation, including whether the entirety of the distribution or only the portion corresponding to the share capital reduction would benefit from the exemption, remain unclear.

Article 97(1)(1) LITL – A Broad Conception of Taxable Distribution

Article 97(1)(1) LITL defines taxable income from movable capital as “dividends, profit shares, and other products allocated, in whatever form, by reason of shares, capital interests, profit-sharing interests, or other participations of any kind” in resident entities. The Court adopted a broad interpretation of this provision, holding that the repayment of a share premium without a corresponding share capital reduction constitutes an “other product” allocated by reason of a participation, even where it does not qualify as a dividend or a profit distribution.

In addition, the Court does not seem to consider whether the funds distributed originate from profits or from shareholder contributions: the determining factor is that the allocation is made by reason of the participation and is charged against the entity’s net assets.

Share Premium and The Implications for the Participation Exemption Regime

The judgment raises a separate and significant question: whether share premium should still be regarded as forming part of the acquisition price of a participation for purposes of the participation exemption regime (“PER”) under Article 147 LITL.

Article 147 LITL conditions the application of the exemption on, among other things, a participation with an acquisition price of at least EUR 1,200,000 for dividends (or EUR 6,000,000 for capital gains) in the share capital of the entity distributing the income.

In this context, the Court referred to a previous judgment of the Administrative Court which held that a contribution to account 115 (capital contribution without issuance of shares), while forming part of equity, “remains separate from the share capital” and does not confer on the shareholder any direct right to shares or to an increase in their nominal value, with the consequence that “such a contribution does not present a sufficient link with the participation itself in the share capital of the relevant entity to form part of the acquisition price of the participation in the share capital”.

Although questionable, it might be difficult not to transpose this reasoning to share premium.

To the extent this interpretation prevails, structures where the acquisition price threshold was met in whole or in part through amounts booked to the share premium account may not, in fact, satisfy the conditions for the PER.

Practical Implications and Recommended Actions

Given the significance of this decision and its practical consequences, stakeholders should consider the following:

• Structures involving share premium repayments without a corresponding capital reduction should be reviewed as a priority. Such repayments are taxable under Article 97(1)(1) LITL and may be subject to 15% withholding tax, unless an exemption applies under other provisions of the LITL or applicable double tax treaties.
• Structures relying on the acquisition price threshold for the purpose of the PER should also be closely reviewed. Where the threshold under Article 147 LITL has been met through amounts booked to the share premium account, questions arise as to whether the conditions for the PER are satisfied. Existing arrangements may therefore need to be restructured to ensure compliance.