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On December 27, 2016, the Luxembourg tax authorities published a new circular (Circular L.I.R. 56/1 - 56bis/1— “new circular”) reshaping the rules for Luxembourg companies engaged in intra-group financing activities. Whilst the existing substance and arm's length requirements remain largely similar to those set forth in previous circulars, the new rules aim at being even more in line with OECD guidelines by removing the artificial 1 percent equity at risk requirement to implement a genuine equity test. Most Luxembourg companies engaged in intra-group financing will therefore have to reassess their level of equity and financing structures will have to be adjusted before the end of 2017.
Luxembourg intra-group financing rules were based on Article 56 of the Luxembourg income tax law (stating the general arm's length principle) together with two specific circulars issued in 2011. These circulars were applicable to Luxembourg companies whose principal activity consists of intra-group financing transactions. An intra-group financing transaction was defined as the granting of loans to related entities financed out of (related or third party) debt. The definition of related entities for this purpose includes any direct or indirect participation in the management, control or capital of another company.
The 2011 circulars introduced formal rules to obtain advance pricing agreements which were only available for financing companies which had a certain level of substance (directors/managers and equity at risk) and proper transfer pricing documentation supporting the pricing of their financing activities. As a rule of thumb, a minimum equity at risk of 1 percent of the amounts lent (capped at 2 million euros) was required.
Whilst the scope remains the same, the requirements are now adjusted to strengthen the beneficial ownership position of financing companies in line with OECD principles.
The new circular still requires a financing company to determine its remuneration on the basis of OECD transfer pricing guidelines. The financing company is required to substantiate its remuneration on the basis of a transfer pricing analysis which should contain a functional analysis taking into account the functions performed, assets used and risks assumed in relation to the financing activities and an economical analysis of data on comparable transactions.
In this respect, the following points should be noted:
When a financing company acts as a pure intermediary and meets the substance requirements described above, the company will be deemed to carry out arm's length transactions if the company reports a return on its financing activities of 2 percent after tax. This percentage will also be regularly updated by the tax authorities based on market evolutions.
In order to benefit from this simplified rule, a specific application will have to be made by the company in its tax returns.
Opting for this simplified rule may, however, weaken the beneficial ownership position of the financing company and the Luxembourg tax authorities may (on demand or spontaneously) exchange this information with foreign tax authorities.
Whilst the new circular is immediately applicable and existing advance pricing agreements will be cancelled as from January 1, 2017, we understand that pre-existing structure will have till the end of 2017 to be adjusted.
Geoffrey Scardoni, Tax PartnerKim Ngo, Economist - Transfer pricingDLA Piper, Luxembourg
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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