In August 2018, along with the introduction of VAT grouping provisions, Luxembourg transposed Article 80 of the EU VAT directive (Directive 2006/112/EC) into its domestic VAT legislation.
The newly implemented provisions may be of great significance for business, and their practical implications should therefore be analyzed in detail.
The VAT authorities have also recently provided additional guidelines in a recently issued circular (Circular n°790 of 18 January 2019).
Article 80 of the EU VAT directive provides that member states have the discretion to take measures to combat VAT fraud or evasion. According to this article, the taxable basis of transactions between related parties may be – in some instances – re-valuated according to their normal (in other words, open market) value.
Article 4 of the Luxembourg law of 6 August 2018 transposed Article 80 of the VAT directive into the Luxembourg legislation and a new paragraph 3 was inserted in Article 28 of the VAT law. According to this new provision, the VAT taxable basis for transactions between related parties may be deemed to be the normal value in three different scenarios:
- The consideration is lower than the normal value, and the recipient cannot fully recover VAT;
- The consideration is lower than the normal value, and the transaction does not give the provider the right to recover VAT;
- The consideration is higher than the normal value, and the transaction gives the provider the right to recover VAT.
Article 28.3, first indent of the Luxembourg VAT law defines related parties as parties with family or other close personal links as well as organizational, property, membership, financial or legal links.
The notion of related parties appears to be wide, with a scope which is, unequivocally, specific to VAT. For instance, the guidance provided by the OECD in the context of Transfer Pricing is that enterprises are related parties where persons participate directly or independently in the management, control or capital of those enterprises. This definition is somehow narrower than the one given for VAT.
Circular N° 790 does not provide additional details regarding the definition. Some could see this as an indication that the tax authorities do not want to limit their interpretation and keep a flexible approach.
Transactions in scope
Not all transactions between related parties are subject to the new VAT rules. At first glance, the measure is aimed at avoiding VAT fraud or evasion and its application is limited to situations where related parties seek to minimize their total amount of VAT payable. This covers three different scenarios.
1. Supplies to partially exempt recipients
Article 28.3.a) of the Luxembourg VAT law provides that the taxable basis of a supply between related parties will be the normal value, where the recipient has a limited right to recover VAT and the agreed consideration is lower than that value.
This provision is to prevent businesses from reducing the consideration of their taxable supplies, therefore the amount of VAT charged, to related parties that cannot fully recover VAT.
Circular N° 790 specifies that the provision applies to transactions subject to Luxembourg VAT, whether chargeable by the supplier or to be accounted for by the recipient. Therefore, the new measure should not affect transactions with a place of supply outside Luxembourg.
2. Exempt supplies
Businesses with exempt activities have, generally, a limited right to deduct VAT. In Luxembourg, this is the case where those activities are exempt under Article 44 of the Luxembourg VAT law (although exceptions may apply).
The amount of non-recoverable VAT for a business is linked with the total of exempt supplies made by that business. Broadly speaking, the more exempt supplies, the less VAT may be recovered.
Article 28.3.b) of the Luxembourg VAT law provides that supplies which are exempt under Article 44 of the Luxembourg VAT law and that do not give right to recover VAT on costs shall be deemed to be made at the normal value. This is limited to transactions between related parties where the agreed consideration is lower than that value, thus reducing the amount of non-recoverable VAT for the business.
In Circular N° 790, the VAT authorities acknowledge however that a re-valuation of the taxable basis applies only where the agreed consideration cannot be economically justified. This should therefore guarantee some flexibility for businesses trading with related parties. However, to what extent and how the tax authorities will be satisfied with the economic justifications provided will only be determined in practice. Notwithstanding this, the circular is only the interpretation of the VAT law by the Luxembourg VAT authorities and has no force of law.
3. Supplies by partially exempt businesses
Supplies giving right to recover VAT made by partially exempt businesses are also governed by the new provisions.
As outlined above, the amount of VAT that cannot be recovered is linked with the total of exempt supplies (not giving right to recover VAT) made by the business in question. The converse is equally true, meaning that the amount of recoverable VAT is generally connected with the total of taxable supplies (and/or exempt supplies giving right to recover VAT) made by a business.
Article 28.3.c) therefore provides that supplies of goods or services by businesses that cannot fully recover VAT may also be re-valuated according to their normal value. This happens if the supply is made to a related party and the consideration agreed is higher than that value so that it increases the amount of VAT that the business can recover on costs. Again, it is possible to avoid a re-valuation if the agreed consideration can be economically justified.
It is worth highlighting that the Luxembourg VAT authorities have made it clear in Circular N° 790 that the amount of VAT payable will be subordinated to the amount of VAT charged on the relevant invoice. Therefore, businesses whose services are re-assessed will be encouraged to issue corrective invoices to avoid their related party paying more TVA that the amount used to determine how much VAT the business can recover on costs.
The open market value provisions went almost unnoticed given the hype around VAT grouping which was introduced at the same time and was considered a small revolution in the Luxembourg VAT world. However, they are of no less importance and may affect all businesses in Luxembourg.
This is of particular relevance as VAT rules are independent from any other legislation, including Transfer Pricing. It might be the case that transactions between related parties were agreed in accordance with Transfer Pricing rules but are not necessarily equal to the open market value. Companies with financing activities in Luxembourg are a good example when it comes to interest rate calculation. More broadly, any business that provides goods or services to related parties, which cannot fully recover VAT, should also make sure that the agreed consideration is in line with the market.
A detailed VAT analysis of supplies between related parties is always strongly recommended.
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