On 22 December 2016 the Luxembourg Parliament passed article 56bis of the Luxembourg Income Tax Law (LITL). This provision gives taxpayers and tax authorities more guidance on how to apply the arm's-length principle. The new article can be seen as a transposition of OECD BEPS reports (actions 8-9-10) released in late 2015 into national law.
Par. 7 of Art 56bis1 will affect future transfer pricing work because taxpayers must now be prepared to be able to document the commercial rationale behind intercompany transactions as part of transfer pricing documentation. Attention will need to be paid to this in pre-structuring documentation. Therefore, a description of the Luxembourg value chain should take any non-tax reasons into account.
The new Circular
On 27 December 2016, in light of the above mentioned article, the Luxembourg Tax Authorities published a new transfer pricing circular2 aiming to clarify the transfer pricing rules for companies principally performing intra-group financing transactions.
The scope of application of the new Circular remains the same as under the 2011 transfer pricing circulars; holding activities remain out of its scope. Rather, in this new Circular, strong emphasis is put on the analysis of the risks assumed by companies performing intra-group financing transaction.
The Circular further provides that if the companies have a similar functional profile to the entities regulated under EU Regulation n° 575/2013, which transposes the Basel Accords, and such companies have an amount of equity complying with the solvency requirements under this regulation, then it is considered that these companies have enough capital to support the risks assumed. Moreover, as a safe harbour it is considered that these companies comply with the arm's length principle if their remuneration corresponds to a return on equity equal to 10% after taxes. In practice, it is not expected that many Luxembourg companies will fall into the above-described category due to the particular nature of the required functional profile.
All other companies should perform an analysis to determine the necessary capital at risk using methodologies widely accepted in this area. These companies must have the financial capacity to assume such risks. The level of capital at risk should correspond to the functional profile under review. It must be noted that there is no reference anymore to the minimum required capital at risk of 1% of the financing volume (capped at EUR 2 million) that could be derived from the application of the 2011 Circulars.
Furthermore, the Circular provides that in order to be able to control the risks (i.e., decision-making capacity), the company performing the intra-group financing transaction should comply with the following substance requirements:
- Regarding the Luxembourg residence of the members of the board of directors, or managers empowered to engage the entity: the majority of board members should be Luxembourg resident or, if non-Luxembourg resident, should be taxable for at least 50% of their income (listed in the Circular) in Luxembourg.
- The company should have qualified employee(s) to control the performed transactions. However, the company could outsource some functions that do not have a significant impact on the control of the risks. We expect this requirement to be heavily debated in the near future.
- The entity must not be considered a tax resident of a foreign jurisdiction.
Linked to the above article 56bis, the Circular provides that if one or several transactions cannot be observed between independent parties and no commercial rationale could be identified, then such transactions should be disregarded in order to comply with the arm's length principle.
The Circular also provides for a measure of simplification which a taxpayer can opt for, should the following conditions be fulfilled:
- No transfer pricing study has been prepared.
- The intra-group debt receivables are financed by intra-group debt payables.
- The company fulfils the substance requirements (as outlined above).
It will be considered that such companies comply with the arm's length principle if their remuneration corresponds to a return on the financed assets of at least 2% after taxes. These cases will be subject to the information exchange process.
The Circular provides that it remains possible to obtain an advanced pricing agreement, based on the facts and circumstances of each case, if the conditions outlined in the Circular are respected.
The Circular also stipulates that any advanced pricing agreement issued before the entry into force of article 56bis LITL should not be binding upon the Tax Authorities, as from 1 January 2017, for the fiscal years following 2016.
Although it is not indicated, it can be interpreted that a Luxembourg entity carrying out an intra-group financing activity that does not have the so-called organisational and economic substance would be considered "conduit" and that Luxembourg may exchange that information spontaneously with the debtor's and creditor's jurisdictions. It can then be anticipated that a tax audit in those jurisdictions may be initiated and that the beneficial ownership of the Luxembourg entity will be questioned.
The conclusion would be that Luxembourg taxpayers will need to develop agile documentation in order to fit with these new developments, as Luxembourg certainly wants to be in a level playing-field situation.
In this respect, you have to ask yourself the following questions:
- Can you provide evidence that your existing substance is in line with the above requirements?
- Does your functional profile fit with the required level of organisational substance?
- What's the risk linked to your intra-group financing activity and do you have enough equity to bear that risk?
Additionally, each functional profile may be different, and the income left will not automatically increase in all cases.
Finally, please do not forget the non-public country-by-country ("CbC") reporting transposing the EU Directive 2016/881 of 25 May 2016 into Luxembourg law. E-notifications about the reporting entities for MNE groups having a fiscal year-end in 2016 (and a fiscal exercise starting as of 1 January 2016) must be provided on an exceptional basis no later than 31 March 2017 (instead of 31 December 2016 as initially foreseen in the Law).
Read more about the five comparability factors mentioned in article 56bis here.
Or, read more about country-by-country reporting in Luxembourg.
1. "...transactions between the parties can be disregarded for transfer pricing purposes, if [part of] the transaction does not possess the commercial rationality of arrangements that would be agreed between independent parties..."
2. Circulaire du Directeur des contributions L.I.R. n° 56/1 – 56bis/1 du 27 décembre 2016
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.