Taxation of income from capital reduction

Taxation of income from capital reduction

When a company is set up, the share capital is formed by the contributions of the founders. Throughout the life of the company, the partners can increase the capital by new contributions but also by incorporation of reserves. The capital can also be reduced. In some cases, the income from a capital reduction can be taxed.

Taxation of income from a reduction of social capital in the case of a luxembourg tax resident company

Two parts need to be distinguished:

• Shareholder contributions

Income from shareholder contributions are taxed unless the capital reduction is motivated by serious economic reasons ⁽¹⁾ (it needs to be demonstrated that the company had no other choice but the reduction of its capital).

• Capital from incorporated reserves

Income from incorporated reserves are always subject to income tax. Incorporated reserves are the part supposed to be distributed first.

A capital reduction unsupported by economic reasons could lead to a requalification as investment income ⁽²⁾ and hidden profit distribution ⁽³⁾. This would lead to a 15% ⁽⁴⁾ withholding tax and subject the income to tax.

Taxable income in two different countries

When revenue is taxable in two different countries, there is a risk of double taxation. This is the reason why countries often agree on tax treaties to define each country’s taxation authority.

When there is a disagreement on the legal qualification of an income, the country where the income is generated qualifies the revenue according to its national legislation. It then looks at the tax treaty to determine the taxing authority of each state.

1. Article 97, paragraph 3 b) tax law
2. Article 97 paragraph 1 tax law
3. Article 164 paragraph 3 tax law
4. Article 146 and 148 tax law