March 03, 2006 | By Keith Martin in Washington, DC

LUXEMBOURG is under pressure from the European Union to do more to limit the use of 1929 holding companies. A 1929 holding company is a type of holding company that is exempted from Luxembourg corporate, municipal business and net worth taxes. It is subject to capital duties and an annual subscription fee.

Dividends and interest paid by such companies do not attract a withholding tax at the Luxembourg border. The holding companies are not considered tax residents of Luxembourg for purposes of tax treaties. Therefore, their use is pretty much limited to situations where a multinational corporation using a holding company in Luxembourg establishes a two-tier holding company structure, with the 1929 holding company as the parent with a second Luxembourg company below it as a subsidiary.

The European Union has been trying to rid the region of tax regimes that introduce “harmful competition” among member countries. It has set a goal of getting rid of regimes like 1929 holding companies by 2010. Luxembourg amended the holding company law in April 2005 to deny exempt 1929 status to any company if more than 5% of the dividends it receives are from companies that are not subject to income taxes at least at a level equivalent to the Luxembourg corporate tax.

This change did not go far enough for the European Commission. It informed Luxembourg on February 8 that it is launching a formal investigation. The investigation is expected to lead to an order from the commission to take more significant action.