Since the Luxembourg tax authorities (LTAs) issued guidelines on transfer pricing regarding the intercompany financing transactions in 2011, transfer pricing in Luxembourg has emerged a new era. Indicators include a recent court case that scrutinised the interest rates applied by a Luxembourg tax payer, and the coalition programme of the Luxembourg government announcing the introduction of new transfer pricing regulations. What's more, on a global level, the OECD is paying increasing attention to Based Erosion and Profit Shifting (BEPS).
A transfer price designates the price at which goods, services, intellectual property, or financing is transferred between related parties. The transfer price between related parties should be set as if the transaction took place between unrelated parties, i.e. at an arm's length price. In this respect, reference is made to article 9 of the OECD Model Convention and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which provide guidance on how to establish an arm's length price.
Here is an overview of the recent transfer pricing developments that may impact your business.
Towards more transparency
Transfer Pricing is on the radar of the BEPS Action Plan. One of the proposed measures relating to transfer pricing is Action Point 13. This will result in an OECD document on country-by-country reporting.
A proper transfer pricing study should comprise (i) a detailed description of all intercompany transactions, (ii) a functional analysis, (iii) the selection of the most appropriate transfer pricing methodology, and (iv) an economic analysis attesting that the transactions under review comply with the arm's length principle.
The proposal in question stipulates that transfer pricing studies have to provide a more detailed description of the intercompany flows, including information per country. Whereas this initiative aims at more transparency to assess the transfer pricing risk and perform a proper tax audit, it may lead to a higher compliance burden for tax payers, i.e. the preparation of transfer pricing documentation and higher risks of tax audits. A tax authority may argue, for instance, that it did not receive an appropriate profit in view of the profitability of the Multinationals (MNEs) in other countries.
While the OECD issues guidelines, it is up to the countries to adapt them to their own transfer pricing regulations.
Luxembourg transfer pricing circulars
From 2011 onwards, LTAs have provided guidance on the tax treatment of intercompany on-lending transactions, notably via the publication of two circulars.1 These circulars were issued in line with the OECD transfer pricing guidelines for MNEs and tax administration.2
The circulars list specific requirements and guidelines concerning Luxembourg entities, stating how to conform to and determine the arm's length remuneration of intercompany lending/borrowing activities. Companies falling within the scope of these circulars should fulfil the following main requirements.
- Substance
The companies must have a minimum level of operational substance in Luxembourg and meet certain requirements mentioned in the circulars.3 The substance requirements listed in the circulars are stricter than the residency criteria stipulated by the Luxembourg Income Tax Law (LITL), especially regarding the country the companies and members of the boards pay taxes in, the location of key decision-making, the requirements related to the filing of the tax returns, and an appropriate amount of equity at risk required in relation to the functions performed.
- Minimum equity at risk
The Luxembourg companies performing an intercompany on-lending financing activity are also required to have at least a minimum amount of equity to support the credit risk. The minimum equity at risk is set to be at least 1% of the intercompany loans receivables or €2 million.
- Transfer pricing documentation
A transfer pricing study should be available, determining the arm's length remuneration for the functions performed, risks born, and assets used regarding the intercompany transactions.
Last year, the LTAs started to request copies of the transfer pricing studies from taxpayers falling within the scope of the above-mentioned circulars. Non-compliance with these circulars may result in a tax reassessment or even an exchange of information with foreign tax jurisdictions. It is, therefore, recommended to comply with these circulars.
Luxembourg Court Case
A recent court case related to a reassessment of a Luxembourg company involving intercompany financing transactions further marks the changing view towards transfer pricing in Luxembourg. The LTAs scrutinised the adherence of the company to the arm's length principle regarding the interest rate applied to intercompany loans,4 which shows their increased focus on financing transactions.
Coalition Programme
Moreover, on 2 December 2013, the Government issued a new coalition programme confirming their intention to ensure the reputation of Luxembourg for tax stability and compliance with international initiatives in order to increase tax transparency.
The coalition programme also indicates that additional transfer pricing guidelines should be implemented in the coming years to ensure the competitiveness of the Grand Duchy within an international context.
The international developments, such as the OECD BEPS initiative, will lead to a greater focus on transfer pricing.
In Luxembourg, the recent developments in transfer pricing show that the latter has emerged in a new era. Taxpayers will have to be aware of the upcoming changes regarding the transfer pricing requirements by reviewing their intercompany transactions and taking into account the substance rules. What is more, they will have in respect to the circulars to be able to provide proper transfer pricing documentation that complies with the arm's length principle, including an appropriate economic analysis upon request.
The changing transfer pricing environment can lead to more transparency; it may, however, also generate a greater administrative burden.
Notes to the editor
1. PwC Luxembourg ( www.pwc.lu) est le premier cabinet de services professionnels au Luxembourg, employant 2300 personnes originaires de 57 pays différents. PwC Luxembourg fournit des services en matière d'audit, de fiscalité et de conseil, comprenant notamment des services de conseils en gestion, en transactions, en financement ainsi que des services de conseils portant sur des aspects réglementaires. La firme fournit ces conseils à une clientèle très variée allant des entrepreneurs locaux et des PME aux grandes multinationales ayant leurs activités au Luxembourg et dans la Grande Région. La firme aide ses clients à créer la valeur qu'ils recherchent en contribuant au bon fonctionnement des marchés de capitaux et en fournissant des conseils privilégiant une approche sectorielle.
2. Le réseau international PwC est le plus important prestataire de services professionnels dans les domaines de l'audit, du conseil fiscal et du conseil en gestion. Nous sommes un réseau de firmes indépendantes présentes dans 157 pays et comptons plus de 184 000 collaborateurs. Faites-nous part de vos enjeux et consultez nos sites de référence : www.pwc.com et www.pwc.lu pour davantage de précisions.
Footnotes
1 Circular L.I.R. N° 164/2 (28 January 2011) and Circular L.I.R. N° 164/2 bis (8 April 2011)
2 OECD Guidelines, 2010
3 Refer to Circular L.I.R. N° 164/2 (28 January 2011) for more details
4 Refer to article in IBFD - Luxembourg Court Case on Intercompany Financing Increases Focus on Transfer Pricing, by Marc Rasch, Lise Lozano-Moury and Dario Pala.
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.
