Hybrid financial instruments
Deduction of interests
In general, any interest paid by a Luxembourg company to one of its creditors is deductible from the taxable base of this company. If it pays interests relating to a loan taken out with a bank or any other creditor, it will be able to deduct them from its taxable base.
Here are different financial instruments generally used by companies:
- Simple bonds
- Profit Participative bonds
- Convertible bonds
- Equity/Participant bonds
- Equity loans
- Tracker-certificate
- PEC (Preferred Equity Certificates)
- CPEC (Convertible Preferred Equity Certificates)
Simple bonds
Bonds issued by companies represent an effective means of financing. Indeed, bonds constitute long-term debts. They are negotiable and allow their holder to get a fixed (or variable) interest.
"The zero-coupon bonds" do not grant any interest, but they concede, at their term, a redemption premium to their bearers.
"The only-coupon bonds" grant an interests payment in one lot (in fine). This principle allows a capitalization of the interests normally paid annually.
Any interest or redemption premium paid within the context of a simple bond is deductible of the taxable base of the company which borrows.
Compounds bonds
These bonds can be composed of variable interests or a right.
Convertible bonds
The bearers of this type of bonds receive a fixed interest and can, according to the conditions mentioned in the issue contract, become shareholders of the company which they lent to.
As soon as they convert their bonds into shares, they do not have the status (legal and economical) of a lender (but the status of a shareholder).
The fixed interests paid by reason of convertible bonds are fiscally deductible for the company which lends.
Bonds convertible into shares can sometimes be issued without giving right to a fixed right insofar as the conversion option reserved to the bearer is equivalent to the interest which should have been paid.
Profit Participative Bonds
These bonds allow their holder to benefit from a part of the yearly profit and/or from the proceeds of liquidation of the company which borrows.
These bonds can give right to a fixed interest. The participation in profit constitutes then an additional interest, variable.
However, the interests paid by the company which borrows are not deductible of its taxable base. Indeed, this type of bonds has similarities with the share; the interests paid are besides described as a distribution of dividends.
Equity loans
Equity loans remunerate the creditors according to the profit generated by the company which lends. However, a fixed interest can be paid in addition to the participations in profit.
Within the framework of these loans, the creditor (often a company's partner) stays a sleeping partner and is considered as a last rank creditor. This means that in case of liquidation, he will be paid back after all the others creditors. The interest is considered as a simple loan interest and is so deductible for the company.
Tracker-Certificate
This type of loan generates a variable interest sum of which is not fixed according to the profits of the company but according to the return realized by an underlying asset.
For instance, the dividends and capital gains generated by participation financed with this loan. The interests are deductible for the company and are not considered as profits distribution.
PEC (Preferred Equity Certificates)
It is a hybrid financial instrument which is considered as a debt for the company which borrows and the interests as a dividends for the lender.
The (fixed) interests paid by the company will be fiscally deductible for itself.
The PECs concede no voting right to the creditor who will be subordinated by all other creditors.
CPEC (Convertible Preferred Equity Certificates)
The CPECs are PECs convertible into shares. The choice between one or the other depends on the skills the holder needs to be considered as instrument of capital (and no instrument of debt) in the country in which he is resident.
|
Financial Instrument |
Lender |
Borrower |
Withholding tax |
| Simple bonds | Taxable interests | Deductible interests | No * |
| Convertible bonds | Taxable interests – Exonerated rights of conversion | Deductible interests | No * |
| Participative bonds | Taxable fixed interests + profit participations = dividend | Non deductible interests | 15 % on fixed and variable interest |
|
Equity loan sleeping partner |
Profit participations | No deductible interests | 15 % |
| Tracker-certificate | Taxable interests | Deductible interests | 0 % |
| PEC | Profit participations | Deductible interests | 0 % |
| CPEC |
Profit participations + right conversion |
Deductible interests | 0 % |
