Agefi Luxembourg - février 2025

AGEFI Luxembourg 34 Février 2025 Fonds d’investissement By Vinayak BHATTACHARJEE, managing partner of Antwort Capital* C limate change affects stan- dards of living and increases global inequality by altering habitability across world regions and the distribution of natural entitle- ments. One result of this is humanmigration pat- terns across the world with the resultant po- litical tensions we are currently witnessing across countries. While periods of cooling and warming on Earth have been a natural occurrence over geological time periods, the fundamental question is whether humanactivityisitselfleadingtoasignificantchange in climate? The answer, according tomore than 95% ofscientistsandscientificreports,isanemphatic“yes”. In this article I return to first principles and explain why government intervention is a pre-condition to pave theway for the creationand implementationof CC solutions. Climate change is an economic externality It is observable that in today’s modern society hu- mans will not freely act tominimise climate impact. Everything we produce and consume, whether di- rectly or indirectly, affects the environment, but some goods and services are more damaging than others and we refer to these as “DGS” (i.e., climate damaging goods and services) to differentiate these fromthose goods and services that aremore climate friendly (“FGS”). CCisaby-productofhumaneconomicactivitiesand if DGS are inexpensive relative to alternatives, they will tend to be consumed in excess. The market mechanism does not have an auto-correction func- tionandhence, there exists a justification for govern- ments to intervene and fine-tune the functioning of the market mechanism. This is an example of the classic economic problem known as “externality” whichoccurswhen an economic activity creates an- other (unintended) product that affects a thirdparty not involved in the original economic activity. In the case of CC, this “third party” is the entireworld. Market prices, particularly spot prices, of fossil fuels aredrivenby supplyanddemandandanticipations of changes to these. The market mechanism on its own has been unable to incorporate in the price of fossil fuelsneither the environmental impact of their consumption nor the declining stock of non-renew- able fossil fuels. The consumption of fossil fuels results in two broad externalities.Thefirstistheemissionofpollutantsaf- fecting the health of humans and other life. The sec- ondistheemissionofgreenhousegases(GHGs)that result in global warming, CC and are an externality affecting all life. Production v consumption behaviour – drivers of economic activity Both production and consumption drive economic activity and by influ- encing the price of goods and services, a government can nudge economic ac- tivity towards FGS. Raising funding, contrac- tual negotiations, secur- ing customers are structural barriers to change. Equally insidious are behavioural attitudes of individualsandinstitutions. For example, many institutions act without an understanding of “sunk costs”. A large DGS investment made many years ago should be de-commissioned to favour FGS rather than kept alive because a lot of money (the “sunk cost”) has been spent. This is an exam- ple of an institutional bias that can limit or delay the introduction of CC solutions. Behavioural economics has focussed on the deci- sion-making behaviour of individual consumers. To displace current consumption practices, be- havioural economics has emphasised the prefer- ence individuals place on status quo. “Anchoring” and “heuristic bias” tend to make consumption patterns “sticky”. Public policy can effect important change to consumption patterns through subsidies to promote the use of energy ef- ficient white goods and appliances. Trade-offs, supply, demand and prices Economists look at an economy in terms of trade- offs. Without trade-offs, there would be no scarcity in goods and services and hence no real underlying price. This concept is neatly summarisedby the “produc- tion possibility frontier” (PPF). This describes the trade-off that exists in an economy between the production of different goods and services. Since production processes require energy and other re- sources, in an optimally functioning economy, more of one good cannot be produced with pro- ducing less of another. Let’s illustrate the concept using electric vehicles and traditional petrol vehicles as in the figure below. Their relative prices and costs of running these vehicles are key determinants of which vehi- cle to buy. If the price of gasoline is low relative to electricity, consumers will favour petrol vehicles. The government can introduce policies to increase the price of gasoline used by traditional vehicles relative to the price of electricity used to charge EV’s. Such policies typically involve a sales tax on gasoline. In addition, the government can also in- troduce subsidies (subsidies, waivers of road taxes) to reduce the relative cost of buying EV’s. How can government intervention help reduce climate change? Quotas and Indirect Taxation The price of fossil fuels is the key determinant of their medium- and long-term consumption. In simple terms, the higher the price of fossil fuels, the higher the savings made by NOT using them and alternative solutions become more viable. The most immediate thing that can be done by governments is to correct the market mechanism for the price of fossil fuels to better reflect external- ities. Governments have addressed this by creating quotas on the amount of GHGs that industries can emit. These quotas are then transferable and can be traded to allow corporate consumers of fossil fuels to expand their businesses as needed. This in- creases the total cost of using fossil fuels which over time should reduce their relative usage. Another option are indirect taxes, such as a sales tax, on the price of fossil fuels to push their price to levels that would begin to move consumers away fromfossil fuels to other energy sources. The big advantage of indirect taxation or the sale of quotas is that they generate revenues for govern- ments that can be used to fund the development of alternatives. Globally Concerned - Global CoordinatedAction Even more than an economic externality, climate change is a classic “global commons” issue, meaning its causes and impacts transcend na- tional borders. While climate-related harms (like extreme weather or rising sea levels) are felt glob- ally, the actions required to mitigate them are largely taken within national boundaries. This structure creates a paradox, namely that countries that act alone may incur significant costs, while benefits are spread worldwide, potentially dis- couraging unilateral action. This is particularly challenging as certain economies, often the largest emitters, must make themost substantial changes for meaningful progress. Economists argue that this “global commons ex- ternality” requires coordinated policies, such as carbon pricing and trade regulations that penalize carbon-intensive imports, to prevent “carbon leak- age” (where emissions are effectively outsourced tocountrieswithweaker cli- mate policies). Without coordination, individual national efforts are under- mined, as productionmight shift to less regulated regions and global emissions would then continue unabated. Coor- dinated frameworks for climate action, suchas theParisAgreement, playanes- sential role in tackling climate change. A globally harmonized approach also allows for scaling climate finance and technology-sharing mechanisms that canbenefit lower-income countries dis- proportionately affected by climate change. By increasing the effectiveness of policymeasures, through global coordination tax rises need not be as substantial if these are coordinated and taken by all countries. Locally Aware – National Interests and Sticky Consumption Behavioral and institutional obstacles to climate ac- tion are pervasive at individual, national and inter- national levels. Consumers andpolicymakers often struggle to prioritize long-term climate goals over immediate economic interests. Nations are hesitant to adopt stringent policies that coulddisadvantage their economies if competitors do not adopt similar standards. Economic research emphasizes collective actionmechanisms (e.g. such as binding treaties) as essential to overcome these barriers.Agreater focus on collaborative tools that tie economic incentives to climate goals, like the trade of emissions permits and green finance com- mitments, can align disparate national interests. Behavioural economics suggests that the be- haviours of actors must be influenced to nudge changes in consumption patterns, especially of more expensive items such as cars and white goods. Government policywill play a key role here through subsidies or by resetting the framework through which alternative products and services are assessed. * The author is an economist and a managing partner of Antwort Capital, a specialised private equity business. He is also on the boards of various investment holding companies and private eq- uity businesses such as GHO and Onepointfive Thematics. Vinayak has been in the fund management industry for over three decades and as an economist has researched and authored articles in behavioural economics and decision-making. References -“WhydoEconomistsDescribeClimateChangeasaMarketFail- ure?” Alex Bowen et al, The London School of Economics and GranthamResearch Institute on Climate Change and the Envi- ronment,March2014. -“TheParisAgreementandGlobalCooperation”,UNFCCParis AgreementOverview,December2015. - “Thinking, Fast and Slow”, Daniel Kahneman, Penguin UK, April2013. -“Nudge:TheFinalEdition”,RichardH.ThalerandCassR.Sun- stein,YaleUniversityPress,August2021. -“EnergyUtilities,ConservationandEconomicEfficiency”Bhat- tacharjeeetal,ContemporaryPolicyIssues,January1993. Some economic considerations relating to climate change ProductionPossibilityFrontier EconomicGrowth Petrolvehicles Electricvehichles Electricvehicleuserelativelyinexpensivefollowingfavourable government intervention,suchas impositionoftaxesonfossil fuelsoroffersofsubsidiesonEV’s Petrolvehiclesrelatively inexpensivebefore governmentintervention By Pierre-Régis DUKMEDJIAN, Founder DPR Tax Law Update to the circular dealingwith UCIs and tax residence certificates O n 27December 2024, the Luxembourg tax authorities pu- blished a newcircularwith res- pect to the residence certificates to be issued to the benefit of Undertakings for Collec- tive Investments (UCIs) (1) – Circular of the head of the direct tax authorities L.G.. – An°61 of 24December 2024 (theCircular). The Circular replaces the circular L.G. An°61of8December2017.TheCirculardoes not amend the conditions and process to obtain the tax residence certificates. Nevertheless, the Circular provides for a useful update of the tax treaties for which a tax residence certificate may be issued for UCIs aswell as the one forwhich this is not possible. Thefollowingjurisdictionshavebeenaddedto thelistoftaxtreatiesforwhichataxresidence certificatemaybe issued forUCIs: Botswana, Cyprus, Ethiopia, France,Hungary, Kosovo, Rwanda and theUnitedKingdom. Senegal with a new tax treaty was added to the list of tax treaties for which a tax residence certificate cannot be issued forUCIs. The Circular provides for a summary of the provisions of the relevant tax treaties ac- cording to which a tax resi- dence certificate could be issued for UCIs. The new Circular with res- pect to the interest rates in relation to shareholders’ cur- rent accounts in debit of Luxembourg companies subject to corporate income tax On3February2025, another circularwas releasedby the Luxembourg tax authorities: the Circular of the head of the direct tax authorities L.I.R., n° 164/1 of 29 January2025(“ theCircular ”).TheCirculardealswith the applicable interest rate for shareholders’ current accounts indebit regarding Luxembourg companies subject to corporate income tax. The Circular replaces the Circular L.I.R. n°164/1 of 23 March 1998 ( the Former Circular ). The Circular provides for a difference in case the shareholder is an individual or a related company. In case of indi- viduals, the interest rate to be applied to sharehold- ers’ current account in debit, should be determined according to the arm’s lengthprincipal, pursuant to article 164 paragraph 3 of the Luxembourg Income Tax law ( LITL ). For simplification purposes, an interest rate equal to theannualinterestrateapplicabletoconsumercredits isallowed.Inthisrespect,itshouldbepossibletobase the interest rate on the average of the months of the relevant fiscal year, asmentioned in themonthly sta- tistics publishedby theCentral Bankof Luxembourg with respect to interest rates applied to Luxembourg credit institutions to consumer loans. The Former Circular provided for a 5% interest rate as from1998 tax year. The Circular provides for the general method of computation of the interest as well as specific methods in case of special circum- stances. The Circular specifies that the administra- tive guidelines (Note de service LIR. /NS n°164/1 of 9 June 1993 – “ the Note ”) is still applicable in par- ticular with respect to the criteria of the repayable current account in debit. The Note provided in particular that if the share- holder’s current account in debit had only the ap- pearance of a loan but this shareholder didnot have thewilltorepaytheloan,inthiscase,thefullamount was ahiddendividenddistributionwithin the scope of the article 164 paragraph 3 of the LITL. In case of aLuxembourgcompany,withinrelatedcompanies, the interest rate should be determined on a case by case basis pursuant to the arm’s length principle based on articles 56 and 56 bis of the LITL and re- flected in article 164 paragraph 3 of the LITL. The interest to be applied is in particular depending on the currency in which the receivable is denomi- nated, the foreign exchange risk, the hedging risk, the refinancing interest rate, the maturity of the re- ceivable etc. 1) Pursuant to the Law of 17December 2010 relating to UCIs and the law of 13 February 2007 relating to specialized investment fund as amendedandthelawof23July2016relatedtotheReservedAlternative Investment Funds. Welcome updates Circulars dealing with UCIs and tax residence certificates & interest rates on shareholders’ current accounts