On 16 June 2014, the Tax Authorities issued a circular letter - Circular L.G.- A n°60 - setting forth a framework of rules governing the functional currency regime (“FCR”) applicable under Luxembourg tax law. The FCR shall allow a corporation to determine the taxable income in the currency of its corporate capital (other than Euro), provided the former represents the main currency of its primary economic environment (“functional currency”). As a result, the triggering of exchange differences in Euro could be avoided since the drawing up of a tax balance sheet in Euro according to Luxembourg tax valuation rules will no longer be required under the FCR.
Scope of the FCR
The FCR shall apply to corporations with a corporate capital expressed in a currency other than Euro and which prepare the accounts and financial statements in this same currency. The above shall apply mutatis mutandis to entities and taxpayers which under Luxembourg tax law have to determine their taxable income based on a comparison of net assets.
The FCR applies to Luxembourg income tax (“LCIT”), municipal business tax (“LMBT”) and net wealth tax (“LNWT”) at the same time.
Opting in but no opting out
The taxpayer shall opt for the FCR by submitting a written request to the Tax Authorities at least three months before the end of the first financial year under the FCR (for corporations newly set up, the request has to be filed before the end of the first financial year). The taxpayer shall also opt for the exchange rate to be used under the FCR (either the average of monthly exchange rates or the exchange rate as at year end, as published by the ECB). The decision to apply the FCR as well as the choice of the exchange rate shall in principle be irrevocable and shall only end further to a change of the currency of the corporate capital.
The computation of the taxable income shall entirely be made in the functional currency. Therefore the profit or loss for the current financial year, non deductible expenses to be added on as well as non-taxable income to be deducted shall accordingly be taken out of the annual accounts expressed in that currency. The carry forward of tax losses triggered under the FCR shall also be made in that currency.
The taxable income shall then be translated into Euro at the applying exchange rate.
Tax credits shall be computed in the functional currency and converted to Euro at the applying exchange rate. The carry forward of tax credits shall only be available in Euro but not in the functional currency.
The tax due shall be computed and the tax assessments shall be issued in Euro. Tax payments and reimbursements continue to be made in Euro.
The above rules apply to both LCIT and LMBT. They apply mutatis mutandis to the LNWT. The relating computations have to be documented in specific enclosures to be attached to the tax return.
Specific transition rules shall apply where a corporation, before opting for the FCR, determined the taxable income based on a tax balance sheet in Euro according to Luxembourg tax valuation rules. In this case the corporation shall prepare a tax balance sheet in Euro for the first year under the FCR. The latter shall be converted back into the functional currency at the applying exchange rate and shall constitute the basis for determining the taxable income in the first and, where needed, in the following years under the FCR.
Tax losses triggered before applying the FCR shall be carried forward with their historic amounts in Euro, converted in the functional currency at the exchange rate applying for the first year under the FCR.
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