Typical due diligence issues

Legal due diligence generally covers broader matters such as corporate issues, business permits, commercial agreements, tax issues, financing agreements, securities, employment and pensions matters, IP/IT and litigation, and for specific matters, such as for the acquisition of a real estate company or building, title deeds, lease agreements, easements, authorizations for the building and exploitation permits (in particular, commodo/incommodo authorization).

The scope of the due diligence mainly depends on the activities and business of the target company. Customarily, the party instructing a third party to conduct a due diligence exercise on a target will tend to agree beforehand not only the scope of the due diligence, but also materiality thresholds applicable for reporting and sampling criteria for carrying out the due diligence in a more efficient way.

Disclosure of documents and information is driven by the seller generally on the basis of the buyer's requests (in the case of buyer due diligence), while the buyer has limited independent and external sources to obtain information.

The legal due diligence is typically limited to a review of documents in a virtual data room combined with a Q and A exercise and management interviews. It has become more common for a seller to provide a vendor due diligence report as part of the information granted to bidders in auction processes.

Issues identified in the due diligence are typically dealt with by either: (i) having them rectified by the seller before signing/closing, sometimes addressed via conditions precedent, for the most salient points, or actions to signing/closing; (ii) representations and warranties in the share purchase agreement' or (iii) specific indemnities.

Independent appraisal

In a typical private M&A transaction (share or asset deal), an independent appraisal is not required by law where the purchase price is paid in cash. However, it is customary to use a valuation in determining the enterprise value and the purchase price for a certain target company.

Depending on the corporate form of the companies involved in the transaction, independent appraisals may be required if the purchase price is not paid in cash but in kind through the issuance of new shares (capital contribution in kind).

Pricing and payment

There are generally no restrictions on the pricing or methods of payment of the purchase price from a legal perspective.

The purchase price can be paid in euro or other currency, in cash or in kind, in one or several instalments, etc. The acquisition agreement can provide for the full spectrum of price determination mechanisms customarily used in M&A transactions. Recent trends indicate that s locked-box price mechanisms are becoming more popular.

Options to secure the payment of the purchase price by the buyer (e.g. escrow mechanisms, holdback amounts, other forms of guarantee, etc.) are also generally used in practice.

Signing/closing

Share sale

Share deals are commonly and frequently used in Luxembourg.

The transfer of shares does not require notarization and the share purchase agreement can be executed under private seal. The articles of association or shareholders' agreement may restrict or add additional conditions to the transfer of shares (preemptive rights, transfer restrictions, lock-up).

The law provides for specific formalities depending on the corporate form of the company whose shares are sold (e.g., specific shareholders' approval, registration in the shareholders' register). The target company needs to be notified with respect to the transfer of shares and, for this reason, it is customary that the target company be a party to the share purchase agreement.

In principle, in share deals, agreements entered into by the target company remain unchanged and the company retains all its assets and all its liabilities.

Asset sale

In principle, in asset sales, each single asset must be transferred in compliance with the transfer and form requirements applicable to that asset. Notarization is usually not required except for real estate. Sales of real estate assets require the involvement of a public notary. The transfer deed will take the form of an authentic notarial deed and must be recorded at the Mortgage Registry to provide the owner rights of opposition against third parties.

In asset deals, business permits, licenses or contracts are, in principle, not transferred along with the asset, except in certain cases (e.g., lease agreements in real estate, building permits and authorizations, etc.). The buyer will obtain new permits and licenses (e.g., insurance or regulatory sector).

Foreign investment restrictions

On 1 September 2023, a law creating a national screening regime of foreign direct investments likely to undermine security or public order, aiming to implement Regulation (EU) 2019/452 of 19 March 2019 establishing a framework for the screening of foreign direct investment in the EU, as amended ("FDI Screening Law"), entered into force.

The national screening mechanism in Luxembourg applies to foreign direct investments (excluding portfolio investments) that may impact the security or public order in an entity governed by Luxembourg law engaged in critical activities on the Luxembourg territory. Critical activities encompass various sectors such as energy, transport, health, communications, data processing, defense, finance, media, and agri-food.

The FDI Screening Law defines a control triggering notification and outlines out-of-scope investments. Mandatory notifications are required before completing a foreign direct investment and upon crossing the 25% voting rights threshold. The screening procedure evaluates potential risks to security or public order, considering factors like infrastructure integrity, technology sustainability, and access to sensitive information.

The outcome could be authorization, conditional authorization or prohibition. The Minister in charge of economy ("Minister") may impose measures or sanctions for non-compliance, including fines up to EUR 1 million for individuals and EUR 5 million for legal entities. Foreign investors can dispute fines within one month of the screening decision.

For further information, see the more detailed section on "Foreign investment restrictions".

Antitrust/merger control

Luxembourg currently has no merger control regime. However, a Bill has proposed the introduction of mandatory suspensory merger control. For further information, see the more detailed section on "Antitrust/merger control".

EU Foreign Subsidies Regulation

As of 12 October 2023, the EU Foreign Subsidies Regulation (FSR) requires qualifying transactions, and bids in response to certain large public tenders in the EU, to be notified for upfront clearance by the European Commission where the companies involved have benefited from foreign financial contributions (a broad concept) that exceed certain (low) thresholds. Acquisitions of a target with annual revenues in the EU of at least EUR 500 million will trigger FSR deal notifications. Acquisitions of smaller targets will not, regardless of deal value. Outright mergers and large joint ventures will trigger a notification requirement if the EUR 500 million EU-wide revenue threshold is met by one of the merging parties or the joint venture.

Other regulatory or government approvals

Depending on the type of investments, certain approvals by the applicable Luxembourg regulator might be needed for acquisition (e.g., Commissariat Aux Assurances, Commission de Surveillance du Secteur Financier, etc.)

General

Because in a share acquisition there is no change to the employing entity, insofar as there is no change to employment conditions, no specific notification to or consent from employees and/or staff representatives is required.

When an asset deal concerns the transfer of a business (or part of a business) as a going concern, employees of the business automatically and immediately transfer to the buyer by operation of law. The parties to the transfer of business are not free to choose which employees will transfer with the business and, legally, the employees transfer with all existing rights and obligations and the new employer is held to recognize the employees' previous years of service.

The buyer as the legal successor of the former employer also becomes fully liable for all employment-related liabilities. Compensation for the automatic assumption of liabilities should be addressed in the transaction documents.

Pension schemes and the transfer of pension liabilities need to be considered carefully in the transaction context.

The Labor and Mine Inspection must be informed, according to Article L. 127-3 (2) of the Luxembourg Labor Code, that all required notification formalities relating to the transfer of employees have been effectively fulfilled.

Approval or consultation requirements

The employer must inform the employee representatives of any proposed transfer of business in good time before the completion of the transfer.

If the staff headcount falls under the threshold for mandatory staff representatives, the transferor and/or transferee must notify all concerned employees in writing before the transfer. That notification must include the date of transfer, reasons for the transfer, legal, economic and social consequences of the transfer for the employees, and any measures that may be taken as a result of the transfer.

Mergers also qualify as a transfer of business triggering notification and/or consultation requirements.

Staff representatives are generally required to be informed of the proposed impact of the business transfer on employment conditions and the transfer of the employees. Reorganizations and operational changes that need to be implemented in conjunction with the transaction (e.g., split of operations, carve-outs of employees, relocations) typically affect employment conditions and trigger consultation obligations. Although the staff representation does not have a veto right, consultations may take several months and may, therefore, adversely impact the timing of the implementation of the proposed changes.

Terminations solely due to a "transfer of business" are prohibited by law. Terminations for other business or personal reasons remain possible.

Asset deal

Acquisition

The acquisition of assets by a Luxembourg company does not trigger any tax burden. The acquisition cost of assets from a third party is treated as the base cost of the asset. Depreciation of the assets acquired depends on the nature of the assets and their estimated lifetime. Depreciation on buildings is allowed for tax purposes and is usually based on accounting rules. Some specific guidance exists in this respect. The basis for the amortization of the acquired assets is usually the acquisition price. The acquisition costs could be tax-deductible or amortized when activated. The depreciated acquisition cost determines gains or losses arising on a subsequent disposal. However, in the event that a business is acquired from a related party at a price deemed not to be arm's length, a tax adjustment may be made.

Interest expenses incurred on a loan in relation to the acquisition are tax-deductible. Attention should, however, be paid to the interest deduction limitation rule provided for by Article 168-bis of the Luxembourg Income Tax Law. The principle is that exceeding borrowing costs will be deductible in the tax period in which they are incurred; only up to 30% of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA). Exceeding borrowing costs means the portion of interest expenses exceeding interest income.

Sale

Capital gains triggered from the disposal of assets is, in principle, subject to corporate income tax (CIT) and municipal business tax (MBT) at an ordinary aggregated rate of 24.94%.

Capital gains realized by individuals acting in the course of the management of their private wealth are, as a rule, exempt, unless the gains are speculative or realized in a substantial participation. A gain is speculative if realized within two years regarding real estate or six months regarding all other assets.

Capital gains on foreign real estate are generally exempt under applicable double tax treaties. Luxembourg tax law allows the temporary immunization of a capital gain derived from the disposal of a building or a non-depreciable fixed asset by correspondingly reducing the acquisition price of the asset acquired by the company in lieu of the disposed building or non-depreciable fixed asset.

Provided that the proceeds of the entire sale are reinvested in the acquisition of another qualifying fixed asset at the end of the second year following the year of disposal, at the latest, any capital gains realized on the disposal of the assets will not be subject immediately to taxation in Luxembourg, but will be deferred.

Finally, it is noteworthy to mention that from 1 January 2020 exit taxation rules in relation to the transfer of assets realized upon seat migration (considered as a liquidation from a Luxembourg CIT perspective) have been amended. Indeed, paragraph 127 of the Luxembourg general tax law (Abgabenordnung), which provides the possibility to postpone payment of the tax, under certain conditions, at exit indefinitely, has been changed and replaced by a payment of the exit tax over a five-year period.

Indirect tax

In an asset deal, the transfer of the assets is, in principle, regarded as several distinct supplies of goods, each of which is, in principle, subject to value-added tax (VAT) at the appropriate rate. However, no VAT is due when the sale of assets constitutes a totality of assets/business or part thereof as a going concern.

Transfer tax is among the taxes levied on the acquisition of Luxembourg real estate.

The sale of a real estate asset is subject to a 6% registration duty and 1% transcription tax. A 3% municipal surcharge is added for buildings within the Luxembourg municipality. The tax base is the market value or the consideration paid, if the consideration is higher than the market value.

Legally, transfer tax is due to be paid by the buyer. However, it is customary for the buyer and the seller to agree on who will effectively bear the tax. Transfer tax is not recoverable for the buyer but is added to the cost price and, subsequently, (partly) amortized for CIT purposes.

Transfer tax also applies in the event the sale, for VAT purposes, would be part of the transfer of going concern relief.

Share deal

Acquisition

The acquisition of shares in a company does not trigger any transfer tax.

For CIT purposes, the acquired shares should be taken up in the books against cost price. Acquisition costs can be added to the fiscal cost price of the shares.

Under certain conditions, tax unity is available to achieve an efficient debt push-down. If a Luxembourg resident company or a Luxembourg permanent establishment of a foreign company that is subject to tax corresponding to Luxembourg CIT, holds directly or indirectly at least 95% of the nominal paid-up share capital of another Luxembourg resident company or Luxembourg permanent establishment of a foreign company that is subject to a tax equivalent to Luxembourg CIT, both companies can, subject to certain conditions, form a fiscal unity. Within a fiscal unity, the income and costs of the members are aggregated, and this mechanism can be used to pool or offset the respective taxable profit of each company in the group and to be taxed on the global amount. When the tax consolidation regime applies, the parent company, which is the "umbrella" company, will pay the CIT on the overall taxable profit of the consolidated companies. Under certain conditions, a horizontal tax unity is also possible between companies with the same direct or indirect parent company without the parent company forming part of the consolidation. The parent company can be a fully taxable Luxembourg share capital company, a domestic permanent establishment of a fully taxable foreign share capital company, a fully taxable European Economic Area (EEA) share capital company, or a fully taxable permanent establishment of a fully taxable EEA share capital company.

Sale

In general, capital gains are subject to the maximum statutory rate of 24.94% CIT and MBT for the fiscal year 2024. However, capital gains derived from shares in a qualifying subsidiary may be exempt under the conditions of the participation exemption regime. Capital losses on shares are generally deductible for Luxembourg CIT purposes.

The right to tax capital gains on shares realized by a corporate nonresident acting without a permanent establishment in Luxembourg is generally allocated to the seller's country of residence based on the applicable tax treaty.

However, if the sale of a participation in a Luxembourg company qualifying as a substantial participation is made within a period of six months after the acquisition, any gain realized upon the sale will be taxed in Luxembourg, unless a double tax treaty provides otherwise.

Merger

As a rule, any profit realized in the context of a transfer of assets/liabilities in the case of a demerger is subject to Luxembourg CIT. Realized hidden reserves (built-in gains), goodwill and fiscal reserves that are not retained following the demerger will be added to taxable profits in the year of the merger or division. However, tax law provides possibilities to realize the demerger in a tax-neutral way under certain conditions. Situations must, therefore, be analyzed on a case-by-case basis.

Indirect tax

Transactions relating to shares and participations in other companies (e.g., acquisition, holding and sale of shares), in principle, fall outside the scope of VAT.

However, these transactions may fall within the VAT scope where they are performed in the context of a trading activity. In this case, transactions relating to shares will be exempt from VAT.

The traditional view is that VAT incurred on costs referable to the disposal/acquisition of shares is not deductible. However, the Court of Justice of the European Union has sometimes conceded that this VAT might be deducted where the costs incurred present a direct and immediate link to the taxable person's general activities giving right to a VAT deduction.

The deductibility of input VAT attributable to the sale/acquisition of shares or participation very much depends on the facts of each case. Therefore, the setup of a share deal should be carefully reviewed to mitigate the risk of non-recoverable VAT.

OECD's Two Pillar Solution

The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting has put forward a so-called Two-Pillar Solution to address the tax challenges arising from the digitalization of the economy. Pillar Two is intended to introduce a global minimum effective rate of tax of 15% for large businesses in each jurisdiction where they operate and will lead to fundamental changes in the international tax system. It is currently being implemented in a large number of jurisdictions.

Groups will need to consider how the Pillar Two rules could impact on the life cycle of M&A transactions from the pre-acquisition phase (including transaction planning (such as the choice of acquisition structure and financing) and due diligence of the target group), the acquisition phase (such as contractual risk allocation around Pillar Two) to the post-acquisition phase and the impact of Pillar Two on any post-acquisition integration.

For information on post-acquisition integration matters, please see our Post-acquisition Integration Handbook.