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### Introduction
- Luxembourg receives ample investment from multinational corporations despite a comparatively high corporate income tax rate.
- Non-tax advantages: international financial center ecosystem, skilled multilingual workforce, stable political and social climate.
- Tax features aiding inbound investment: relatively generous participation exemption regime, low withholding tax rates on dividends, interest, and royalties, and a wide treaty network.
- Around 95 percent of multinational investments pass through Luxembourg via special purpose entities (SPEs).
- SPEs: generate around 3 percent of GDP in tax revenue, create almost 4500 direct jobs, and spend almost 3 percent of GDP on salaries and purchases of business services.
- International tax system changes (OECD Inclusive Framework, EU reforms, US tax revisions) may reduce FDI and corporate income tax revenue; the paper quantifies some potential effects.
- Four directions for revenue mobilization explored: changes in business taxes, greater use of environmental taxes, modernization of housing taxation, and individualization of the personal income tax system to increase female labor participation.

### Business Taxation in Luxembourg — Domestic Tax Law
- Combined corporate income tax rate in Luxembourg City: 24.94 percent.
- Components:
  - National CIT rate: 17 percent (gradually reduced from 21 percent in 2016); applies to corporations with taxable income over EUR 200,000.
  - Surcharge to unemployment fund: 7 percent of the CIT rate, adding 1.19 percentage points (7 percent of 17).
  - Local business tax (municipalities): varies between 6.75 and 10.5 percent; tax base similar to national CIT with thresholds (income over EUR 17,500 for corporations and EUR 40,000 for other businesses).
  - Luxembourg City municipal business tax rate: 6.75 percent, producing overall 24.94 percent combined rate.
- Comparatives: EU average combined rate 21.6 percent; OECD average 23.7 percent.
- Effective tax rates:
  - Marginal Effective Tax Rate (METR), 2018: Luxembourg 11.4 percent; EU median 12.2 percent.
  - Average Effective Tax Rate (AETR), 2018: Luxembourg 22.8 percent (9th highest in the EU).
- Net Wealth Tax (NWT):
  - Rate 0.5 percent applied to total assets minus liabilities up to EUR 500 million.
  - Rate 0.05 percent for net assets above EUR 500 million.
  - NWT can be reduced by the amount of CIT due in the previous year or if a company holds sufficient reserves for a 5-year period.
  - Minimum NWT for most corporations: progressive from EUR 535 (balance sheet up to EUR 350,000) to EUR 32,100 (balance sheet exceeding EUR 30 million).
  - Corporate collective entities with qualifying holding and financing assets pay minimum NWT of EUR 4,815.
- Investment funds:
  - Registered funds at end of 2019: 3779.
  - Subscription tax: 0.05 percent on net assets.
  - Reduced rate 0.01 percent for institutional funds and specialized investment funds.
  - Exemptions: institutional money market funds, exchange traded funds, pension funds, and microfinance funds.
  - Distribution: 30 percent of funds subject to 0.05 percent rate, 26 percent to 0.01 percent rate, 44 percent exempt.
- IP regime (innovation box):
  - Introduced in 2018 to meet nexus requirements.
  - Qualifying IP income receives an 80 percent exemption from CIT and local business tax, and a full exemption from the NWT.

### Business Taxation in Luxembourg — International Aspects
- Participation exemption regime:
  - Luxembourg grants 100% participation exemption under relatively mild conditions.
  - Exemption conditions: 10 percent minimum participation held for at least twelve months; or participation below 10 percent if acquisition price at least EUR 1.2 million and held for at least twelve months.
- Withholding taxes (WHTs):
  - Domestic law: Dividends 15 percent; Interest 0 percent; Royalties 0 percent.
  - Luxembourg extends intra-EU directive benefits to payments to companies residing in a non-EU country if it has a tax treaty with Luxembourg and certain conditions apply (e.g., recipient subject to similar CIT and 10 percent participation or acquisition price EUR 1.2 million held 12 months).
  - Luxembourg has 84 bilateral tax treaties (BTTs) with comparatively low agreed WHT rates, notably on interest.
- Advance rulings and APAs:
  - Advance ruling practice reformed after LuxLeaks (2014); decisions now by a special commission of five tax officials.
  - Filing fee for APA requests: between EUR 3,000 and EUR 10,000 depending on complexity.
  - Transfer price guidelines updated per BEPS Actions 8–10 (Art. 56bis).
  - Participation in automatic exchange of advance cross-border rulings and APAs in the EU.
  - Number of APAs in force: 599 at end-2016, 14 at end-2018.
- Anti-tax avoidance and BEPS compliance:
  - Measures introduced: limits on excessive interest deductibility, tax on passive income in low-tax jurisdictions outside the EU, exit tax, general anti-abuse rule (GAAR), provisions to tackle hybrid mismatches.
  - Modified transfer pricing rules, amended definition of foreign permanent establishment, law on country-by-country reporting, ratified multilateral instrument updates (e.g., against treaty shopping).

### Revenue Performance and Fiscal Implications
- Corporate tax revenue is 6.4 percent of GDP (Figure 4), or 23 percent of total tax revenue.
- Revenue productivity—CIT revenue as a percent of GDP divided by the CIT rate—is 0.19.
- Revenue productivity comparisons: EU average 0.14; OECD average 0.13 (Figure 5).
- Corporate tax-to-GDP ratio in Luxembourg is twice the average in the EU and OECD (Figure 6).
- Corporate tax revenue increased from 4.3 percent of GDP in 2014 to over 6 percent today.
- Temporary factors:
  - Part of the increase likely due to switch to mandatory electronic filing from tax year 2017 onward; quarterly tax receipts show a significant uptick in collections in 2018Q4 and 2019Q1 before returning to prior numbers (STATEC 2019).
- Additional corporate taxes:
  - Corporate net wealth tax raised EUR 0.7 billion in 2018, which is 1.1 percent of GDP.
  - Taxes on capital income (such as dividend withholding tax) brought in EUR 0.5 billion (0.9 percent of GDP).
  - Together with the CIT, taxes on corporate businesses are almost 8 percent of GDP (Figure 4).

### Special Purpose Entities (SPEs) and SOPARFIs: scale, role, and domestic contributions
- Definition (IMF Task Force): legal entities with little or no physical presence (e.g. less than 5 employees), controlled by a non-resident, established to obtain specific advantages, and primarily transacting with non-residents.
- SOPARFIs:
  - Number registered in Luxembourg in 2019: 45,613; grown by over a quarter over the last decade.
  - BCL 2018 survey: SPEs in Luxembourg had total balance sheet of EUR 8,600 bln.
    - Around 60 percent of assets held by SPEs specializing in intragroup lending; 30 percent held by pure holding companies.
  - Selected figures (Table 3):
    - Number of SOPARFIs/SPEs: Luxembourg (2018) 45,231; Netherlands (2016) 15,000.
    - Balance sheet total Luxembourg: EUR 8,600 bln; Netherlands: EUR 4,400 bln.
    - Total foreign income received by SPEs Luxembourg: EUR 85 bln (Share: Dividend 68%, Interest 30%, Royalties 2%).
    - Total payments made by SPEs to foreign jurisdictions Luxembourg: EUR 67 bln (Share: Dividend 54%, Interest 40%, Royalties 6%).
    - Contribution of SPEs to the economy Luxembourg: EUR 0.5 bln salaries; EUR 1.2 bln business services (4,465 direct jobs); EUR 1.6 bln business tax revenue.
  - SPEs account for the lion share of reported FDI in and out of Luxembourg:
    - BCL 2019Q3: stock of inbound FDI EUR 4.4 trillion; stock of outbound FDI EUR 5.2 trillion.
    - More than 95 percent of these FDI stocks are associated with SPEs (Figure 9b).
  - Large stock of foreign portfolio investment (FPI) also contributes to SPE balance sheets:
    - 2019Q3 inbound FPI EUR 5.4 trillion; outbound FPI EUR 4.3 trillion.
- Domestic economic contributions of SPEs:
  - SPEs spend almost 3 percent of GDP on salaries and purchases of business services and add 3 percent of GDP in business tax revenue.
    - Data for approximately 42,000 SPEs: EUR 508 million (0.9 percent of GDP) on salaries in 2018; EUR 1.2 billion on audit, legal, and accounting fees (2.1 percent of GDP).
  - Employment in SPEs grew from 690 jobs in 2005 to 4,465 in 2018.
  - Combined tax payments and domestic spending mean SPEs add 5.9 percent of GDP to the Luxembourg economy.

### Recent international tax changes and observed impacts
- International changes reshaping tax outcomes:
  - OECD BEPS Project (final package agreed in 2015) with four ‘minimum standards’; development of multilateral instrument (MLI). Luxembourg has signed and ratified the MLI.
  - EU Anti-Tax Avoidance Directives (ATAD I and II); Luxembourg has legislation in place to comply per 2020.
  - Unilateral measures such as the US Tax Cuts and Jobs Act: federal CIT rate cut from 35 to 21 percent and shift from worldwide to territorial regime.
- Observed tentative signs of change in Luxembourg’s economy and revenue mix:
  - Large negative gross FDI inflow of €400 billion in 2018 and 2019, versus gross inflows of €200 to 600 billion over the past 5 years (Figure 11).
  - US repatriation example: repatriation of dividends by US-owned MNEs in Luxembourg increased from US$ 6.5 billion in 2017 to US$ 28.5 billion in 2018 (reflecting negative reinvestment of earnings, BEA 2019). In 2018, US$ 232 billion of capital withdrawn from Luxembourg into the Netherlands; US MNEs repatriated US$ 139 billion of dividends from the Netherlands.
  - Number of SOPARFIs declined from 46,238 in 2016 to 45,613 in 2019.
  - Balance sheets of SPEs fell from EUR 9,6 trillion in 2016 to EUR 8,6 trillion in 2018, mainly due to reduction of participating interests in pure holding companies (from EUR 3.4 to 2.7 trillion).
  - Share of US assets dropped between 2016 and 2018 from 25 to 18 percent (Feuvrier 2019).
  - Intragroup loans to foreign affiliates dropped from EUR 1.7 trillion in 2016 to EUR 1.4 trillion in 2018 (Feuvrier 2019).
  - Interest income from abroad peaked at 104 percent of GDP in 2013, falling to 53 percent of GDP in 2018 (Figure 12).
  - Composition of CIT payments shifted away from SPEs toward other companies; share of national and sub-national CIT revenue generated by SOPARFIs has stopped rising since 2018 and declined somewhat in 2019 (Figure 13).

### Possible future international tax reforms analyzed
- OECD Inclusive Framework proposals (aiming for consensus by mid-2021):
  - Pillar 1: new “nexus” approach addressing digital economy; attributes portion of profit to market jurisdictions using formulary methods rather than arm’s-length pricing.
  - Pillar 2: design of a minimum level of taxation of multinationals globally for in- and outbound investment.
- EU debate on a common consolidated corporate tax base (CCCTB) with formula apportionment using weights of employment, payroll, assets and sales by destination.
- Analytical focus of the paper:
  - Formula apportionment with profit allocation based on either source or market factors.
  - Introduction of minimum taxes on either outbound or inbound investment.
  - Estimates partly based on country-by-country reports (CbCR) filed in Luxembourg for the tax year 2016.

### Box 1 — Luxembourg Country-by-Country Reports, 2016 (key points)
- Dataset covers 120 large MNEs headquartered in Luxembourg and 85 MNEs headquartered elsewhere but operating in Luxembourg.
- Data aggregated for full sample of 120 MNEs and separately for 52 headquartered MNE groups that made a profit in 2016.
- Data limitations: double counting from intracompany dividends, stateless entities, related-party transactions, and timing issues (deferred taxes, provisions).
- Sample characteristics:
  - The 120 Luxembourg-headquartered MNEs operate on average in 21 jurisdictions.
  - Main jurisdictions include the US, large EU countries, Brazil, Kazakhstan and Mexico.
- Key statistics:
  - Global employment by these MNEs: 1.5 million people.
  - Employment in Luxembourg: 15,000 (1 percent of the global total for these MNEs).
  - Tangible assets owned: US$210 billion.
  - Tangible assets located in Luxembourg: US$ 25billion (12 percent of the total tangible assets).

### Analytical results — Formula Apportionment (FA), OECD Unified Approach (“Amount A”), and Minimum Taxes
- C. Formula Apportionment (FA) — revenue and economic impacts
  - Luxembourg would lose around 70 percent of the tax currently paid by US-based MNEs, irrespective of the allocation formula used, including one based on sales by destination.
  - FA attributes profits to where formula factors are located; an important part of the tax base of Luxembourg SOPARFIs would therefore disappear under FA.
  - FA may encourage relocation of real factors to low-CIT countries; Luxembourg’s relatively high CIT rate implies behavioral responses will likely exacerbate revenue losses and economic costs.
  - European Commission CCCTB assessment (2016): Luxembourg would experience a reduction in welfare between 0.6 and 1 percent of GDP.
  - Financial sector special treatment under FA could mitigate but not necessarily undo negative results; modified formulas (e.g., include a portion of financial assets) reduce losses.
  - BEA-based analysis for US-based MNEs:
    - If financial assets excluded, revenue loss is 74 percent (approximately 1 percent of GDP).
    - If 10 percent of financial assets included in asset-based formula, revenue loss declines to less than 3 percent.
  - Fitch-based analysis for 18 multinational banks (2016):
    - Consolidated global profit: US$96 billion; profit reported in Luxembourg: US$653 million.
    - Tax liability in Luxembourg: US$124 million (implying an effective tax rate of 18.9 percent); global tax: US$5.4 billion (implying an average tax rate of 22 percent).
    - Under FA, Luxembourg would lose between 8 and 38 percent of the tax revenue from these banks.
    - Revenue loss largest for employment factor; including asset factor (fixed assets plus 10 percent of financial assets) or loans/deposits factor reduces loss to less than 10 percent.
- D. OECD’s Unified Approach — “Amount A” and estimated effects
  - “Amount A” reallocates a fixed share of residual profits (profits exceeding a routine return threshold) to market countries based on their share in third-party sales.
  - Using Luxembourg’s CbCR data for profit-making MNEs headquartered in Luxembourg:
    - Residual global profit (surplus over either a 7.5 percent mark-up on third-party sales or a 10 percent return on fixed assets) is respectively 33 and 65 percent of total profits.
    - If 20 percent of those excess profits are reallocated under Amount A, this would apply to between 6.6 and 13 percent of global MNE profits (US$ 2.8 – 5.6 billion).
    - Using sales by origin to allocate profits, Luxembourg would receive 2.2 percent of the residual.
    - If Luxembourg surrenders a portion of the current tax base proportional to its share in global reported profit of MNEs, this surrender would be 19.2 percent.
    - On balance, Luxembourg would lose 17 percentage points of its tax base related to residual profits (Amount A), equivalent to 12 percent of Luxembourg’s current tax base.
    - As an upper bound the revenue loss would be between 5.8 and 11.5 percent of total current tax collections from large MNEs (US$ 7-13 million).
    - If the portion surrendered by Luxembourg is proportional to its share of residual profit (32 percent based on mark up, or 22 percent based on fixed assets), the revenue loss would be between 10 and 14 percent of current tax collections.
- E. Minimum Taxes — outbound and inbound measures and implications
  - Global minimum tax: ambiguous revenue implications for Luxembourg due to potential behavioral responses and low-tax jurisdictions’ adjustments.
  - Minimum tax on outbound foreign investment (reminiscent of GILTI):
    - CbCR data: share of profits earned in countries where effective tax rate of the MNE sub-group is reported below 10 percent exceeds 60 percent.
    - Upper bound potential base for the minimum tax: US$16 billion (almost twice the current profit of these MNEs in Luxembourg).
    - Each percentage point of minimum tax could raise US$ 160 million in revenue.
    - A global blending approach would reduce revenue to one-third smaller.
    - Indirect effects: low-tax jurisdictions may raise effective tax rates to the global minimum, nullifying revenue gain in Luxembourg; MNEs may shift behavior reducing Luxembourg’s revenue.
  - Minimum tax on inbound foreign investment (reminiscent of BEAT):
    - Could deny certain deductible payments (intracompany interest or royalties) or impose WHTs conditional on recipient country tax rate below minimum.
    - BCL data: approximately 60 percent of all foreign debt in Luxembourg is held by countries with a CIT rate below 10 percent.
    - Net foreign interest income in Luxembourg (balance of payments) is around 4 percent of GDP; assuming 60 percent comes from low-tax jurisdictions, if taxed at 25 percent revenue at risk would be around 0.6 percent of GDP.
    - Indirect effects: denying deductions or imposing WHTs could remove intracompany lending activities in Luxembourg and cause adverse revenue effects.
  - Note: Estimates abstract from exclusions (e.g., extractive industries or banks) and scope limitations which would reduce the size of excess profits subject to reallocation.

### IV. Potential Reform Directions — options if structural business tax revenue falls
- Four robust reform directions: (i) business tax reform; (ii) environmental taxes; (iii) property tax; and (iv) personal tax reform.

- A. Business Tax Reform — constraints and options
  - Limited domestic options to strengthen business tax revenue:
    - CIT rate is already relatively high and pressures likely downward due to tax competition (global minimum tax could mitigate this).
    - CIT base is not particularly narrow; base broadening (e.g., tax depreciation, loss offset) risks increasing METR and hurting real investment incentives.
    - Reform of the IP box could be considered; IP boxes are generally not most cost-effective at stimulating innovation and could be replaced by R&D tax credits; revenue effect would be modest.
  - Reform of corporate net wealth tax:
    - Net corporate wealth tax imposes large disincentives to investment and magnifies debt bias; it is levied independent of profit, harming small loss-making companies.
    - Repeal has economic appeal but net wealth tax currently raises 1.2 percent of GDP in revenue.
    - Mitigation option: maintain in some form a minimum asset tax on SOPARFIs or transform into a registration fee; a fee of EUR 4,815 on each of the 45,000 SOPARFIs would generate EUR 220 million, approximately 0.4 percent of GDP.
  - Consider introducing a financial activities tax:
    - Levy on sum of financial institutions’ profits and remuneration (value added) or only on economic profit of financial institutions.
    - With financial sector value added share in GDP of 26 percent (data for 2006), a 4 percent tax rate could raise 1 percent of GDP; if applied only to economic profits, could generate 0.6 percent of GDP.

- B. Environmental Tax Reform — revenue and climate co-benefits
  - Environmental taxes correct pollution externalities; Luxembourg’s environmental taxes currently yield one of the lowest revenues in the EU.
  - Luxembourg climate commitment: target CO2 emissions reduction of 55 percent below 2005 levels for non-ETS sectors (in line with EU target of reducing greenhouse emissions by at least 55 percent).
  - Emissions profile (2015): total 10.3 MtCO2e; road fuel sales to non-residents account for 39 percent, fuel use by national road fleet 17 percent, manufacturing 16 percent. Power sector contributes only a small amount.
  - Carbon tax plan:
    - Starting in 2021, introduce carbon tax of EUR 20/tCO2e for non-ETS sectors, gradually raise to EUR 30/tCO2e.
    - Authorities expect the tax to raise around 0.25 percent of GDP in revenue in 2021.
    - Carbon tax will increase tax on gasoline and diesel by just over 10 eurocents by 2023.
    - Fully capturing negative externalities would require consumer prices of around EUR 2 per liter.
  - Road user pricing and congestion charging:
    - Examples: London flat US$ 15 per day; Singapore around US$ 4 per passage; Stockholm around US$ 4 per passage.
    - Annual net revenues in these cities range from US$ 100 million to US$ 182 million with traffic reduction around 20 percent.
    - Luxembourg drivers spend 37 hours in congestion annually (fourth longest in EU).
    - Implementing congestion charging challenging due to high number of foreign-registered vehicles; collection arrangements (e.g., London’s use of a European company) can improve collection rates.
  - Higher registration fees and recurrent motor vehicle taxes can support revenue mobilization and climate mitigation.
  - Vehicle taxation and emissions:
    - Recurrent tax for a typical passenger car in Luxembourg: EUR 118 per year (Figure 18).
    - Germany: annual tax on the same car is EUR 246.
    - Average new-car CO2 emissions:
      - Luxembourg: 131.4 gCO2/km.
      - European average: 120.6 gCO2/km.
    - Thirty countries in Europe have a one-off registration tax linked to CO2 emissions; Luxembourg has a flat registration fee of 50 euros.
    - Policy simulation: changing recurrent motor vehicle tax to lower threshold from 90gCO2/km to 50gCO2/km and increase penalty from 0.1 to 0.2 euros could yield additional 0.1 percent of GDP in revenue.
    - Current motor vehicle tax formula: Tax = a x b x c, where:
      - a = emissions of the vehicle;
      - b = 1.5 if the vehicle is diesel or 1 if the vehicle is anything other than diesel;
      - c = 0.5 when the emissions do not exceed 90gCO2/km and is incremented by 0.10 for each additional 10g of CO2/km.
  - VAT and energy taxation:
    - Electricity and natural gas taxed at a reduced VAT rate of 8 percent (standard rate 17 percent).
    - Heating gas oil VAT rate is 14 percent.
    - Removing reduced VAT rates on electricity, natural gas and heating gas oil—while protecting the most vulnerable—would help reach Luxembourg’s energy efficiency target of a 44 percent reduction in final energy demand relative to baseline in 2030.
    - Long-term revenue effect of removing preferential VAT treatment for electricity, natural gas and heating gas oil is expected to be 0.1 percent of GDP.
    - Recommendation: preferential VAT rates are an inefficient method of protecting vulnerable households; targeted cash transfers to low-income households are recommended instead.

- C. Housing tax reform
  - Recurrent property tax revenue is among the lowest in the EU at less than 0.1 percent of GDP (Figure 19).
  - Underlying valuations are based on a valuation regime from 1941, so property taxes are a small fraction of current market values.
  - Housing supply pressures:
    - Land available for housing construction is mainly privately owned; 33 percent of such land are plots enclosed in urbanized areas that are already serviced and available for immediate development (OECD 2019).
    - Law of 17 April 2018 on spatial planning encouraged municipalities to allocate previously unallocated land to residential areas, but this has not resulted in a significant increase in housing supply.
    - Result: increasing gap between housing demand and supply, upward pressure on house prices, decreased affordability.
  - Policy options to support housing supply and raise revenue:
    - Taxes on unused land and unoccupied dwellings could stimulate construction and housing occupation and reduce pressures on housing prices.
    - The 2008 Housing Pact allows municipalities to levy an annual specific tax on unused constructible land and unoccupied housing; only 8 out of 102 municipalities have introduced such a levy.
    - Central government options to encourage municipal use:
      - Require municipalities to use this tax as a precondition for receiving grants (recommendation by Conseil Economique et Social in 2018).
      - Central government could levy an additional, gradually increasing tax on unused land and unoccupied dwellings.
    - International example: Seoul taxes land parcels left vacant for two years at 5 percent property tax (instead of the normal 2 percent); 7 and 8 percent tax applies for land left vacant for three and five years respectively.

- D. Personal income tax (PIT) reform and labor supply
  - Current system:
    - Luxembourg uses a traditional family-based taxation model with income splitting for married couples and registered domestic partnerships: incomes aggregated and split in two equal halves that are taxed at the prevailing progressive rate structure.
    - Since 2018, Luxembourg allows couples to voluntarily opt for individual taxation, with deductions equally split between partners; the option is almost never beneficial compared to income splitting.
  - Distortions and gender effects:
    - Income splitting can create a “marriage bonus” and distort cohabitation choices.
    - In progressive systems, income splitting reduces marginal tax rates of primary earner and raises them for secondary earner (often women), disadvantaging women and discouraging overall labor supply.
  - Transition recommendations:
    - Transition to individualized PIT can be smoothened by family-based allowances or tax credits that are gradually phased out.
    - Example: United Kingdom introduced individual taxation combined with a new tax allowance for married couples, phased out over ten years.
  - Empirical evidence and simulations:
    - Ex-post evaluations show positive employment effects from individualizing the PIT (Czech Republic, Canada, Sweden, US).
    - Netherlands reform (2001): removing basic tax deduction transfer to non-working spouse increased female labor-force participation in couples by 1.2 percentage points (Euwals 2008).
    - Jaumotte (2004) simulations:
      - For an average OECD country, eliminating tax discrimination against secondary earners would raise female labor-force participation by 3.9 percentage points.
      - For Luxembourg, simulations suggest an increase of 1.8 percentage points.
  - Luxembourg female labor-force participation:
    - 67.4 percent in 2018.
    - Comparisons: Denmark 76.6, the Netherlands 75.8, Switzerland 79.9, Sweden 81.2, United Kingdom 73.6.

*Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020264-print-pdf.pdf*

### References _______________________________________________________________________________________ 34

### wpiea2020264-print-pdf - References _______________________________________________________________________________________ 34

### Introduction
- Luxembourg receives ample investment from multinational corporations despite a comparatively high corporate income tax rate.
- Non-tax advantages: international financial center ecosystem, skilled multilingual workforce, stable political and social climate.
- Tax features aiding inbound investment: relatively generous participation exemption regime, low withholding tax rates on dividends, interest, and royalties, and a wide treaty network.
- Around 95 percent of multinational investments pass through Luxembourg via special purpose entities (SPEs).
- SPEs: generate around 3 percent of GDP in tax revenue, create almost 4500 direct jobs, and spend almost 3 percent of GDP on salaries and purchases of business services.
- International tax system changes (OECD Inclusive Framework, EU reforms, US tax revisions) may reduce FDI and corporate income tax revenue; the paper quantifies some potential effects.
- Four directions for revenue mobilization explored: changes in business taxes, greater use of environmental taxes, modernization of housing taxation, and individualization of the personal income tax system to increase female labor participation.

### Business Taxation in Luxembourg — Domestic Tax Law
- Combined corporate income tax rate in Luxembourg City: 24.94 percent.
- Components:
  - National CIT rate: 17 percent (gradually reduced from 21 percent in 2016); applies to corporations with taxable income over EUR 200,000.
  - Surcharge to unemployment fund: 7 percent of the CIT rate, adding 1.19 percentage points (7 percent of 17).
  - Local business tax (municipalities): varies between 6.75 and 10.5 percent; tax base similar to national CIT with thresholds (income over EUR 17,500 for corporations and EUR 40,000 for other businesses).
  - Luxembourg City municipal business tax rate: 6.75 percent, producing overall 24.94 percent combined rate.
- Comparatives: EU average combined rate 21.6 percent; OECD average 23.7 percent.
- Effective tax rates:
  - Marginal Effective Tax Rate (METR), 2018: Luxembourg 11.4 percent; EU median 12.2 percent.
  - Average Effective Tax Rate (AETR), 2018: Luxembourg 22.8 percent (9th highest in the EU).
- Net Wealth Tax (NWT):
  - Rate 0.5 percent applied to total assets minus liabilities up to EUR 500 million.
  - Rate 0.05 percent for net assets above EUR 500 million.
  - NWT can be reduced by the amount of CIT due in the previous year or if a company holds sufficient reserves for a 5-year period.
  - Minimum NWT for most corporations: progressive from EUR 535 (balance sheet up to EUR 350,000) to EUR 32,100 (balance sheet exceeding EUR 30 million).
  - Corporate collective entities with qualifying holding and financing assets pay minimum NWT of EUR 4,815.
- Investment funds:
  - Registered funds at end of 2019: 3779.
  - Subscription tax: 0.05 percent on net assets.
  - Reduced rate 0.01 percent for institutional funds and specialized investment funds.
  - Exemptions: institutional money market funds, exchange traded funds, pension funds, and microfinance funds.
  - Distribution: 30 percent of funds subject to 0.05 percent rate, 26 percent to 0.01 percent rate, 44 percent exempt.
- IP regime (innovation box):
  - Introduced in 2018 to meet nexus requirements.
  - Qualifying IP income receives an 80 percent exemption from CIT and local business tax, and a full exemption from the NWT.

### Business Taxation in Luxembourg — International Aspects
- Participation exemption regime:
  - Luxembourg grants 100% participation exemption under relatively mild conditions.
  - Exemption conditions: 10 percent minimum participation held for at least twelve months; or participation below 10 percent if acquisition price at least EUR 1.2 million and held for at least twelve months.
  - Of listed countries, only the United Kingdom has a more generous provision.
- Withholding taxes (WHTs):
  - Domestic law: Dividends 15 percent; Interest 0 percent; Royalties 0 percent.
  - Luxembourg extends intra-EU directive benefits to payments to companies residing in a non-EU country if it has a tax treaty with Luxembourg and certain conditions apply (e.g., recipient subject to similar CIT and 10 percent participation or acquisition price EUR 1.2 million held 12 months).
  - Luxembourg has 84 bilateral tax treaties (BTTs) with comparatively low agreed WHT rates, notably on interest.
- Advance rulings and APAs:
  - Advance ruling practice reformed after LuxLeaks (2014); decisions now by a special commission of five tax officials.
  - Filing fee for APA requests: between EUR 3,000 and EUR 10,000 depending on complexity.
  - Transfer price guidelines updated per BEPS Actions 8–10 (Art. 56bis).
  - Participation in automatic exchange of advance cross-border rulings and APAs in the EU.
  - Number of APAs in force: 599 at end-2016, 14 at end-2018.
- Anti-tax avoidance and BEPS compliance:
  - Measures introduced: limits on excessive interest deductibility, tax on passive income in low-tax jurisdictions outside the EU, exit tax, general anti-abuse rule (GAAR), provisions to tackle hybrid mismatches.
  - Modified transfer pricing rules, amended definition of foreign permanent establishment, law on country-by-country reporting, ratified multilateral instrument updates (e.g., against treaty shopping).

### Revenue Performance and Fiscal Implications
- 2019 CIT revenue (national CIT (IRC), solidarity surcharge and subnational CIT (ICC)) on a cash basis: EUR 3.9 billion.
- Observations:
  - Relatively high CIT revenue reflects a broad tax base and strong collection practices including electronic filing.
  - SPE-dominated FDI is large and mobile; internationally coordinated tax reforms and changes in global tax policy could reduce Luxembourg’s corporate tax base and FDI positions.
- Policy directions explored to strengthen and diversify the revenue base:
  - Changes in business taxes.
  - Greater use of environmental taxes.
  - Modernization of housing taxation.
  - Individualization of the personal income tax system to increase female labor participation.

*Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020264-print-pdf.pdf*

### 6.4 percent of GDP (Figure 4), or 23 percent of total tax revenue. Revenue productivity—CIT

### wpiea2020264-print-pdf - 6.4 percent of GDP (Figure 4), or 23 percent of total tax revenue. Revenue productivity—CIT

### Corporate tax revenue levels and productivity
- Corporate tax revenue is 6.4 percent of GDP (Figure 4), or 23 percent of total tax revenue.
- Revenue productivity—CIT revenue as a percent of GDP divided by the CIT rate—is 0.19.
- Revenue productivity comparisons: EU average 0.14; OECD average 0.13 (Figure 5).
- Corporate tax-to-GDP ratio in Luxembourg is twice the average in the EU and OECD (Figure 6).
- Corporate tax revenue increased from 4.3 percent of GDP in 2014 to over 6 percent today.
- Part of the increase is likely temporary due to switch to mandatory electronic filing from tax year 2017 onward; quarterly tax receipts show a significant uptick in collections in 2018Q4 and 2019Q1 before returning to prior numbers (STATEC 2019).
- Two additional corporate taxes yield combined revenue equivalent to 2 percent of GDP:
  - Corporate net wealth tax raised EUR 0.7 billion in 2018, which is 1.1 percent of GDP.
  - Taxes on capital income (such as dividend withholding tax) brought in EUR 0.5 billion (0.9 percent of GDP).
- Together with the CIT, taxes on corporate businesses are almost 8 percent of GDP (Figure 4).

### Composition of business tax revenue by sector
- More than three quarters of business tax revenue comes from the financial sector, including SOPARFIs.
- National and subnational CIT payments can be divided into four groups each paying roughly one quarter:
  - (i) banks;
  - (ii) insurance and other financial institutions;
  - (iii) SOPARFIs;
  - (iv) non-financial companies (Figure 7a).
- In 2018:
  - SOPARFIs generated more than 70 percent of the net wealth tax (Figure 7b).
  - SOPARFIs generated approximately 50 percent of the dividend withholding tax.
  - SOPARFIs paid approximately EUR 1.6 billion in tax, slightly over one third of total business tax, or roughly 3 percent of GDP.

### Special Purpose Entities (SPEs) and SOPARFIs: scale and role
- Definition: SPEs defined per IMF Task Force as legal entities with little or no physical presence (e.g. less than 5 employees), controlled by a non-resident, established to obtain specific advantages, and primarily transacting with non-residents (IMF 2018b).
- In Luxembourg, SPEs are usually associated with SOPARFIs, a tax-administration/STATEC classification.
- Number of SOPARFIs: 45,613 registered in Luxembourg in 2019; grown by over a quarter over the last decade (Figure 8).
- BCL 2018 survey: SPEs in Luxembourg had total balance sheet of EUR 8,600 bln.
  - Around 60 percent of assets held by SPEs specializing in intragroup lending; 30 percent held by pure holding companies.
- Table 3 (selected figures):
  - Number of SOPARFIs/SPEs: Luxembourg (2018) 45,231; Netherlands (2016) 15,000.
  - Balance sheet total Luxembourg: EUR 8,600 bln; Netherlands: EUR 4,400 bln.
  - Total foreign income received by SPEs Luxembourg: EUR 85 bln (Share: Dividend 68%, Interest 30%, Royalties 2%).
  - Total payments made by SPEs to foreign jurisdictions Luxembourg: EUR 67 bln (Share: Dividend 54%, Interest 40%, Royalties 6%).
  - Contribution of SPEs to the economy Luxembourg: EUR 0.5 bln salaries; EUR 1.2 bln business services (4,465 direct jobs); EUR 1.6 bln business tax revenue.
- SPEs account for the lion share of reported FDI in and out of Luxembourg:
  - BCL 2019Q3: stock of inbound FDI EUR 4.4 trillion; stock of outbound FDI EUR 5.2 trillion.
  - More than 95 percent of these FDI stocks are associated with SPEs (Figure 9b).
- Large stock of foreign portfolio investment (FPI) also contributes to SPE balance sheets:
  - 2019Q3 inbound FPI EUR 5.4 trillion; outbound FPI EUR 4.3 trillion.

### Domestic economic contributions of SPEs
- SPEs spend almost 3 percent of GDP on salaries and purchases of business services and add 3 percent of GDP in business tax revenue.
  - Data for approximately 42,000 SPEs: EUR 508 million (0.9 percent of GDP) on salaries in 2018; EUR 1.2 billion on audit, legal, and accounting fees (2.1 percent of GDP).
- Employment in SPEs grew from 690 jobs in 2005 to 4,465 in 2018.
- Combined tax payments and domestic spending mean SPEs add 5.9 percent of GDP to the Luxembourg economy.

### Recent international tax changes and observed impacts
- International changes contributing to reshaping tax outcomes include:
  - OECD BEPS Project (final package agreed in 2015) with four ‘minimum standards’; development of multilateral instrument (MLI). Luxembourg has signed and ratified the MLI.
  - EU Anti-Tax Avoidance Directives (ATAD I and II); Luxembourg has legislation in place to comply per 2020.
  - Unilateral measures such as the US Tax Cuts and Jobs Act: federal CIT rate cut from 35 to 21 percent and shift from worldwide to territorial regime.
- Observed tentative signs of change in Luxembourg’s economy and revenue mix:
  - Large negative gross FDI inflow of €400 billion in 2018 and 2019, versus gross inflows of €200 to 600 billion over the past 5 years (Figure 11).
  - US repatriation example: repatriation of dividends by US-owned MNEs in Luxembourg increased from US$ 6.5 billion in 2017 to US$ 28.5 billion in 2018 (reflecting negative reinvestment of earnings, BEA 2019). In 2018, US$ 232 billion of capital withdrawn from Luxembourg into the Netherlands; US MNEs repatriated US$ 139 billion of dividends from the Netherlands.
  - Number of SOPARFIs declined from 46,238 in 2016 to 45,613 in 2019.
  - Balance sheets of SPEs fell from EUR 9,6 trillion in 2016 to EUR 8,6 trillion in 2018, mainly due to reduction of participating interests in pure holding companies (from EUR 3.4 to 2.7 trillion).
  - Share of US assets dropped between 2016 and 2018 from 25 to 18 percent (Feuvrier 2019).
  - Intragroup loans to foreign affiliates dropped from EUR 1.7 trillion in 2016 to EUR 1.4 trillion in 2018 (Feuvrier 2019).
  - Interest income from abroad peaked at 104 percent of GDP in 2013, falling to 53 percent of GDP in 2018 (Figure 12).
  - Composition of CIT payments shifted away from SPEs toward other companies; share of national and sub-national CIT revenue generated by SOPARFIs has stopped rising since 2018 and declined somewhat in 2019 (Figure 13).

### Possible future international tax reforms discussed and analytical focus
- Ongoing debates and proposals:
  - OECD Inclusive Framework proposals organized around two pillars (aiming for consensus by mid-2021):
    - Pillar 1: new “nexus” approach addressing digital economy; attributes portion of profit to market jurisdictions using formulary methods rather than arm’s-length pricing.
    - Pillar 2: design of a minimum level of taxation of multinationals globally for in- and outbound investment.
  - EU debate on a common consolidated corporate tax base (CCCTB) with formula apportionment using weights of employment, payroll, assets and sales by destination.
- The paper analyzes possible revenue effects for Luxembourg from:
  - Formula apportionment with profit allocation based on either source or market factors.
  - Introduction of minimum taxes on either outbound or inbound investment.
- Estimates are partly based on country-by-country reports (CbCR) filed in Luxembourg for the tax year 2016 (Box 1).

*Source: IMF staff estimates and government/central bank data as presented in the content unit.*

### Box 1. Luxembourg Country-by-Country Reports, 2016

### Box 1. Luxembourg Country-by-Country Reports, 2016

### Overview
- Country-by-country reports (CbCR) for Luxembourg in 2016 provide data for 120 large MNEs headquartered in Luxembourg.
- The dataset also provides data for 85 MNEs headquartered elsewhere but operating in Luxembourg—mostly Chinese MNEs that use Luxembourg as a sales hub.
- The focus here is on the 120 Luxembourg-headquartered MNEs.
- Data have been aggregated for both the full sample of 120 MNEs and separately for the 52 headquartered MNE groups that made a profit in 2016.
- The CbCR data also provide aggregate information for each host country.
- The data have been published, along with those of 25 other countries, in OECD (2020c).

### Data limitations (interpretation caveats)
- Inclusion of intracompany dividends in profits can result in double counting and substantially lower effective tax rates.
- Treatment of stateless entities can lead to double counting if they are tax transparent, as both the stateless entity and the owner may report the profit.
- As CbCR reports represent an aggregation of separate accounts of each affiliate, revenue may be overstated due to related-party transactions.
- Timing issues: CbCR data do not include deferred taxes or provisions for uncertain tax liabilities.

### Sample characteristics
- The 120 Luxembourg-headquartered MNEs operate on average in 21 jurisdictions.
- Main jurisdictions include the US, large EU countries, Brazil, Kazakhstan and Mexico.

### Key statistics
- Global employment by these MNEs: 1.5 million people.
- Employment in Luxembourg: 15,000 (1 percent of the global total for these MNEs).
- Tangible assets owned: US$210 billion.
- Tangible assets located in Luxembourg: US$ 25billion (12 percent of the total tangible assets).

*Source: wpiea2020264-print-pdf - Box 1. Luxembourg Country-by-Country Reports, 2016.*

### Box 1. Luxembourg Country-by-Country Reports, 2016 (Concluded)

### Box 1. Luxembourg Country-by-Country Reports, 2016 (Concluded)

### C. Formula Apportionment (FA) — revenue and economic impacts
- Luxembourg would lose around 70 percent of the tax currently paid by US-based MNEs, irrespective of the allocation formula used, including one based on sales by destination.
- FA attributes profits to where formula factors are located (physical production factors or sales), not where interest margins or IP income are booked; an important part of the tax base of Luxembourg SOPARFIs would therefore disappear under FA.
- FA may encourage relocation of real factors to low-CIT countries, and given Luxembourg’s relatively high CIT rate, behavioral responses will likely exacerbate revenue losses and economic costs.
- An economic impact assessment of the CCCTB by the European Commission in 2016 finds Luxembourg would experience a reduction in welfare between 0.6 and 1 percent of GDP.
- Financial sector special treatment under FA could mitigate but unlikely undo negative results; experience in Canada and the US and the CCCTB proposal suggest modified formulas for financial companies (e.g., include a portion of financial assets).
- Analysis using BEA data for US-based MNEs:
  - If financial assets are excluded, revenue loss is 74 percent (approximately 1 percent of GDP).
  - If 10 percent of financial assets are included in the asset-based formula, revenue loss declines to less than 3 percent.
- Analysis using Fitch data for 18 multinational banks with presence in Luxembourg (2016):
  - Consolidated global profit: US$96 billion; profit reported in Luxembourg: US$653 million.
  - Tax liability in Luxembourg: US$124 million (implying an effective tax rate of 18.9 percent); global tax: US$5.4 billion (implying an average tax rate of 22 percent).
  - Under FA, Luxembourg would lose between 8 and 38 percent of the tax revenue from these banks.
  - Revenue loss is largest for the employment factor due to the relatively small share of employees from these banks in Luxembourg.
  - When the asset factor (including fixed assets plus 10 percent of financial assets) or a factor based on loans and deposits is used, the revenue loss for Luxembourg is less than 10 percent.

### D. OECD’s Unified Approach — “Amount A” and estimated effects
- “Amount A” reallocates a fixed share of residual profits (profits exceeding a routine return threshold) to market countries based on their share in third-party sales; offsets/surrenders will adjust taxable profit in source or residence countries to avoid double taxation.
- Using Luxembourg’s CbCR data for profit-making MNEs headquartered in Luxembourg:
  - Residual global profit (surplus over either a 7.5 percent mark-up on third-party sales or a 10 percent return on fixed assets) is respectively 33 and 65 percent of total profits.
  - If 20 percent of those excess profits are reallocated under Amount A, this would apply to between 6.6 and 13 percent of global MNE profits (US$ 2.8 – 5.6 billion).
  - Using sales by origin to allocate profits, Luxembourg would receive 2.2 percent of the residual.
  - If Luxembourg surrenders a portion of the current tax base proportional to its share in global reported profit of MNEs, this surrender would be 19.2 percent.
  - On balance, Luxembourg would lose 17 percentage points of its tax base related to residual profits (Amount A), equivalent to 12 percent of Luxembourg’s current tax base.
  - As an upper bound the revenue loss would be between 5.8 and 11.5 percent of total current tax collections from large MNEs (US$ 7-13 million).
  - If the portion surrendered by Luxembourg is proportional to its share of residual profit (32 percent based on mark up, or 22 percent based on fixed assets), the revenue loss would be between 10 and 14 percent of current tax collections.

### E. Minimum Taxes — outbound and inbound measures and implications
- A global minimum tax has ambiguous revenue implications for Luxembourg: direct gains might be offset by behavioral responses of MNEs and low-tax jurisdictions.
- Minimum tax on outbound foreign investment (reminiscent of GILTI):
  - CbCR data: focus on share of profits earned in countries where effective tax rate of the MNE sub-group is reported below 10 percent; this share of profits exceeds 60 percent.
  - Upper bound potential base for the minimum tax: US$16 billion (almost twice the current profit of these MNEs in Luxembourg).
  - Each percentage point of minimum tax could raise US$ 160 million in revenue.
  - A global blending approach would reduce revenue to one-third smaller.
  - Indirect effects: low-tax jurisdictions may raise effective tax rates to the global minimum, nullifying revenue gain in Luxembourg; MNEs may shift behavior reducing Luxembourg’s revenue.
- Minimum tax on inbound foreign investment (reminiscent of BEAT):
  - Could deny certain deductible payments (intracompany interest or royalties) or impose WHTs conditional on recipient country tax rate below minimum.
  - Data from the BCL: approximately 60 percent of all foreign debt in Luxembourg is held by countries with a CIT rate below 10 percent.
  - Net foreign interest income in Luxembourg (balance of payments) is around 4 percent of GDP; assuming 60 percent comes from low-tax jurisdictions, if taxed at 25 percent revenue at risk would be around 0.6 percent of GDP.
  - Indirect effects: denying deductions or imposing WHTs could remove intracompany lending activities in Luxembourg and cause adverse revenue effects.
- Note: Estimates abstract from exclusions (e.g., extractive industries or banks) and scope limitations which would reduce the size of excess profits subject to reallocation.

### IV. Potential Reform Directions — options if structural business tax revenue falls
- Four reform directions discussed: (i) business tax reform; (ii) environmental taxes; (iii) property tax; and (iv) personal tax reform. These are robust options regardless of final international tax reform outcomes.

#### A. Business Tax Reform — constraints and options
- Limited options to strengthen business tax revenue domestically:
  - CIT rate is already relatively high and pressures likely downward due to tax competition (global minimum tax could mitigate this).
  - CIT base is not particularly narrow; base broadening (e.g., tax depreciation, loss offset) risks increasing METR and hurting real investment incentives.
  - Reform of the IP box could be considered; IP boxes are generally not most cost-effective at stimulating innovation and could be replaced by R&D tax credits; revenue effect would be modest.
- Reform of corporate net wealth tax:
  - Net corporate wealth tax imposes large disincentives to investment and magnifies debt bias; it is levied independent of profit, harming small loss-making companies.
  - Repeal has economic appeal but net wealth tax currently raises 1.2 percent of GDP in revenue.
  - Mitigation option: maintain in some form a minimum asset tax on SOPARFIs or transform into a registration fee; a fee of EUR 4,815 on each of the 45,000 SOPARFIs would generate EUR 220 million, approximately 0.4 percent of GDP.
- Consider introducing a financial activities tax:
  - Levy on sum of financial institutions’ profits and remuneration (value added) or only on economic profit of financial institutions.
  - With financial sector value added share in GDP of 26 percent (data for 2006), a 4 percent tax rate could raise 1 percent of GDP; if applied only to economic profits, could generate 0.6 percent of GDP.

#### B. Environmental Tax Reform — revenue and climate co-benefits
- Environmental taxes are efficient for correcting pollution externalities; Luxembourg’s environmental taxes currently yield one of the lowest revenues in the EU.
- Luxembourg climate commitment: target CO2 emissions reduction of 55 percent below 2005 levels for non-ETS sectors (in line with EU target of reducing greenhouse emissions by at least 55 percent).
- Emissions profile (2015): total 10.3 MtCO2e; road fuel sales to non-residents account for 39 percent, fuel use by national road fleet 17 percent, manufacturing 16 percent. Power sector contributes only a small amount.
- Carbon tax plan:
  - Starting in 2021, introduce carbon tax of EUR 20/tCO2e for non-ETS sectors, gradually raise to EUR 30/tCO2e.
  - Authorities expect the tax to raise around 0.25 percent of GDP in revenue in 2021.
  - Carbon tax will increase tax on gasoline and diesel by just over 10 eurocents by 2023.
  - Fully capturing negative externalities would require consumer prices of around EUR 2 per liter.
- Road user pricing and congestion charging:
  - Examples: London flat US$ 15 per day; Singapore around US$ 4 per passage; Stockholm around US$ 4 per passage.
  - Annual net revenues in these cities range from US$ 100 million to US$ 182 million with traffic reduction around 20 percent.
  - Luxembourg drivers spend 37 hours in congestion annually (fourth longest in EU).
  - Implementing congestion charging challenging due to high number of foreign-registered vehicles; collection arrangements (e.g., London’s use of a European company) can improve collection rates.
- Higher registration fees and recurrent motor vehicle taxes can support revenue mobilization and climate mitigation.

*Box 1. Luxembourg Country-by-Country Reports, 2016 (Concluded).*

### 2018. Of these, 41 percent have been paid by September 2018 (Transport for London).

### wpiea2020264-print-pdf - 2018. Of these, 41 percent have been paid by September 2018 (Transport for London).

### Vehicle taxation and emissions
- Luxembourg: recurrent tax for a typical passenger car is EUR 118 per year (Figure 18).
- Germany: annual tax on the same car is EUR 246.
- Average new-car CO2 emissions:
  - Luxembourg: 131.4 gCO2/km.
  - European average: 120.6 gCO2/km.
- Thirty countries in Europe have a one-off registration tax linked to CO2 emissions; Luxembourg has a flat registration fee of 50 euros.
- Policy simulation:
  - Change recurrent motor vehicle tax to lower threshold at which penalty rates kick in from 90gCO2/km to 50gCO2/km, and increase the penalty from 0.1 to 0.2 euros.
  - Estimated fiscal effect: can lead to an additional 0.1 percent of GDP in revenue, even after allowing for a reduction in the average emissions of the fleet.
- Note on current motor vehicle tax formula (footnote 39):
  - Tax = a x b x c, where:
    - a = emissions of the vehicle;
    - b = 1.5 if the vehicle is diesel or 1 if the vehicle is anything other than diesel;
    - c = 0.5 when the emissions do not exceed 90gCO2/km and is incremented by 0.10 for each additional 10g of CO2/km.

### VAT and energy taxation
- Reduced VAT rates on energy products:
  - Electricity and natural gas taxed at a reduced VAT rate of 8 percent (standard rate 17 percent).
  - Heating gas oil VAT rate is 14 percent.
- Effect on energy efficiency targets:
  - Removing reduced VAT rates on electricity, natural gas and heating gas oil—while protecting the most vulnerable—would help reach Luxembourg’s energy efficiency target of a 44 percent reduction in final energy demand relative to baseline in 2030.
  - Long-term revenue effect of removing preferential VAT treatment for electricity, natural gas and heating gas oil is expected to be 0.1 percent of GDP.
- Policy recommendation:
  - Excise rates for energy products (like road fuels) should capture negative externalities, including carbon emissions (if not already captured through a carbon tax).
  - Preferential VAT rates are an inefficient method of protecting vulnerable households; targeted cash transfers to low-income households are recommended instead.
  - Additional pricing signals would encourage uptake of energy-efficient appliances; Luxembourg has an energy efficiency action plan centered on regulatory standards and targeted incentives.

### Housing tax reform
- Recurrent property tax:
  - Luxembourg’s property tax revenue is among the lowest in the EU at less than 0.1 percent of GDP (Figure 19).
  - Underlying valuations are based on a valuation regime from 1941, so property taxes are a small fraction of current market values.
- Housing supply pressures:
  - Land available for housing construction is mainly privately owned; 33 percent of such land are plots enclosed in urbanized areas that are already serviced and available for immediate development (OECD 2019).
  - Law of 17 April 2018 on spatial planning encouraged municipalities to allocate previously unallocated land to residential areas, but this has not resulted in a significant increase in housing supply.
  - Result: increasing gap between housing demand and supply, upward pressure on house prices, decreased affordability.
- Policy options to support housing supply and raise revenue:
  - Taxes on unused land and unoccupied dwellings could stimulate construction and housing occupation and reduce pressures on housing prices.
  - The 2008 Housing Pact allows municipalities to levy an annual specific tax on unused constructible land and unoccupied housing; only 8 out of 102 municipalities have introduced such a levy.
  - To encourage municipal use of such taxes, central government options include:
    - Require municipalities to use this tax as a precondition for receiving grants (recommendation by Conseil Economique et Social in 2018).
    - Central government could levy an additional, gradually increasing tax on unused land and unoccupied dwellings.
- International example:
  - Seoul: land parcels left vacant for two years are subject to a 5 percent property tax (instead of the normal 2 percent); 7 and 8 percent tax applies for land left vacant for three and five years respectively.

### Personal income tax (PIT) reform and labor supply
- Current system:
  - Luxembourg uses a traditional family-based taxation model with income splitting for married couples and registered domestic partnerships: incomes aggregated and split in two equal halves that are taxed at the prevailing progressive rate structure.
  - Since 2018, Luxembourg allows couples to voluntarily opt for individual taxation, with deductions equally split between partners; the option is almost never beneficial compared to income splitting.
- Distortions and gender effects:
  - Income splitting can create a “marriage bonus” and distort cohabitation choices.
  - In progressive systems, income splitting reduces marginal tax rates of primary earner and raises them for secondary earner (often women), disadvantaging women and discouraging overall labor supply.
- International context:
  - Family-based tax splitting systems are used in Germany and Portugal; France uses family quotients.
  - Many countries have transitioned to individualized PIT systems; some retain elements of family-based taxation (transferable deductions, family-based deductions, dependent spouse deductions, options for joint filing).
- Transition recommendations:
  - Transition to individualized PIT can be smoothened by family-based allowances or tax credits that are gradually phased out.
  - Example: United Kingdom introduced individual taxation combined with a new tax allowance for married couples, phased out over ten years.
- Empirical evidence and simulations:
  - Ex-post evaluations show positive employment effects from individualizing the PIT (Czech Republic, Canada, Sweden, US).
  - Netherlands reform (2001): basic tax deduction of a non-working spouse could no longer be transferred—using single women as control group, reform increased female labor-force participation in couples by 1.2 percentage points (Euwals 2008).
  - Jaumotte (2004) simulations:
    - For an average OECD country, eliminating tax discrimination against secondary earners would raise female labor-force participation by 3.9 percentage points.
    - For Luxembourg, simulations suggest an increase of 1.8 percentage points.
- Luxembourg female labor-force participation:
  - 67.4 percent in 2018.
  - Comparisons: Denmark 76.6, the Netherlands 75.8, Switzerland 79.9, Sweden 81.2, United Kingdom 73.6.

*Source: wpiea2020264-print-pdf (IMF staff report content as provided).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020264-print-pdf.pdf_