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5 June 2025 Joakim-Antoine Charvet - Danièle Buchler - Cyrielle Nis - Adrien Piron - Delphine Martel - Gaëtan Molina Tax

Key Luxembourg tribunal decision: expense deductibility & hidden distributions

On 30 April 2025, the Administrative Tribunal (the “Tribunal”) once again ruled on (i) the deductibility for tax purposes of certain expenses and (ii) their potential requalification as hidden distributions. While it does not introduce any major new developments, the decision serves as an excellent reminder of the main principles applicable to hidden profit distributions.

Context

A Luxembourg company (“LuxCo”), which was wholly-owned and managed by a single individual shareholder (the “Shareholder”), saw some of its expenses challenged by the Luxembourg tax authorities (the “LTA”), such as:

fees paid to a Spanish company (“SpanishCo”) (in which the Shareholder also held a participation) for financial and accounting services, which were supported by an engagement letter concluded between the two companies; and
travel and accommodation expenses.

The LTA rejected the deduction of these expenses and requalified them as hidden distributions, subject to a 15% withholding tax.

Tribunal findings

Rejection of LuxCo’s tax deduction of expenses

The Tribunal recalled the rules applicable to the admission of tax deductible expenses:

Article 45, (1) of the Luxembourg Income Tax Law (“LITL”) provides that expenses incurred exclusively for the purposes of the business are considered deductible business expenses; and
The taxpayer alone can determine the appropriateness of an expense incurred exclusively for the purposes of the business; this being said, the requirement of a causal link does not assess whether the expense was necessary for the activity or actually likely to benefit the business, but only that the expense results exclusively from the company’s business. The burden of proving this causal link thus lies with the taxpayer.

However, in this specific case, the Tribunal found that LuxCo was unable to sufficiently prove the required causal link, as:

the fees invoiced by SpanishCo merely indicated the billing period, without specifying the details of the hours worked or the actual services rendered. In the Tribunal’s view, LuxCo did not submit any document establishing the reality and detail of the various services provided by SpanishCo; and
the travel expenses were neither adequately justified nor even explained,

so that the Tribunal was unable to establish an exclusive link between these expenses and the company’s business.

Requalification of expenses as hidden distributions

The Tribunal recalled that the mere rejection of the deductibility of an expense does not necessarily result in its requalification as a hidden distribution.

Indeed, an expense, which does not meet the requirement of having a sufficiently direct causal link with the business, only constitutes a hidden distribution of profits if, in addition (in line with article 164(3) LITL), the advantage resulting from the assumption of the expense can be considered as allocated, directly or indirectly, to a partner, shareholder or interested party in a form that may give rise to taxable income.

Two conditions must therefore be verified: (i) the allocation of an advantage without effective and equivalent consideration, and (ii) the existence of a special relationship.

In the case at hand, the Tribunal applied these conditions to the disputed expenses:

For the fees paid to SpanishCo:

there clearly was an advantage, since the reality of the services had not been demonstrated, meaning that the compensation (i.e., the fees) should be treated as an undue benefit granted to SpanishCo, or to its beneficial owner; and
regarding the special relationship, the Shareholder (being the sole shareholder of LuxCo) also holds interests in SpanishCo.

As a result, the Tribunal considered both conditions to be met thereby justifying the requalification of the fees as hidden distributions in favour of the Shareholder, which were correctly subject to a 15% withholding tax.

The fact that this income had in parallel been declared and taxed in Spain did not affect this conclusion.

A similar reasoning was applied regarding the travel and accommodation expenses incurred by LuxCo to the benefit of the Shareholder (characterising the special relationship), which were not considered incurred for the needs of LuxCo's business (thereby characterising an advantage).