Mind the tax bill for investment income

The past five years have been kind to investors. Stock markets have risen, as have bond markets, offering on average significantly higher returns than traditional savings accounts, while inflation has remained very low by historical standards.

However, investors, whether buying securities directly or through investment funds, also need to factor in the tax due on their income or gains.

The Luxembourg tax system draws clear distinctions among various income sources. Tax on investment income from interest and dividends is calculated in a different way from standard employment income, and the same applies to funds held outside structures enjoying tax benefits, such as pension schemes. 

Investment income is subject to a dual tax regime. Interest payments from certain types of investment, mostly savings accounts and government bonds, are subject to a 10% withholding tax. This tax is considered full settlement of tax liability on the income and does not need to be declared on a tax return.

Income from sources that do not qualify for the 10% withholding tax, including income from dividends and most investment funds, benefits from a small tax-free allowance – up to €1,500 for an individual or €3,000 for a couple. Anything above that is taxed at an individual’s marginal tax rate – their top rate, depending on their level of income, which can reach 42% for the highest earners. Losses from one type of income, for example on the value of shares sold, can be offset against gains of another type within a single tax year.

Unlike in some countries, stamp duty is not payable in Luxembourg on the sale of shares – only on the sale of property. 

Luxembourg introduced a temporary tax in 2015 to help balance the national budget, but it is due to expire at the end of this year. The tax applies to both employment or professional and investment income, so it needs to be factored into calculations regarding investment income earned during 2017.

Any gains made by investors when they sell shares, bonds or investment funds may be subject to capital gains tax. The rules on this create an important distinction between long-term and short-term gains. Short-term capital gains are taxed as current income, so may be subject to a rate of up to 42%.

Long-term gains receive more favourable treatment, including an exemption for the first €50,000 gained over a period of 10 years. Taxation of remaining gains is levied at 50% of the taxpayer’s marginal income tax rate. The definition of ‘long-term’ depends on the type of asset – at least two years for property, but just six months for shares, bonds and investment funds. Gains on non-financial assets and individuals’ private residences are exempt.

Taxation of dividends and interest of foreign origin is complex, and investors have some leeway over the way it is taxed. For example, they may request that all income from other foreign countries is aggregated, and for the application of a credit equivalent to the amount of Luxembourg income tax applicable to this total. To some extent, this will depend on the source of the income, and whether it comes from one, or multiple countries.

• For German residents, worldwide investment income, including interest, dividend and capital gains, is subject to income tax at 25%, plus a solidarity surcharge of 5% (and church tax, where applicable), and is generally withheld by the paying entity. There is a standard annual allowance of €801 free of tax for individuals, or €1,602 for married couples.
• The tax withheld is final unless the taxpayer's income tax rate is lower than 25%, or some of the investment income - for instance from abroad - has not been subject to withholding at source. Income from investment funds that do not comply with German registration and publication requirements may be subject to significantly higher rates of tax, sufficient to make them unattractive to investors.
• French residents must declare income from interest, dividends and capital gains as part of their overall income and taxed on a scale starting at 14% and reaching a maximum of 45%, although dividends benefit from a deduction of 40% to reflect tax already paid by the company paying the dividend. Investment income is also subject to social security contributions of 15.5%.
• In Belgium, residents must pay income tax on dividend income from Belgian and foreign companies (there is a 30% withholding tax on domestic dividends). Interest from regulated savings accounts is subject to a 15% withholding tax and other interest is taxed at 30%. While there is no capital gains tax as such, some gains are taxed as part of overall income. 

11/2021