The Luxembourg interest limitation rule

Financing costs recognised in the accounts may not be fully deductible for Luxembourg income tax. Article 168bis generally limits the annual deduction of net borrowing costs to the higher of EUR 3 million and 30% of tax EBITDA, the tax measure of earnings before interest, tax, depreciation and amortisation. The rule has applied to financial years starting on or after 1 January 2019.

The calculation is often relevant to companies used to buy investments, real-estate structures and group financing vehicles. It comes after other tax rules. A payment treated as a hidden distribution, a benefit arising from shareholder or related status that would not normally be available without that relationship, does not become deductible simply because it fits within the Article 168bis limit. Nor does that limit make a payment linked to exempt income deductible.

The annual deduction limit

Under Article 168bis of the Income Tax Law, exceeding borrowing costs, the excess of deductible borrowing costs over taxable interest income and economically equivalent taxable income, are deductible up to the higher of two amounts.

The test applies for each financial year. A short financial year does not reduce the EUR 3 million amount proportionally. The taxpayer first determines which borrowing costs are otherwise deductible, then applies the limitation to the remaining net amount.

The fixed amount is a deduction floor. It sets the minimum annual limit under this rule, but does not exempt the company from other tax rules. Interest can still be denied under transfer-pricing, participation-exemption, anti-hybrid or distribution rules before Article 168bis is calculated.

Net financing and tax EBITDA

Borrowing costs include more than interest on an ordinary loan. They can include economically equivalent financing charges, the interest element of finance leases, capitalised interest, specified foreign-exchange results and certain guarantee or arrangement fees.

A Luxembourg company that borrows and on-lends applies the rule to its net financing position, after subtracting taxable interest income and economically equivalent taxable income from deductible borrowing costs. Its gross interest expense alone does not determine the limitation.

The tax EBITDA calculation starts from total net income and adds back exceeding borrowing costs and tax depreciation. It also adds back deducted impairments, the reductions in asset values allowed for tax. Exempt income and expenses economically linked to it are excluded from the calculation. The ACD circular of 25 March 2022 explains these definitions and the order of the calculation.

The effect on holding companies

A SOPARFI holding company may receive dividends and capital gains that qualify for the participation exemption. That income is not taxed and does not increase tax EBITDA. When the company has little other taxable income, the amount calculated at 30% can be low and the EUR 3 million floor becomes the main annual limit.

The result differs for a financing company earning taxable interest. Its taxable margin can support tax EBITDA, although the amount still depends on the full income and expense profile.

The interest rate and debt amount must first satisfy the arm’s-length principle, meaning terms that independent parties would accept in comparable circumstances. The intragroup financing analysis and the Article 168bis calculation answer different questions and should be kept in that order.

The statutory exclusions

Defined financial undertakings are outside the interest limitation rule. The statutory list covers specified regulated entities and funds. The classification should be checked against the exact definition rather than inferred from a commercial description.

A qualifying standalone entity is also outside the rule. It must have no associated enterprise, no foreign permanent establishment and no place in an accounting consolidation. A shareholder or group relationship can therefore remove the exclusion even when no consolidated accounts are prepared.

Borrowing under loans concluded before 17 June 2016 can be excluded, but later modifications may narrow or end that protection. A change in amount, term, rate or parties requires a review of the original contractual position. Borrowing used for a qualifying long-term public infrastructure project in the European Union is subject to a separate exclusion.

Carry-forwards

Exceeding borrowing costs that cannot be deducted in the current year carry forward without a time limit. The oldest amount is used first when deduction capacity becomes available in a later year. The carry-forward remains attached to the taxpayer that incurred the cost, subject to the statutory rules for qualifying reorganisations.

Unused interest capacity can be carried forward for 5 financial years when 30% of tax EBITDA exceeds the year’s exceeding borrowing costs and those costs are themselves above EUR 3 million. The capacity is the excess of that EBITDA amount over the costs, subject to reductions for older costs deducted. An unused part of the EUR 3 million floor does not create carry-forward capacity.

For example, tax EBITDA of EUR 20 million gives a 30% amount of EUR 6 million. If the year’s exceeding borrowing costs are EUR 4 million, the initial unused capacity is EUR 2 million, before any reduction for older costs used. If the costs are only EUR 2 million, no unused capacity arises under this rule.

The annual tax file should therefore distinguish current-year costs, older disallowed costs and unused capacity by year. Combining them in one balance can hide expiry dates and the order in which amounts are used.

The equity escape

A taxpayer fully consolidated within a group, with its assets, liabilities, income and expenses combined in full, line by line, in the group accounts, may request full deduction. Its equity as a share of total assets must be equal to or higher than the same ratio for the group. A ratio up to two percentage points lower is treated as equal, provided the statutory valuation and accounting conditions are met.

The Law of 20 December 2024 added a comparable route for a taxpayer with associated enterprises or a foreign permanent establishment that is not part of accounting consolidation. An entity left out of consolidated accounts only because of its small size or immateriality is still treated as belonging to the consolidated group. The single-entity-group rule applies to financial years starting on or after 1 January 2024 and includes adjustments for debt owed to associated enterprises.

This equity escape requires a request supported by evidence. It is not automatic merely because the company appears well capitalised on its standalone balance sheet.

The fiscal unity calculation

Within a Luxembourg tax consolidation, the rule is generally calculated at group level. The members’ borrowing costs, taxable financing income and tax EBITDA are aggregated, and one EUR 3 million floor applies to the fiscal unity.

The members may jointly elect an entity-by-entity calculation in the initial request, and that election applies for the duration of the regime. The choice changes how taxable EBITDA and borrowing costs can be shared across the group, so it should be modelled when the fiscal unity is formed rather than selected during the annual return process.

Conclusion

Article 168bis limits net borrowing costs by reference to the higher of 30% of tax EBITDA and EUR 3 million. Exempt income, earlier deduction rules, statutory exclusions, carry-forwards and the group position can each change the result. The annual computation should follow the legal and accounting character of the financing rather than treating total interest expense as one number.