Luxembourg: Financing activities: What is the right price when no APA has been reached with the tax authorities?

Samantha Merle		Olivier Remacle

A recent decision of the Luxembourg Administrative Tribunal deals with a Luxembourg company which granted loans to three group companies which were neither remunerated nor fully documented. The Luxembourg Tribunal ruled on whether the remuneration on the financing activity performed is an arm's length remuneration, whether there is a hidden distribution and finally under which circumstances the tax authorities are allowed to assess Luxembourg companies automatically (so-called taxation d'office).

A Luxembourg company (Luxco) granted loans to three other group companies, which were neither fully documented, nor remunerated. When assessing tax years 2005 to 2010, the tax authorities applied a 3.5% margin on these loans, while they had applied a margin of 0.75% when assessing tax years 2003 and 2004 (the margin had been increased by the tax authorities from 0.5% to 0.75%).

Luxco challenged the position of the tax authorities, arguing that the tax authorities should apply the same margin as the one they had applied in previous tax assessments (0.75%). Luxco argued further that a capital gain had been realised upon the transfer of one of these loans and that this capital gain corresponded to the amount of interest which should be realised in accordance with arm's-length principles, that is, 0.5% margin for the tax years 2003 & 2004 and 0,75% margin for the tax years 2005-2010. Luxco concluded that the remuneration on this loan was in line with the arm's-length principles and that the tax authorities should not have increased its taxable basis.

Regarding the two other loans, Luxco argued that these amounts were not loans but receivables which should not be remunerated. The amounts were however reflected as loans in the accounts of Luxco.

As far as the receivables/loans were concerned, the Tribunal considered that there was a hidden dividend distribution. The Tribunal considered further that since Luxco did not provide any supporting documentation or argumentation evidencing that another level of remuneration would be appropriate, the tax authorities were right in assessing Luxco automatically and considering a margin of 3.5% as appropriate. The fact that the tax authorities agreed in the past on a lower margin of 0.75% was irrelevant, given the annual nature of the tax. The only exception to this principle would be the case where a prior written agreement has been reached with the tax authorities in this respect (an indirect reference to Advance Pricing Agreements (APAs)), which was not the case.

As far as the loan to the other company is concerned, given the facts evidenced by Luxco and the gain made on the transfer of the loan, the Tribunal disagreed with the tax authorities according to which there would be a hidden dividend distribution and considered instead that the taxable basis of Luxco should not have been increased by the tax authorities.

The case, which is one of the few in the area of financing activities performed by Luxembourg companies, is interesting as it shows the tax authorities are getting more and more attentive to the application of arm's-length principles when Luxembourg companies perform financing activities. The Tribunal states that the position taken in one year by the tax authorities as regards the margin is not binding upon the tax authorities for the following tax years, except if an agreement has been reached with the tax authorities (which was not the case here). The fact that the tax authorities have applied a 0.75% margin in one year and considered a 3.5% margin as appropriate in the years after is quite surprising, but we wonder whether the tax authorities would have increased the margin in the same way if Luxco had applied a margin of 0.75% instead of not applying any margin at all in the years 2005 to 2010. It is not clear how the tax authorities ended up with a margin of 3.5% while they previously considered a 0.75% margin as sufficient. The case law seems to tell us that applying a small margin is always better than not applying any margin at all and leaving it to the tax authorities to decide what is the appropriate remuneration. The lesson learned from this case-law is in any case that taxpayers should always remain prudent and seek the advice of experts when defining the terms and conditions of financing transactions and determining the arm's length price. If taxpayers want to be on the safe side, they can take the necessary steps in order to obtain an APA from the tax authorities.

Samantha Merle (samantha.merle@atoz.lu) and Olivier Remacle (olivier.remacle@atoz.lu)

ATOZ – Taxand

Tel: +352 269 401

Fax: +352 269 40 300

Website: www.atoz.lu