Luxembourg: Three Insights On Luxembourg's New Transfer Pricing Circular, Based On Our Client Experience

Some time has now passed since the new transfer pricing circular for financing companies in Luxembourg ("Circular") was passed, and I would like to share with you three insights that I have gained when helping clients to adapt to these new regulations. Since most intermediary intra-group financing companies ("Lux FinCos") need to be compliant before the end of 2017, now is the time to act if you have not yet adapted your structures.

1. What exactly does "qualified personnel" mean?

The Circular states that Lux FinCos should have "qualified personnel" capable of controlling the intermediary intra-group financing transactions. Clients often approach us to inquire what this term actually means in practice.

In my experience, this requirement does not necessarily mean that every Lux FinCo should have an employee on its payroll. In certain cases it is possible that a board member who is involved in the day-to-day management of the transactions could be seen as qualified personnel under the Circular. This needs, however, to be assessed on a case-by-case basis, since it depends on the number and complexity of the Lux FinCo's transactions. In addition, it might be possible to have one employee for several entities under the umbrella of a global employment contract, whilst carefully managing the topic of beneficial ownership.

Generally speaking, a Luxembourg-resident board member acting as qualified personnel should be in the flow of information for the decision-making process in all phases of a financing transaction. This means that he or she should be involved from when potential financing options are explored until the signature of the final loan documents. During the entire process the Luxembourg-resident board member, acting as qualified personnel, should actively raise questions and concerns, should there be any. All financing decisions should additionally be discussed and approved in the respective board meetings held in Luxembourg.

2. What are the main factors influencing the necessary level of equity at risk?

Under the new rules, the equity required by Lux FinCo is no longer limited to the lesser of 1% of the financing volume or €2 million.

My experience applying the Circular in various sectors has shown that the expected loss method is likely to be the most commonly used method for determining the equity required for Lux FinCos. Likewise, I believe that the CAPM will continue to be used to determine the margin in Luxembourg with more emphasis on the determination of the respective betas.

In short, the main factors influencing the equity requirement under the new rules are the credit rating of the Lux FinCo's borrowers and the contractual set-up of the transaction (i.e. the willingness of the Lux FinCo's parent company to regularly inject equity).

3. Can boards include foreign board members?

Another point that clients frequently contact me on is the composition of the Lux FinCo's board. The Circular specifies that the majority of the board members should be Luxembourg residents. Thus, it is certainly possible to have foreign board members.

I have also experienced cases where almost all of the board members are not based in Luxembourg. However, the board members regularly travel to Luxembourg where the relevant decisions are made. As a best practice, I would advise the board of directors to have quarterly meetings on the capacity of the Lux FinCo's borrower to repay the debt. Such review meetings are considered best practice for the qualified personnel of the Lux FinCo.

Conclusion

The deadline to be compliant for most companies in scope of the Circular is 31 December 2017. If you have not done it yet, I recommend verifying whether all your Lux FinCos are compliant with the new Circular.

In cases of non-compliance, the possible risks would be that the Lux FinCo is regarded as a conduit entity. This information might then be exchanged with foreign tax authorities in the country of the borrowers. Ultimately, it could lead to adverse withholding tax implications.

With only a few months left to implement the necessary changes in economic and organisational substance, KPMG Luxembourg's transfer pricing team is here to assist you.

I would like to thank Misela Saifullina and Jens Krüger who helped me prepare this blog.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.