Luxembourg strengthens its Transfer Pricing Rules

Luxembourg reinforces its domestic Transfer Pricing rules as of 1 January 2017 by the enactment of:

(I) General guidelines applicable to Transfer Pricing analysis with the introduction of article 56bis in the Luxembourg income tax law (“LITL”)

(II) Circular LIR N°56/1 – 56bis/1 of 27 December 2016 applicable to intra-group financing activities.

EXECUTIVE SUMMARY

Article 56bis LITL

Article 56bis LITL is a complement to article 56 LITL modified in 2015:

Article 56 LITL introduced the general arm’s length principle based on article 9 of the OECD model tax treaty ;
Article 56bis LITL introduces general guidelines applicable to transfer pricing analysis performed to determine the arm’s length price applicable to intra-group transactions.

The basic principle of article 56bis LITL is to determine how to perform the comparability analysis and chose the appropriate criteria to compare an intra-group transaction to relevant third-party transactions. Several criteria need to be retained such as (i) contractual terms, (ii) functions exercised and risks assumed, (iii) type of asset, service or engagement and (iv) economic circumstances (of the parties and the market).

Article 56bis LITL adds that the technical methods used to determine the arm’s length price must be consistent with the nature of the transactions and must enable to obtain the best possible determination of the applicable arm’s length price.

Such relevant methods should be chosen amongst the transfer pricing methods identified by the OECD.

Circular n°56/1 – 56bis/1 of 27 December 2016

Content

The main rules are as follows:

Advance Pricing Agreements obtained under Circular 164/2 of 28 January 2011 do no longer bind the Luxembourg tax authorities as of 1 January 2017.
Transfer pricing analysis based on Circular 164/2 of 28 January 2011 LITL should be revised based on the rules set out in the new Circular.
The arm’s length remuneration must be determined based on the guidelines set out in article 56bis LITL. Relevant comparables shall be based on a functional analysis (functions exercised, risk assumed, assets engaged) and an economic analysis (data on comparable third party transactions). The new Circular is based on the same principles than Circular 164/2 on that point but provides more technical details to be followed.
The process to determine the arm’s length remuneration shall be transparent, systematic and verifiable. The research of potential comparables to determine the arm’s length remuneration shall be made by using all available sources of information at the date of implementation of the transaction.
Substance requirements remain basically unchanged compared to the ones described in Circular 164/2 (where such requirements were already reinforced and precise).
The minimum equity requirements must be based on the transfer pricing analysis and the ability of the Luxembourg financing company to assume the financial risk if it realizes. The threshold equity level of 1% of the loans granted or EUR 2 million is thus no more applicable.
For companies performing functions comparable to regulated financing and treasury companies, the remuneration shall comprise a return on the equity of 10% after tax (percentage being regularly revised by the tax authorities).
The Circular contains simplified rules: for companies acting as mere intermediaries and opting for the simplified regime, a minimum return of 2% after tax of the assets financed (percentage being regularly revised by the tax authorities) should be considered as compliant with the arm’s length principle. There are constraints and risks associated to this option.
Taxpayers can apply for the obtaining of a formal Advance Pricing Agreement binding on the Luxembourg direct tax authorities based on certain conditions and requirements.
For taxpayers which do not opt for the filing of an Advance Pricing Agreement with the tax authorities, the latter can request that the transfer pricing analysis having been used to determine the prices of its intra-group financing transactions are communicated to them upon request.

Entry into force and actions required

Circular n°56/1 – 56bis/1 enters into force as of 1 January 2017. It is however expected that taxpayers have until the end of 2017 to be compliant with the new Circular.

Advance Pricing Agreements filed before 31 December 2016 are no more binding on the Luxembourg direct tax authorities. Luxembourg companies willing to secure their arm’s length prices shall apply for the obtaining of a new Advance Pricing Agreement.

Taxpayers which opt to not file an Advance Pricing Agreement shall review their transfer pricing policies and prepare the documentation enabling them to justify the intra-group prices applied which should be available upon request of the tax authorities. Preparing transfer pricing analysis compliant with the new Circular and revised OECD Guidelines are strongly recommended.

More detailed descriptions are included in the following pages.

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