Transfer pricing and intra-group financing in Luxembourg
Magazine du trésorier
Luxembourg has been an attractive and well-known location for intra-group financing activities for multinational companies for many years. Thus, Luxembourg has been chosen by many multinational companies to centralize intra-group financing activities. Additionally, the circulars describe the requirements in order to obtain an up-front confirmation of the tax treatment from the Luxembourg tax authorities in the form of an Advance Pricing Agreement.
This article intends to give a basic overview with respect to this new regulatory framework and to provide guidance on the practical implications.
1. Scope of the Circulars
The first circular, issued on 28 January 2011 (hereafter, the “January Circular”), defines intra-group financing activities as all transactions consisting of the granting of loans or advances to associated enterprises refinanced by financial means and instruments such as public issuances, private loans or bank loans. Additionally, the January Circular provides guidance on how to determine an arm’s length price to be realized by an intra-group financing company and on the required level of substance for such company.
The second circular, dated 8 April 2011 provides for a grand-fathering period until 31 December 2011 for existing companies to comply with the organizational and economic substance requirements, as well as with the transfer pricing documentation and other requirements of the January Circular.
Accordingly, as from 1 January 2012, existing clearances obtained prior to 28 January 2011 from the Luxembourg tax authorities on the remuneration for financing activities will no longer be binding. Companies that comply with the conditions of the January Circular may however file an Advance Pricing Agreement on the remuneration derived from their intra-group financing activities.
2. Practical implications
Insofar as financing activities fall within the scope of the circulars, an Advance Pricing Agreement on the annual remuneration realized on intra-group financing transactions may be obtained to the extent the intra-group financing companies meet certain substance criteria in Luxembourg and effectively bear the risks related to the financing transactions. Additionally, the application for an Advance Pricing Agreement has to include a transfer pricing analysis on the remuneration realized by the financing company.
a. Transfer pricing analysis
The January Circular provides guidance on determining the arm’s length remuneration to be realized by an intra-group financing company. In this context, similar to what a financial institution would carry out before granting a loan, intra-group financing companies should carry out a risk analysis before granting intra-group loans and take into account any other elements influencing the transfer prices to be applied. This transfer pricing analysis should be supported by a comparability analysis and indicate the following essential comparability factors:
- Characteristics of the assets transferred or services rendered
- Functions assumed by the intra-group financing company
- Terms and conditions of the agreements
- Economic situation of the parties
- Risks assumed by the intra-group financing company (credit risk, foreign exchange risk, market risk, operational risk)
Such transfer pricing analysis serves as a basis for obtaining an Advance Pricing Agreement from the Luxembourg tax authorities.
b. Other requirements for Advance Pricing Agreements
In order for intra-group financing companies to be able to seek up-front confirmation of their tax treatment from the Luxembourg tax authorities, formalized within an Advance Pricing Agreement, the following conditions need to be met in addition to the transfer pricing analysis described above.
(i) The financing company has sufficient substance in Luxembourg
In this respect, the January Circular includes guidance on the conditions to be met in order to have sufficient substance. According to the January Circular, the intra-group financing company would be considered as having a sufficient level of organizational substance in Luxembourg in particular, if:
- The majority of the members of the board of directors (or of managers) are either Luxembourg-resident individuals or non-resident individuals deriving at least 50% of their professional income from Luxembourg sources. In the case where corporations are members of the board of directors or of managers, that corporation must have its registered seat and central administration in Luxembourg
- The directors (or managers) have appropriate professional experience and competencies to carry out their duties
- The directors (or managers) have the power to engage the company and to ensure proper execution of all financing transactions
- The key decisions are taken in Luxembourg
- For those companies which are required to hold shareholders meetings, at least one of the shareholders meetings must be held at the place indicated in the companies’ bylaws
- The company has a bank account in its own name with a Luxembourg bank
- The company may not be considered to be a tax resident abroad
- The company is compliant with all filing obligations relating to income and net worth taxes
(ii) The financing company effectively bears the risks related to the financing transactions for which clearance is sought
As regards the risks, the intra-group financing companies will be considered as effectively bearing the risks related to the financing transactions if it has equity at risk for its financing activity corresponding to at least 1% of the nominal value of the loans granted without exceeding EUR 2 million. In our view, the equity at risk requirements should be analyzed transaction by transaction involving a close monitoring each time a loan is granted by the Luxembourg financing company to an associated company. An intra-group financing company has equity at risk if it can demonstrate that it is obliged to effectively use its equity if the risks relating to the financing transactions materialize.
Luxembourg remains an attractive location for the centralization of intra-group financing activities of multinational companies. The circulars issued by the Luxembourg tax authorities in 2011 bring now additional guidance and legal security with respect to existing financing activities of Luxembourg companies. In our view, it is highly recommendable for Luxembourg companies to analyze if their activity is covered by the scope of the circulars and in case they are, to obtain an Advance Pricing Agreement from the Luxembourg tax authorities.
By Elmar Schwickerath, Partner, Business Tax Advisory, Ernst & Young, Luxembourg
And Nicolas Gillet, Partner, Transfer Pricing / Transaction Financial Engineering, Ernst & Young, Luxembourg
Posted on 8 February 2012