Two situations should be scrutinized: where the service provider is a Luxembourg tax resident; and where the service provider is a foreign tax resident but has a permanent establishment in Luxembourg.
Luxembourg cloud service providers
Where the service provider is a Luxembourg tax resident, the tax analysis is very straightforward: the total net income arising from the cloud computing transactions should be subject to corporate income tax and municipal business tax in Luxembourg at a global rate of 28.80 percent.1
Non-Luxembourg cloud service providers
For corporate income tax purposes, a non-resident is liable to tax in Luxembourg when business income is realized directly or indirectly by a permanent establishment (PE) or a permanent representative (PR) in Luxembourg, except where the PR is a wholesale representative, a commission agent or an independent trade representative.2 Under Luxembourg law,3 any located facility or place through which the business of an enterprise is carried on is considered as a PE from a tax perspective and in particular:
- a place of management
- a branch, a factory, storage facilities, sales and purchase facilities, ship's berth, offices for planning and information purposes as well as any other fixed places of business where the businessman or his/her PR (e.g. a proxy holder) carries on business
- a building site or a construction, assembly or installation project, where its effective or projected duration exceeds six months.
Furthermore, a PE may exist where there are preparatory or auxiliary activities, such as shipment and exposition through a server (even when there is no possibility to buy the asset). In addition, a PE exists regardless of the presence of employees.
The above also applies to municipal business tax and net worth tax. Regarding the latter, a foreign taxpayer may find him/herself in a situation where there is a PE that does not generate profit but remains subject to net worth tax.
The concept of PE is thus defined broadly under Luxembourg tax law and there is no specific provision with respect to cloud computing. As a result, the Luxembourg tax authorities should apply the general principles as set above as well as the Organisation for Economic Co-operation and Development (OECD) commentaries related to E-commerce (especially 42.1 to 42.10 of article 5) according to which there should be a PE where the following conditions are met:
- the website of the company is hosted on a server resident in Luxembourg
- the company carries out business on the server, regardless of whether the company is the owner or the tenant of the server (more generally, the company should have the server "at disposal")
- the server is fixed, i.e. it should not be moved from a place to another.
The OECD commentaries indicate that a website should not be considered as a PE, due to the lack of the necessary material characteristics. However, the server hosting the website may be considered to be a PE (the server on which a website is stored, and through which it is accessible, is a piece of equipment with a physical location, and such location may thus constitute a fixed place of business of the enterprise that operates the server).
Thus, whether a data server should be considered a PE in Luxembourg is dependent upon analysis on the basis of a detailed fact pattern of the envisaged transactions, Luxembourg tax laws and tax treaties concluded by Luxembourg.
To conclude, according to current Luxembourg tax law and OECD comments, a data server could be considered as a PE for Luxembourg income tax purposes. This position is confirmed by Luxembourg doctrine. Where a non-Luxembourg cloud service provider is a resident of a state with which Luxembourg has a double taxation agreement, the terms of that particular treaty will need to be considered.
If a Luxembourg cloud service provider receives a payment from a foreign jurisdiction, it will be necessary to assess whether any tax has been deducted by the customer, and determine whether credit can be received for this withholding tax in Luxembourg. In general, a Luxembourg cloud service provider should be able to obtain relief for foreign taxes suffered, the relief being limited to the amount of Luxembourg tax due on the income.
In general, a non-Luxembourg cloud service provider should not suffer Luxembourg withholding tax on payments received for services rendered to Luxembourg customers.
From a Value Added Tax (VAT) perspective, cloud computing should fall within the scope of electronically supplied services (ESS). According to Annex II of the Directive 2006/112/EC (the Directive), ESS cover the following:
- website supply, web-hosting, distance maintenance of programs and equipment
- supply and updating of software
- supply of images, text and information and making available of databases
- supply of music, films and games, including games of chance and gambling games, and of political, cultural, artistic, sporting, scientific and entertainment broadcasts and events
- supply of distance teaching.
Cloud computing can be linked to both (1) and (2).
When both the supplier and the customer are established in Luxembourg, the place of taxation of ESS is Luxembourg, where the applicable VAT rate for this type of service is 15 percent.
For international transactions, it should be determined beforehand whether the customer is a non-taxable person (e.g. a private consumer) (i), or a VAT taxable person (or VAT-registered non-taxable person) (ii).
(i) For ESS supplied to a non-taxable person, the place of supply is the place where the supplier of the service has established its business.
(ii) For ESS supplied between VAT taxable persons established in different EU member states, or by a non-EU resident entity to an EU resident VAT taxable person, the place of taxation is the place where the recipient of the service is established.
Where non-EU resident entities provide ESS to EU resident non-taxable persons, Article 58 of the Directive provides that the place of taxation is where the customer is established. In that case, the non-EU ESS provider must register for VAT purposes in the EU4 and apply different VAT rates on its ESS, depending on the EU member state where its customers are established.
Another potential option is for the non-EU ESS provider to set-up its business in the EU, in which case Luxembourg is highly attractive since it has the lowest standard VAT rate within the EU (15 percent). As a consequence of this second option, the 15 percent rate would apply to ESS rendered from Luxembourg to non-taxable persons located anywhere in the EU. This tax treatment is due to change from 1 January, 2015. Indeed, ESS supplied by a Luxembourg resident provider to non-taxable persons established in other EU member states will be taxable in the country where the customer is established.
Distribution of shrink-wrapped software
The third channel partners should not cause a vendor to have a PE in Luxembourg, assuming the Luxembourgish channel partners are treated as principals (as opposed to agents).
The sales and marketing assistance of the local country sales agent in Luxembourg should also not cause a vendor to have a PE in Luxembourg, as this agent should have no authority to contract.
If the third party channel partners act as the local country sales agent, or if this agent's activities are expanded, the agent's activities may cause the vendor to have a PE in Luxembourg.
Distribution of shrink-wrapped software would be characterized as a sale of goods to the extent that there is a fixed price for perpetual license of a shrink-wrapped software's source code, notwithstanding that the legal form is as a license.
Payments for the sale of goods are not subject to withholding tax.
However, each scenario should be analyzed on a case-by-case basis in order to characterize the income adequately.
If the payments are made to a US tax resident, payments for the use of the software's copyright should be exempt from withholding tax under Article XIII(1) (Royalties) of the Luxembourg-US treaty, provided said US resident is the beneficial owner and no limitation of benefits provisions are applicable.
Luxembourg VAT is due on the importation of goods into Luxembourg from outside the EU.
Where the Luxembourg third party channel partners perform the importation, they should be liable for payment of the import VAT at the standard 15 percent VAT rate. The subsequent local sale of the shrink-wrapped software to Luxembourg end users should be subject to 15 percent Luxembourg VAT.
Where the end users perform the importation into Luxembourg, they should be liable for payment of the Luxembourg import VAT at 15 percent.
It is also important to consider customs duties implications regarding the importation of the shrink-wrapped software.
Marketing and sales services supplied by a Luxembourg local country sales agent to Luxembourg third party channel partners should be subject to 15 percent Luxembourg VAT.
Other issues or planning opportunities
The location of the server should be irrelevant.
Public or private cloud
From a Luxembourg tax perspective, no distinction is drawn between public and private cloud services.
Public cloud: the sales and marketing assistance of the local country sales agent in Luxembourg should not cause a vendor to have a PE in Luxembourg, as this agent should have no authority to contract.
As explained earlier, a Luxembourg-based server may cause a PE in Luxembourg. If a backup server is located in Luxembourg, some income should be allocated to the backup server.
Private cloud: it's likely that there would be no business carried on in Luxembourg, and therefore the vendor should not have a PE in Luxembourg.
The hardware (servers) should be considered to be used outside of Luxembourg.
Unless the end user is granted a certain right to download and modify certain software's source code for its use, the payments would be classified as business income, and no withholding tax would apply.
If the payments are made to a US tax resident, payments for the use of a software's copyright should be exempt from withholding tax under Article XIII(1) (Royalties) of the Luxembourg-US treaty, provided said US resident is the beneficial owner and no LOB provisions are applicable.
Public and private cloud services should qualify as ESS for Luxembourg VAT purposes.
Where such services are supplied by a non-EU resident entity to a VAT taxable person established in Luxembourg, the place of taxation of the ESS should be Luxembourg. Luxembourg VAT at 15 percent should be self-accounted for, declared and paid by the recipient under the reverse-charge mechanism.
Where such services are supplied by a non-EU resident entity to a non-taxable person established in Luxembourg, the place of taxation of the ESS should be Luxembourg. In this case, the non-EU ESS provider should be obliged to register for VAT purposes in one member state of the EU. The non-EU ESS provider should apply 15 percent Luxembourg VAT on the ESS supplied to its Luxembourg private consumers.
Marketing and sales services supplied by a Luxembourg local country sales agent to Luxembourg end users should be subject to 15 percent Luxembourg VAT.
Other issues or planning opportunities
The Luxembourg tax authorities have not yet usefully commented on this type of arrangement.
1Rate applicable in the city of Luxembourg since 2011.
2Article 156 (1) a of the Luxembourg Income Tax Law (hereafter, "LITL").
3Article 16 of the SteuerAnpassungsGesetz.
4A specific registration regime (the "one-stop shop") applies when it comes to ESS: even if the services are provided to non-taxable persons located in all the countries of the EU, the non-EU ESS provider is obliged to register in only one of the EU Member States. This only applies where only ESS are provided by the non-EU ESS provider.