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Introduction to transfer pricing in Luxembourg
Transfer pricing rules
- The internationally accepted arm’s length principle, per Article 9 of the OECD Model Tax Convention on Income and Capital, is incorporated under Article 56 and Article 56bis of the Luxembourg Income Tax Law (LITL).
- Article 56 LITL is the core transfer pricing provision in Luxembourg that requires the arm’s length principle to be applied to intra-group transactions concerning goods, services, intellectual property or financing activities. It serves as a legal basis for the upward and downward adjustments when Luxembourg group entities do not comply with the arm’s length principle.
- Article 56bis further provides detailed guidance to Luxembourg taxpayers and Luxembourg tax authorities (LTA) on how to apply the arm’s length principle.
- On 27th December 2016, the LTA issued new guidelines reshaping the transfer pricing framework for entities carrying out intra-group financing activities in Luxembourg. The new Circular L.I.R. n°56/1-56bis/1 (Circular) is applicable to any entity carrying out intra-group financing transactions.
- As an OECD member country, Luxembourg bases its domestic transfer pricing framework in accordance with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, released in July 2017 (OECD Guidelines).
Transfer pricing methods
- Luxembourg’s transfer pricing framework does not prescribe any preference or hierarchy for specific method(s) and supports the application of the most appropriate method – in accordance with the OECD Guidelines.
Transfer pricing documentation
Preparation of transfer pricing documentation
- Taxpayers in Luxembourg are obliged to prepare documentation to support the intra-group transactions.
- Such documentation needs to be provided to the LTA during tax assessment to evidence facts and provide information with respect to statements made in the tax returns. Additionally, such documentation can also be filed together with the corporate income tax returns.
- An Advance Pricing Agreement (APA) for intra-group financing intermediation activities, per the Circular, cannot be requested for without a transfer pricing documentation.
- LTA accept transfer pricing documentation prepared in Luxembourgish, French, German, and English.
Master and local file
- Consistent with the OECD Guidelines and BEPS Action 13, Luxembourg adopts the Master and Local file documentation approach.
- Typically, the Master file should provide information on: the global business operations and transfer pricing policy of the multinational enterprise (MNE) group, organisational structure of the MNE group, significant value drivers, main geographical locations, MNE group intangibles, financing activities within the MNE group and financial and tax positions of the MNE group.
- A Local file would supplement the information provided in the Master file and should include detailed information on: management structure of the Luxembourg group entity, intra-group transactions concerning goods, services, intellectual property or financing activities, an analysis of the functions performed, assets utilized and risks assumed, an industry analysis and an economic analysis sufficiently documenting the arm’s length range of remuneration.
Some risk factors for challenge
- Luxembourg group entities that receive and further grant loans to other group entities.
- Interest rates on intra-group loans.
- Licensing payments.
- Business restructurings, or changes in TP model, can also trigger a challenge but needless to say, businesses can evolve, and if the previous TP method no longer appears the most appropriate, it should always be reviewed, rather than being ignored for the sake of maintaining consistency.
CbC legislation in Luxembourg
- Effective as from 1 January 2016, Luxembourg implemented the Country by Country (CbC) legislation applicable to the MNE groups with revenues exceeding EUR 750 million during the fiscal year immediately preceding the reporting fiscal year.
- The Luxembourg tax resident ultimate parent entity of an MNE group must, on an annual basis, file a CbC report with the LTA with respect to its reporting fiscal year.
- Additionally, a notification must be made by each Luxembourg entity to the LTA on their status. The notification essentially indicates whether the entity submitting the notification is the reporting entity or not, and, if not, which entity within the MNE group is the reporting entity.
- The filing of the CbC report must be done within 12 months of the last day of the reporting fiscal year by the relevant reporting entity.
- The filing of the CbC notification must be done by the last day of the reporting fiscal year by the Luxembourg entity.
- As such there are no stand-alone transfer pricing penalties for not maintaining a transfer pricing document.
- However, the absence of a document adequately evidencing the intra-group transactions could give rise to adjustments to the taxable income or attract related penalties for incorrect filing of the corporate tax return.
- In accordance with the CbC legislation, a penalty of up to EUR 250,000 could be imposed on the taxpayer for non-compliance arising from non-filing, late filing or incorrect filing.
Economic analysis and how to demonstrate an arm’s length result
- No preference for either internal, external, domestic or foreign comparables.
- In accordance with the Circular, the determination of the minimum amount of equity-at-risk and related remuneration for a Luxembourg group entity undertaking financial intermediation activities should utilise economically suitable methods.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- APA is a written agreement between a taxpayer and LTA to govern the appropriate transfer pricing method for a forward-looking period (up to five years in total).
- Most APAs are unilateral and deal with the tax treatment of Luxembourg taxpayer’s intra-group transactions.
- A maximum filing fee of EUR 10,000 can be charged for APAs, which is fully payable within one month following the confirmation from the LTA of the amount to be charged.
- In accordance with BEPS Action 14, Luxembourg incorporated the Mutual Agreement Procedure (MAP) into its bilateral tax treaties.
- MAP may be requested when a taxpayer considers that measures taken by one or both jurisdictions result in taxation not in accordance with the provisions of an applicable double tax treaty.
- The Circular states that when a Luxembourg group financing entity meets the minimum substance requirements and carries out purely intermediary activity, the arm’s length principle should be met when a minimum return on the assets financed of at least 2% after-tax is achieved.
- The percentage will be regularly revised by the Luxembourg tax authorities based on relevant market analysis.
- It is worth mentioning that this minimal return cannot be applied to entities having different functional profiles. A transfer pricing document sufficiently evidencing the arm’s length remuneration should be performed.
- Pursuant to the Circular, a Luxembourg group entity involved in intra-group financial intermediation activities must maintain an appropriate level of substance in Luxembourg.
- The Circular stresses that the substance requirements, from a Luxembourg perspective, would be considered as met when:
- A majority of the members of the board of directors or managers, who have the authority to bind the Luxembourg group financing entity, are either Luxembourg residents/non-residents who carry on professional activity in Luxembourg or are subject to income taxation in Luxembourg on at least 50% of the income derived from their activities;
- Luxembourg group financing entity employs qualified personnel with the necessary skills required to control and assume risks related to the financing intermediation activities performed;
- Key decisions concerning the management of the entity are taken in Luxembourg; and,
- The entity is a tax resident only in Luxembourg.
- The above-mentioned substance requirements should typically be met by any Luxembourg taxpayer involved in intra-group transactions to avoid recharacterisation of the intra-group transactions in any (relevant) jurisdiction or reassessment of the tax residency.
- MNEs should undertake a review of the existing transfer pricing policies to assess and monitor any potential exposure due to COVID.
- Measures/decisions taken in the intra-group context during and post COVID should be adequately documented for future audits.
- Based on the industry of the taxpayer and the related intra-group transactions, utmost care should be taken when considering the applicable transfer pricing method(s), benchmarking strategy, year(s) under review when preparing the transfer pricing documentation.