OUR INSIGHTS AT A GLANCE
- The Luxembourg VAT Authorities released Circular n°790 in which they have provided some clarifications on the taxable basis to be considered in transactions involving related parties.
- The Circular requires that transactions involving related parties be charged at "open market value". If this was not the case, the VAT authorities would be entitled to take into consideration that "open market value" and to reconsider the VAT deductible rights of the taxable person.
- Related parties should properly reflect that the fees agreed or charged are consistent with the open market value criteria.
On 18 January 2019, the Luxembourg VAT Authorities released Circular n°790 (hereafter "the Circular") in which they have provided some clarifications on the taxable basis to be considered in transactions involving related parties. This Circular comments on the 2018 Luxembourg VAT Law amendments establishing new VAT rules for transactions between related parties.
Purposes of the new regime
These new rules aim at avoiding fraudulent or abusive situations that could lead to undue VAT advantages. The typical situations for which the above-mentioned anti-abusive rules have been implemented are, for instance, cases where the VAT deduction right could be positively impacted by an artificial increase of the fees charged for transactions allowing a full VAT recovery, or the situation where the fees subject to VAT invoiced to entities without VAT deduction right are artificially decreased to lower the VAT cost for these entities.
The concept of "open market value"
The key concept surrounding these new rules is the concept of "open market value". This notion is defined by the Luxembourg VAT Law and the VAT Directive as "the full amount that, in order to obtain the goods or services in question at that time, a customer at the same marketing stage at which the supply of goods or services takes place, would have to pay, under conditions of fair competition, to a supplier at arm's length within the territory of the Member State in which the supply is subject to tax".
Scope of application and impacts
In terms of scope, the Circular and the related legal provisions apply in situations where two cumulative conditions are met.
The first condition relates to the persons involved in the transaction and the links between each other. The transaction shall be carried out between related persons. This first condition is fulfilled where the transaction is performed between persons bound by family links (or other closed personal links), organisational, ownership, affiliate or financial links as well as legal relationships.
The second condition concerns the transaction itself and the VAT recovery right of the entities involved. The new regime applies in the three following situations:
- The purchaser of the goods or services does not have a full VAT recovery right and the fees invoiced for the transaction (i.e. the VAT taxable services) are below the open market value;
- The company providing both VAT taxable (with VAT recovery right) and VAT exempt (without VAT recovery right – e.g. EU financing, regulated fund management services, etc.) services charges a fee lower than the normal value for the VAT exempt turnover in order to indirectly increase its VAT recovery right;
- The company providing both VAT taxable (with VAT recovery right) and VAT exempt (without VAT recovery right – e.g. EU financing, regulated fund management services, etc.) services charges a fee higher than the normal value for the VAT taxable turnover in order to indirectly increase its VAT recovery right.
In cases where the Circular and the related legal provisions apply, the consideration to be taken into consideration for VAT purposes is the open market value, regardless the value of the fees agreed or charged. Should this not be the case, the VAT authorities would be entitled to reconsider the taxable basis of the transactions in light of that open market value concept and to draw the relevant conclusions regarding the VAT deduction rights of the parties involved.
Transactions involving related parties shall henceforth be closely monitored not only from a transfer pricing perspective but also from a VAT standpoint in order to properly reflect that the fees agreed or charged are consistent with the open market value criteria and thus do not trigger issues in terms of VAT deduction right and VAT liability.
Transfer pricing, in general, has become increasingly important since 2011 when the Luxembourg tax authorities released a first Circular on the tax treatment of entities carrying out financing activities. Over the years, the Luxembourg legislator implemented several tax law changes in regard to transfer pricing that formalise the application of the arm's length principle and the relevance of the OECD Transfer Pricing Guidelines. This inevitably exerts pressure on taxpayers to find a balance between a comfortable level of security and the costs for the preparation of sound transfer pricing documentation.
In practice, Luxembourg companies should screen major intra-group transactions in order to identify issues that could raise suspicion on the part of the Luxembourg tax authorities and assess the magnitude of tax risks.
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.