Luxembourg Tax Alert 2016-35

Luxembourg Tax Alert 2016-35

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Revision of the 2011 Transfer Pricing Circulars applicable to companies realizing intra-group financing transactions

On 27 December 2016, in light of the new article 56bis of the Luxembourg Income Tax Law (“LITL”) voted on 22 December 2016, the Luxembourg Tax Authorities published a new Transfer Pricing Circular aiming at clarifying the Transfer Pricing rules for companies principally performing intra-group financing transactions (“Circulaire du directeur des contributions L.I.R. n° 56/1 – 56bis/1 du 27 décembre 2016”).

Luxembourg is adapting its legal framework to take into account the latest international and European evolutions. As stated on the official website of the Luxembourg’s government, the new Circular follows the discussions between Luxembourg and the European Commission’s DG for Competition.

KPMG Luxembourg considers the publication of this Circular, as well as the new article 56bis LITL, as positive new developments regarding the application of the arm’s length principle.

Scope of application and definitions

The scope of application of the new Circular remains the same as under the 2011 Transfer Pricing Circulars. Notably, it applies to all entities realizing intra-group financing transactions, while holding activities remain out of its scope. The definitions of “intra-group financing transactions” and “associated enterprises” remain unchanged.

The arm’s length principle, as defined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“the OECD Guidelines”) and article 9 of the OECD Model Tax Convention, is enshrined in article 56 LITL, while the new Circular, together with article 56bis LITL, highlights the importance of comparability analysis in the application of the arm’s length principle.

Application of the arm’s length principle to intra-group financing transactions

According to the Circular, the comparability analysis should consist of two main elements:

  1. Identification of commercial and financial relations between associated enterprises, and determination of economically material conditions and circumstances in order to delineate the controlled transaction;
  2. Comparison of the controlled transaction with comparable transactions between independent enterprises and determination of the arm’s length remuneration.

A strong emphasis is put on the analysis of the risks assumed by the companies performing the intra-group financing transaction under review. In that regard, different factors will need to be taken into account such as the solvency of the borrower, the potential guarantees for specific financing transactions, the costs in relation with the financing transactions or the actual value of the underlying assets.

The Circular further provides that if the companies have a similar functional profile to the entities regulated under the EU Regulation n° 575/2013 that 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 harbor 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. The Luxembourg Tax Authorities reserve the right to regularly update this percentage based on a market analysis.

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 the widely accepted methodologies 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, meaning that the required equity at risk should decrease when the risks borne become more limited. 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:

a. The Luxembourg residence of the members of the board of directors' or managers' empowered to engage the entity in particular, 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;

b. The company should have qualified employees 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;

c. The fact that the entity is not considered as a tax resident of a foreign jurisdiction.

Transactions with no commercial rationale

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.

This is not the case if one or several transactions cannot be observed between independent parties, but a commercial rationale exists. In these cases arm’s length principle could very well be applicable.

Measure of simplification

The Circular provides for a measure of simplification should the following conditions be fulfilled:

  1. No Transfer Pricing study has been prepared;
  2. The intra-group debt receivables are financed by intra-group debt payables;
  3. andThe company fulfills 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. The Luxembourg Tax Authorities reserve the right to regularly update this percentage based on a market analysis.

In order to opt in for this measure of simplification, companies will have to inform the Tax Authorities of such decision in their corporate tax return from the fiscal year 2017.

These cases will be subject to the information exchange process.

Advanced pricing agreements with the Tax Authorities

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 specifies that any request for an advanced pricing agreement should contain at least the following information:

  1. Precise identification of the applicant (name, address, tax identification number), as well as the entities and branches participating in the transactions under review;
  2. Detailed description of the intra-group financing transactions involving the company;
  3. Qualifications of the relevant employees, as well as the description of their functions;
  4. State or States concerned by the transactions under review;
  5. Legal chart of the group, including the shareholders of the applicant;
  6. The fiscal years under review;
  7. Transfer pricing report in line with the OECD Guidelines and this Circular, including:
    a. description of the capital allocation, as required to assume the risks,
    b. description of the group and the functions performed by the enterprise of the group, as well as the description of value creation by the concerned enterprises,
    c. precise delineation of the transactions being analyzed,
    d. complete list of comparables search,
    e. the rejected comparables and the reasons for such rejection,
    f. the final list of comparable transactions that serves as a basis for the determination of the arm’s length remuneration,
    g. general market overview,
    h. examination of any potential fiscal problems that a chosen methodology could imply,
    i. list of all advanced pricing agreements concluded in different States concerning the transactions under review,
    j. list of all advanced pricing agreements concerning the enterprises under review that are still applicable,
    k. forecasted annual accounts for the fiscal years under review;
  8. Assurances that the information provided is complete and truthful.

The Circular outlines 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.

KPMG Luxembourg proposes to perform a review of the previously filed advanced pricing agreements, as well as past defensive Transfer Pricing documentation, in light of this revised legal framework.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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