On 1 January 2019, the revised Liechtenstein tax law entered into force. Among other amendments to the tax law, the revision introduced new anti-avoidance rules in connection with dividend income and capital gains derived from participations in foreign entities. Foreign subsidiaries already being held by a Liechtenstein company at 1 January 2019 were able to benefit from a three-year transition period. However, as of tax year 2022, every foreign entity will fall under the scope of the new anti-avoidance rules.
Liechtenstein companies with foreign subsidiaries should review their structure in light of possibly affected subsidiaries and initiate the potentially necessary actions before the end of tax year 2021 (not calendar year).
Liechtenstein’s Government proposed in 2017, based on the demands of the European Union (EU) Code of Conduct Group, to adjust Liechtenstein’s tax law in order to comply with the EU’s requirements. Through the revision of the tax law the following new regulations were introduced:
Implementation of anti-avoidance rules in connection with dividend income and capital gains deriving from participations in
Implementation of anti-avoidance rules regarding the notional interest deduction
Elimination of tax deductibility of depreciation or value adjustments on participations
The new tax law entered into force as of 1 January 2019. However, for foreign participations which were held by a Liechtenstein entity before this effective date, a transition period was provided until tax year 2022. The same transition period applies for dividends derived from foreign foundations, establishments structured in similar ways to foundations and special endowments of assets if the beneficiary relationship existed prior to 1 of January 2019. All other regulations entered into force immediately.
Anti-avoidance rules in connection with dividends and capital gains derived from participations in foreign entities
Before the introduction of Liechtenstein’s revised tax law in 2019, dividends and capital gains were generally tax exempt (neither holding period nor minimal participation quota needed) unless dividend payments from participations exceeding 25% of the voting rights or the capital were treated as tax deductible at the level of the subsidiaries.
The new anti-avoidance rule stipulates that in addition to the above-noted restriction, dividends and capital gains may not profit from the tax exemption if the following requirements are met cumulatively:
More than 50% of the total gross revenue of the foreign legal entity derives from passive sources
Taxable net profits (before taxes) of the foreign legal entity are subject (directly or indirectly) to low taxation
This anti-avoidance rule only applies to dividends and capital gains received from foreign investments. According to Liechtenstein tax law, revenues from passive sources are defined conclusively as interest income, royalties, income from finance leasing as well as dividends and capital gains derived from such passive sources. Entities, in which the participation quota amounts to less than 25% of the voting rights or capital, are regarded as low taxed if they are subject to an effective tax rate of half or less of the Liechtenstein effective tax rate, i.e., 6.25%. If the participation quota is 25% or more, an entity is considered as low taxed if the effective tax burden of that entity under foreign tax law is half or less of the tax burden calculated according to Liechtenstein tax law for equivalent circumstances.
It should be noted that these rules apply to any existing profit reserve at the level of the investment, irrespective of its year of creation (in particular, also reserves created in years before the implementation of the anti-avoidance rules).
Termination of transition period
In order to provide Liechtenstein companies with time to adapt to the new anti-avoidance rules with regards to dividends and capital gains, the Parliament agreed on a three-year transition period applicable for foreign participations already held by Liechtenstein entities prior to 1 January 2019. However, as of tax year 2022, all Liechtenstein taxpayers with investments in foreign subsidiaries will be subject to the new anti-avoidance rules. For entities which do not close their financial year as of 31 December, the transition period expires during 2021 (i.e., with the end of the tax year 2021 of the respective entity).
For income received from foreign foundations, establishments structured in similar ways to foundations and special endowments of assets, the three-year transition period applies likewise if the beneficiary relationship was established before 1 January 2019. Liechtenstein entities receiving such income will need to comply with the anti-avoidance rules as of tax year 2022.
Need for action
Liechtenstein entities which are currently not yet in scope of the anti-avoidance rule relating to foreign dividends and capital gains due to the applicability of the three-year transition period should take this final time period to review their structure with regard to subsidiaries potentially qualifying as passive, and respectively as low taxed. In particular, if a Liechtenstein entity is holding participations domiciled in offshore jurisdictions, further analysis should be made and potential restructuring alternatives considered.
Subsidiaries realizing predominantly passive income may still be considered as active if the passive income derives from an actual business activity (e.g., interest income of a bank). A similar view may be taken for foreign entities engaged in the holding of intellectual property or in financing provided that sufficient functions are allocated at the level of these foreign entities which includes in particular having adequate staffing for performing the foreseen business activities.
Furthermore, for the determination of whether a qualifying subsidiary is low-taxed, a comparison of the actual tax burden with the tax burden resulting if the entity was resident in Liechtenstein needs to be performed. In such calculation it may also need to be considered that Liechtenstein applies a notional interest deduction on modified equity. By doing so, the comparable Liechtenstein tax burden might be below the headline tax rate and, therefore, the threshold for the low-taxation criteria would decrease. In particular, this is relevant for fully equity financed subsidiaries, e.g., financing companies, located in a jurisdiction with low-tax rates.
Based on the outcome of the analysis of the structure, further actions should be considered if certain foreign subsidiaries are qualified as predominantly passive and low taxed. Such actions may consist of reorganizations, a migration to Liechtenstein, the opting-in for a special private wealth tax status in Liechtenstein or dividend planning (or at least a distribution of the retained earnings before tax year end). In the light of the termination of the transition period at the end of 2021 (or during 2021 in the case of a closing of the fiscal year during 2021), taxpayers should promptly take action.
For additional information with respect to this alert, please contact the following:
Ernst & Young AG, St. Gallen
Ernst & Young LLP (United States), Swiss Tax Desk, New York