The concept of economic substance lies at the heart of tax audits carried out by the Luxembourg Inland Revenue (ACD) and by European authorities. It refers to the concrete reality of a company’s presence and activity within Luxembourg territory.
Definition adopted by the authorities:
- A company is considered to have real substance if it carries out a genuine economic activity in Luxembourg, with human and material resources proportionate to that activity.
- This definition is based on the work of the OECD (BEPS project), the European anti-abuse directives (ATAD I and II), and Luxembourg case law.
- The European ATAD II Directive, transposed into Luxembourg law in 2019, strengthens substance requirements for purely artificial arrangements.
What the authorities specifically verify:
- Place of effective management: where are strategic decisions made? Who makes them, and from which country?
- Physical presence of directors: do the directors actually attend meetings in Luxembourg? Do the minutes prove this?
- Qualified staff on site: does the company employ staff or use competent local service providers in Luxembourg?
- Adequate infrastructure: dedicated office space, equipment, and information systems installed in Luxembourg.
- Consistent financial flows: are the company’s income, expenses, and bank accounts connected to a real activity carried out in Luxembourg?
Warning signs that trigger an audit:
- All directors reside abroad and never travel to Luxembourg.
- The company generates no local expenses (no rent, no salaries, no Luxembourg-based service providers).
- Decisions are systematically made in writing from another country (exclusive use of written circular resolutions).
- The company’s activity is identical to that of a related entity located in a higher-tax jurisdiction.
There is no legally established minimum threshold. The authorities assess substance on a case-by-case basis, taking into account the size, sector, and complexity of the company. A private holding company is not subject to the same requirements as an active service company.
Sources:
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