Luxembourg: recent developments in transfer pricing and tax ruling practice

by DLA Piper

The Luxembourg tax authorities are currently carrying out transfer pricing audits, particularly for financing companies. When the transfer prices are not substantiated through proper documentation, the Luxembourg tax authorities do not hesitate to reassess the tax bill, by adding an at arm’s length remuneration to the taxable basis. Recent decisions of the Luxembourg courts give further support to these attempts of the Luxembourg tax authorities. It is an understatement to say that transfer pricing is now becoming a serious concern for Luxembourg companies engaging in intra-group financing operations. 

Apart from transfer pricing, there is another hot topic in Luxembourg: tax ruling practices. Two information injunctions have been adopted by the European Commission on 24 March 2014, requesting Luxembourg to send information about its tax ruling practices and intellectual property tax regime before the end of this month. The aim of these information injunctions is to enable the Commission to assess the compliance of Luxembourg’s tax ruling practice with EU state aid rules. 

I will briefly touch on these two subjects.


The Luxembourg tax authorities are focusing increasingly on transfer pricing.

Background: transfer pricing circular

The publication of the transfer pricing circular of January 28, 2011, outlining the tax treatment of Luxembourg entities carrying out intra-group financing activities, was a (first) major step in this direction. According to the circular, the taxpayer should provide a transfer pricing report in line with the OECD guidelines if requesting an advance pricing agreement from the direct tax authorities. Such requirement was new for Luxembourg, even though some transfer pricing reports have sometimes been provided to the tax authorities for certain specific operations.

Another requirement laid down in the circular is that the Luxembourg financing company should have an amount of equity at risk (equity amounting to the lower amount of either 1 percent of its financing volume or €2 million is considered as satisfactory).

Finally, the circular provides organizational substance requirements for Luxembourg intra-group financing vehicles (e.g., the majority of Luxembourg resident directors).

Recent case law: need for TP documentation

The Luxembourg tax authorities are currently carrying out transfer pricing audits, particularly for financing companies. Recent court decisions show that the Luxembourg tax authorities verify, in the course of tax audits, whether transfer pricing documentation is available (contracts, economic analysis supporting the margins applied, etc). A recent decision of the Luxembourg administrative court (Tribunal administratif) on 1 July 2013 shows the tax risks that may arise when transfer pricing is not taken seriously.

In the case at hand, a Luxembourg company had granted several loans to affiliated companies. The interest rate applied on these loans amounted to 0.75 percent. In the course of a tax audit, the Luxembourg company failed to provide to the Luxembourg tax authorities the requested TP documentation (i.e., loan agreements; economic analysis supporting the interest rate applied). The Luxembourg tax authorities held that the interest rate of 0.75 percent was too low and reassessed the tax bill, by applying an "at arm’s length" margin of 3.5 percent (qualification of the margin as a hidden dividend distribution). The taxpayer brought the case before the Luxembourg court and argued, among other things, that (i) the Luxembourg tax authorities had accepted the interest rate of 0.75 percent in previous income tax years and (ii) the margin of 3.5 percent was excessive.

The judge endorsed the position of the Luxembourg tax authorities. First, he considered that the tax position needed to be examined on a yearly basis, so that previous opinions of the tax authorities should, as a rule, not be relevant. Second, the judge recalled that there was a reversal of the burden of proof as the taxpayer did not provide any documents (neither to the tax authorities nor to the court) evidencing the interest rate applied. On this basis, the Tribunal accepted the interest rate of 3.5 percent applied by the Luxembourg tax authorities, even though it presented (according to the judge) a rather wide margin of uncertainty.

From a practical perspective, it goes without saying that it is advisable to prepare in-depth transfer pricing documentation and, in some cases, to seek an advance pricing agreement with the Luxembourg tax authorities to confirm the margin applied.


Information injunctions from the European Commission

Foreign investors often seek a tax ruling from the Luxembourg tax administration, particularly when substantial sums are at stake, to confirm the Luxembourg tax treatment of an operation. The pragmatic and flexible tax ruling policy is clearly one of the main reasons why Luxembourg is often used in international tax planning.

In this context, attention should be paid to the two information injunctions adopted by the European commission on 24 March 2014, requesting Luxembourg to send information about its tax ruling practices and intellectual property tax regime before the end of April. The goal of these information injunctions is to enable the Commission to assess whether the Luxembourg ruling practice complies with the EU state aid rules.

The move by the European Commission came after Luxembourg failed to provide data on its tax rulings in 2011 and 2012, as well as details about the 100 largest companies which came under its intellectual property tax regime. If Luxembourg fails to timely deliver the requested information, the Commission may refer the issue to the EU Court of Justice.

Potential tax impact for multinationals

These information injunctions are a potential cause of concern for multinationals having obtained a Luxembourg tax ruling. The EU state aid rules have indeed a binding effect. And if it is considered that Luxembourg tax rulings constitute a prohibited state aid, the Commission may require said aid to be recovered.  The impact of these recent developments should, however, not be overestimated. It remains indeed to be seen whether the tax rulings meet all the conditions for constituting state aid. In particular, the key issue is whether (certain types of) tax rulings provide or not selective advantages to specific companies or groups of companies.  By way of example, tax rulings granted by the Luxembourg tax authorities based on the new TP Circular should, in my view, be beyond any suspicion of state aid, due to the way the spreads are applied (substantiation by a TP report established in accordance with the OECD guidelines), the organizational and economic substance requirements set by the Luxembourg tax authorities, etc.


Finally, I would like to mention that the Brussels tax court recently rejected a claim from the Belgian tax authorities that requested the Paris-headquartered energy giant GDF Suez to pay a tax bill of more than €285 million.

In the case at hand, one of the Belgian subsidiaries of GDF Suez had set up a finance branch in Luxembourg, which was subject to an effective tax rate of less than 2 percent thanks to a ruling obtained from the Luxembourg tax authorities (the so-called finance branch ruling).

The financial profits earned by the Luxembourg finance branch were exempt at the level of the Belgian head office, by virtue of the double tax treaty between Luxembourg and Belgium. The Belgian court rejected all the arguments invoked by the Belgian tax authorities based on such factors as the absence of permanent establishment in Luxembourg, domestic anti-abuse provisions, treaty abuse and double non-taxation.

The game may not be over yet, if such finance branch rulings are considered to be prohibited state aid.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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