Country How are penalties calculated? Luxembourg Potential adjustments result in penalties of 0.6% per month on the tax assessed. Introduction In 2011, the Luxembourg tax authorities issued two circulars on TP for Luxembourgbased entities that are mainly engaged in intragroup financing activities (i.e. intragroup lending activities financed by borrowings). Recently, the Law of 19 December 2014 further formalised legislation on TP in Luxembourg and introduced TP documentation requirements for any type of intragroup transactions. The new TP rules take effect as from 1 January 2015. Legislation and guidance The statutory rule on TP is found in Article 56 of the Luxembourg Income Tax Law (LITL) which has recently been restated by the Law of 19 December 2014. The new Article 56 LITL reads as follows: When an enterprise participates, directly or indirectly, in the management, control or capital of another enterprise, or where the same individuals participate, directly or indirectly, in the management, control or capital of two enterprises and where, in either instance, the two enterprises are, within their commercial or financial relations subject to conditions made or imposed which differ from those which would be made between independent enterprises, the profits of these enterprises are to be determined under conditions prevailing between independent enterprises and taxed in consequence. Whereas under the previous Article 56 LITL, the concept of related parties was broadly defined (i.e. special economic relationship), the new legislation outlining the arm s length principle became more aligned with the Organisation for Economic Co-operation and Development (OECD) Tax Model Convention. One consequence is that the arm s length principle is to be applied in transactions between two related entities both located in Luxembourg, as well as where one party is taxed in a foreign jurisdiction. Moreover, the new text should in effect oblige the taxpayer to report in its tax return an adjustment of profits whenever transfer prices do not reflect the arm s length principle. It is expected that further guidance on the application of the new Article 56 LITL may be introduced by way of a Grand-Ducal Regulation. Furthermore, if a shareholder receives an advantage from a company which the shareholder would not have received if there had not been a shareholding relationship, then this could be characterised under article 164 of the LITL as a hidden distribution. This might occur in a case where a shareholder charged a Luxembourg company significantly more than the market rate for a service provided by the shareholder. Such a hidden distribution would result in an add-back to the taxable profits of the Luxembourg company, and also possibly an obligation to account for withholding tax (WHT) on the deemed distribution. The rate of WHT on a hidden distribution of dividends is 15% of the gross amount received (therefore, 17.65% of the net amount), 684
unless reduced under the application of a double tax treaty (DTT) or the European Commission (EC) Parent-Subsidiary Directive. An abnormal advantage granted by a Luxembourg shareholder to an affiliate could be seen as a hidden contribution and taxed at the level of a Luxembourg subsidiary. However, profits corresponding to such hidden contribution could still be deductible against relevant accounting year expenses and offset against losses carried forward. On 28 January 2011, the Luxembourg tax authorities issued Circular L.I.R. n 164/2 (the circular) providing guidance on intragroup lending activities financed by borrowings. In the context of the circular, two enterprises are deemed to be related where one enterprise participates directly or indirectly in the management, control or share capital of the other, or if the same persons participate directly or indirectly in the management or in the share capital of both companies. The term intragroup financing transaction refers to any activity consisting of granting loans or cash advances to related companies. The scope of the circular applies to entities that are principally engaged in intragroup financing activities. The circular, however, does not provide guidance on when an entity is principally engaged in intragroup financing activities. The circular further states that an arm s-length remuneration should be determined for a Luxembourg entity carrying out such intragroup on-lending transactions in accordance with OECD Guidelines. A functional analysis is to be carried out to determine the remuneration of each entity, based on the functions performed and taking into account the assets used and risks borne. Moreover, the circular mentions that a company should have sufficient equity to assume the risks in connection with its financing transactions and that such equity should be effectively used if the risk related to the financing materialises. The minimum equity at risk should amount to 1% of the nominal value of the granted financing or 2 million euros (EUR). L In addition to the equity requirements, companies falling under the scope of the circular are also required to satisfy certain substance requirements in order to be considered to have real substance in Luxembourg. On 8 April 2011, the Luxembourg tax authorities issued an additional circular (L.I.R. n 164/2bis) to clarify the application of Circular L.I.R. n 164/2. This additional circular clarifies that confirmations obtained by the tax authorities before 28 January 2011 regarding the arm s-length nature of intragroup financing activities will no longer have effect as from 1 January 2012. Taxpayers must comply with the requirements set out in the 28 January 2011 circular (L.I.R. n 164/2) and file a request in this respect with the Luxembourg tax authorities. Penalties A local tax inspector (there is no central Luxembourg team of TP auditors) can scrutinise all transactions of all sectors of business and have the power of investigation including requesting information from third parties. Should such an audit result in an amendment of the taxpayer s tax return, the burden of proof is reversed and it will therefore be up to the taxpayer to prove the arm s-length nature of the transaction targeted by the tax authorities. Potential adjustments could result in penalties of 0.6% per month on the tax assessed for the taxpayer. However, there is a very limited experience of litigations. www.pwc.com/internationaltp 685
Documentation The Law of 19 December 2014 introduced a separate measure in the General Tax Law (Abgabenordnung) that made explicit the need for documentation for any type of intra-group transactions, by providing that the existing law on documentation requirements shall apply accordingly to transactions between related parties. This new subparagraph hence clarifies that normal disclosure and documentation requirements also apply to transactions between related parties. The Luxembourg tax authorities may request from the taxpayer all facts relevant for verifying a tax liability. For this purpose, the taxpayer is required to provide all necessary supporting documentation to facilitate the task of the Luxembourg tax authorities. The new subparagraph makes it clear that this obligation to provide documentation is applicable when the Luxembourg tax authorities are seeking to verify transfer prices. The Commentary on the text of the bill that led to the Law of 19 December 2014 confirms that one consequence of this change is that, whenever the Luxembourg tax authorities have reason to consider that a transfer of profits might have occurred (because the transaction under analysis does not comply with the arm s length principle) and the facts are not made clear or documented by the taxpayer, the Luxembourg tax authorities may look to the underlying economic reality of the operations and presume that there has been an undue reduction in profits, without having to justify this exactly. Hence, the absence of proper TP documentation could result in a reversal of the burden of proof towards the taxpayer. No explicit documentation requirements are imposed. The Commentary on the text of the bill that led to the Law of 19 December 2014 notes that the nature and extent of the documentation needed depends on the circumstances of the case under consideration. It notes that, in principle, the expectation of the level of documentation needed should be lower for straightforward corporate transactions, or for those undertaken by small businesses. Lastly, the Commentary on the text of the bill that led to the Law of 19 December 2014 points out that Chapter V of the OECD Transfer Pricing Guidelines referred to here as being the directing principles relating to documentation are being revised. Hence, once the revision of Chapter V is completed it may be expected that taxpayers will need to apply the three-tiered approach to documentation, which will include countryby-country reporting obligations, deriving from Action Point 13 of the OECD s BEPS Action Plan. The current version of the new Chapter V is set out in its entirety in the September 2014 OECD report Guidance on Transfer Pricing Documentation and Countryby-Country Reporting. This will not become fully finalised and effective until the OECD BEPS project is completed at the end of 2015. Transfer pricing controversy and dispute resolution A recent Luxembourg court case in which the arm s-length interest rates applied by a Luxembourg company were scrutinised demonstrates that the Luxembourg tax authorities increasingly focus on cross-border transactions, especially for companies that are mainly involved in intragroup financing transactions. Therefore, it is recommended that taxpayers carefully evaluate and substantiate the pricing of their intragroup financing activities through proper TP documentation. 686
Most of the tax treaties concluded by Luxembourg provide for an exchange of information procedure and contain mutual agreement procedure provisions. With the law passed on 24 April 1993 and subsequent amendments, Luxembourg approved the adoption of the EU Arbitration Convention and follows the EU Council Code of Conduct for the effective application of the arbitration convention. With the Law of 19 December 2014, a revised and unified system for advance tax confirmations was introduced in Luxembourg. This system includes any form of Advance Pricing Agreement (APA), whether covered by the scope of the 2011 Circular relating to financing activities, or otherwise. The aim remains to provide taxpayers with legal certainty for their transactions, while offering a uniform and egalitarian treatment between taxpayers and, importantly, increasing the transparency of the Luxembourg tax system. Filing fees, of a maximum of EUR 10,000, will apply to cover the administrative and operation expenses of the tax administration. The written confirmations are limited to five years. Luxembourg companies are required to make their annual accounts publicly available by filing a copy with the local court. However, the accounts do not necessarily provide much information on potentially comparable transactions or operations because they do not normally contain detailed financial information. Comparison with OECD Guidelines The revised TP measures that were introduced in Luxembourg with the Law of 19 December 2014 should be seen as an extension and clarification of the current tax law, with change being made in order to make explicit the application within Luxembourg of the OECD concepts of TP. L www.pwc.com/internationaltp 687
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