Peter Moons, Gaspar Lopes Dias, and Sophie Ogden
Loyens & Loeff, Luxembourg
Legislation (e.g., new legislation or regulations that have impacted the transfer pricing landscape in your country.)
The arm’s length principle has been enshrined in article 56 of the Luxembourg Income Tax Law (‘‘LIR’’) for some years now, following the same notion already applied in Luxembourg law (and in particular on payments and distributions between an entity and its shareholders). Important transfer pricing legislative and regulatory changes came into effect as of January 1, 2017. Article 56bis LIR incorporates into domestic law aspects of BEPS Actions 8-10, including the possibility for tax authorities not to recognize certain transactions or parts thereof, as well as requiring details on the selection of the TP method and on establishing comparability. Article 56bis LIR was introduced by the Budget Law 2017, and parliamentary documents explicitly refer to the OECD Transfer Pricing Guidelines (‘‘OECD TPG’’) thus stressing the authoritative status of the OECD TPG and its latest updates. The Luxembourg tax authorities (‘‘LTA’’) published a circular on December 27, 2016 on intra-group financing transactions (‘‘Circular’’), providing pricing guidance and setting documentation requirements for Luxembourg financing companies. In the 2018 fiscal year companies continue to adapt to the changes of the previous year.
On June 19, 2018, a bill transposing the anti-tax avoidance directive (‘‘ATAD 1 Bill’’) was presented in parliament.1 It was initially expected to be approved before year-end and to come into force on January 1, 2019. This schedule looks somewhat uncertain at the moment. In essence, the ATAD 1 Bill would implement, inter alia, CFC rules and the interest deduction limitation rule, whereby exceeding borrowing costs are deductible up to the higher of 30% of the company’s EBITDA or EUR 3 million.
The OECD released its long-awaited discussion draft on financial transactions, which may have had the drafting assistance of the LTA. Considering the significance of the OECD TPG and the lack of specific guidance for financial transactions, the draft in itself constitutes an important document.
Cases and Rulings (e.g., recent transfer pricing cases or rulings, as well as changes in the volume or types of transfer pricing cases being litigated.)
In a 2017 landmark decision,2 the Administrative Court requalified a profit-participating loan (‘‘PPL’’) into equity for net wealth tax purposes. The Court applied an economic approach to determine the debt/ equity qualification of the instrument and provided a non-exhaustive list of criteria to determine whether an instrument qualifies as debt. Amongst other factors, the Court looked at whether the PPL carried a fixed interest, whether the loan was secured, and whether the agreement contained repayment terms. It further touched upon the disproportionate debt-toequity ratio of the company, noting that the main purpose of the PPL was to obtain interest deductions for tax purposes, to offset potential capital gains.
In 2018, a lower court ruled in favor of the LTA on an issue involving interest rate application. In this case, the LTA in 2014 had challenged the 12% interest rate set on a shareholder loan financing real estate situated in another jurisdiction for the litigated years 2011 and 2012.3 The excessive interest was requalified into a hidden dividend distribution for which withholding tax was due. While this case is not groundbreaking in itself, it does provide valuable information on how the tax authorities decided to apply an interest rate and how they treated the transfer pricing reports produced post facto by the taxpayer. The LTA had assessed the taxpayer, setting the interest at 12m-Euribor plus a low-risk premium, which was found to be appropriate in another court case. Apparently because of a rather substantial contradiction between the two TP reports brought forward by the taxpayer, the lower court sided with the LTA on the basis that the LTA interest rate still fell within the range of one of the TP studies brought forward by the taxpayer for the litigated year 2011. No TP report was applicable in 2012, though the TP report prepared in 2011 mentioned that it would need to be reviewed every year. Hence, the taxpayer’s TP analysis submitted for that year was effectively dismissed entirely. The lower court did not discuss in any way how one should set an interest rate at arm’s length. The decision of the Administrative Court, the appeal court for tax matters, will be decisive in terms of procedure, specifically regarding how reports produced at a later stage are considered and potentially, on the interest rate used by the LTA, as well.
The LTA has issued tax rulings (ATRs and APAs) in many individual cases, which were typically valid for a period of up to five years. However, in its Circular, the LTA communicated that it would no longer consider itself bound by the APAs granted for intra-group financing entities falling under the scope of the Circular, as of January 1, 2017.
The number of APAs submitted to the LTA dropped significantly from 118 for the year 2016 to 29 in 2017. This follows a trend that had already started in prior years.4 Several factors explain this fall in APA submissions: (i) starting in 2015 the administrative fee associated with an APA request was set at EUR 10,000, whereas previously there was no such fee; (ii) despite the legislative and circular novelties, taxpayers with older APAs did not feel the need to formally have them reconfirmed; (iii) as of January 1, 2017 the BEPS and EU frameworks for automatic exchange of tax rulings may have had a deterrent effect on the submission of APAs; and (iv) publicly expressed reluctance of the LTA to approve as many APAs as it used to.
In the European context, the EU Commission concluded that Luxembourg granted illegal tax state aid through tax rulings in both the Engie case,5 which involved hybrid convertible loans, as well as in the Amazon case,6 where royalty payments were considered to deviate from economic reality and the arm’s length principle. Both cases are being appealed to the CJEU.
Transfer Pricing Documentation (e.g., new master file or local file requirements, as well as other documentation or reporting requirements.)
Luxembourg tax law provides that upon request, taxpayers are required to substantiate the correctness of their tax return and any transaction related to the determination of the taxable basis. Effective as of January 1, 2015, the provision relating to taxpayers’ documentation obligations has been codified to clarify that it applies mutatis mutandis to transfer pricing and, since 2017, the previously mentioned article 56bis LIR gives guidelines on what information the TP documentation should contain.
Currently, there are no Master File or Local File documentation requirements in Luxembourg. On December 13, 2016, the parliament adopted the ‘‘CbC law.’’7 The CbC law contains notification requirements for Luxembourg taxpayers forming part of an MNE to file the CbC Report or to indicate which entity of the group will submit the CbC Report. The ultimate parent entity controlling an MNE group with total consolidated revenues above the EUR 750 million threshold must file a CbC
Transfer Pricing Examinations/Audits (e.g., any changes in the tax authorities’ focus on transfer pricing issues during an examination or changes in the way tax authorities audit transfer pricing issues, as well as a discussion of any changes or enhancements to the MAP process.)
The 2017 tax return form has been amended to include questions on transfer pricing, namely whether the Luxembourg entity is engaged in transactions with related parties and whether the entity opted for the simplification measure available in the administrative circular for intra-group financing activities. It is expected that the simplification measure normally will not be used, as it typically results in a much exaggerated tax liability.
In mid-2018, the head of the Luxembourg APA committee within the LTA internally moved to the position of head of the audit department of the tax administration. The tax administration informally communicated that going forward it will increase its focus on transfer pricing during audits.
During the debates for the national elections, most parties agreed to reinforce the operational capacity of the LTA and to reinforce tax audits, as well as to improve the MAP procedure in Luxembourg. Overall, transfer pricing audits are expected to rise.
What Can We Expect in 2019? (e.g., any anticipated transfer pricing developments or issues that we should be aware of as we enter 2019.)
The recently elected government coalition has internally agreed on the reduction of the aggregate corporation tax rate (26.01% for 2018) to 25.01% for 2019, in reaction to the declines in the EU (21.9%) and the OECD (23.9%) average corporate income tax rates. However, no measures will be taken that could potentially jeopardize the AAA rating, which the Grand Duchy has enjoyed for so long. The administration remains committed to taking an active role with regard to international tax cooperation initiatives, in particular at the OECD and EU levels. In general, developments in the Luxembourg transfer pricing environment will also to a large extent be driven by the international setting. Following the call for public comments, a final version of the OECD TPG on financial transactions is expected in the course of 2019. Considering that most intra-group transactions relate to financing activities in Luxembourg, the final version is expected to have an impact on the TP practice.
In the first quarter of 2019, the Advocate General of the General Court of the CJEU will render its conclusions in the Fiat state aid case.8 This case in particular is most awaited for the additional guidance it could provide on the TP methodology for establishing the remuneration of a Luxembourg financing entity at arm’s length.
The article appeared in Bloomberg Tax.