Luxembourg adapts taxation of non-resident taxpayers

Rental losses in connection with principal dwelling located abroad can now be taken into account for the calculation of the non-resident taxpayer’s average income tax burden.

On July 18th 2007, the European Court of Justice ruled that certain regulations regarding the treatment of mortgage interest in Luxembourg were discriminatory.

Indeed, up until then, non-residents were not able to take into account interest deductions paid on a mortgage in relation with their principal residence.

This was also the case for non-residents that, in accordance with article 157 ter had opted to be treated as a resident by virtue of earning more than 90% of their professional income in Luxembourg. This was judged to be discriminatory and resulted in a change of law applicable as from January 1st 2008. It has taken the tax authorities until 19th November 2008, in order to issue a circular that sets forth the exact rules.

First of all a distinction is made between Belgian residents and all other non-residents. Indeed a Belgian resident may take advantage of a similar if not more favourable regime by virtue of the double tax treaty signed between both countries.

All other non-residents, may take into account their mortgage interest deductions in the same manner a Luxembourg resident may. However, one difference remains : a resident may deduct the interest from his taxable income, this results in a lower tax base as well as a lower tax rate.

A non resident may only use the mortgage deduction to lower the tax rate (notional deduction) that is then applied to his Luxembourg sourced income. The tax base remains the same.

Furthermore, the changes made since 2008, also imply that foreign income will influence the tax finally paid on the professional income of non-residents who have opted for the article 157 ter.

If a non resident taxpayer, who elects to be taxed as resident in accordance with article 157 ter, derives positive income outside of Luxembourg , then such income will generally not be taxed in Luxembourg, but this income will nevertheless be taken into account in order to establish (and in this case to increase) the tax rate applied to professional income taxable in Luxembourg. The taxpayer could therefore end up paying more tax in Luxembourg than if he hadn’t opted for the article 157 ter.

If a non resident taxpayer, who elects to be taxed as a resident in accordance with article 157 ter, derives negative income outside of Luxembourg, he won’t get a tax deduction for the losses realised outside of Luxembourg. Nevertheless such income will be taken into account in order to compute (and in this case reduce) the tax rate applicable to professional income taxable in Luxembourg.

As was the case in the past for Belgian non-residents who claimed a deduction of mortgage interest on their homes situated outside of Luxembourg, the Luxembourg tax authorities will be obliged to determine a deemed rental income in order to compute the exact amount of deductible interest. This value will be estimated by comparing similar property located in Luxembourg.