Tax governance and the increased focus on TP in Luxembourg
Enrique Marchesi-Herce and Serena Picariello of Deloitte examine the interaction between tax, transfer pricing, and regulatory considerations for asset managers in Luxembourg.
Financial services industry players are facing unprecedented tax, legal, and regulatory changes that they can no longer address in isolation. The complicated and ever-increasing interplay between tax and regulatory considerations means asset managers must consider tax and transfer pricing (TP) as part of their corporate governance framework.
In the past, asset managers could expect scrutiny on tax matters primarily from local tax authorities. Today, however, financial regulators are also increasingly focusing on tax as an indicator of the proper management of regulated entities.
Going one step further, Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF) published Circular 20/744 (the new circular) containing a list of tax fraud indicators for regulated investment fund managers – one of which specifically relates to compliance with TP regulations.
The new circular
Luxembourg’s position as one of the main global hubs for the fund industry has prompted its financial regulator to increase its focus on tax as an indicator of proper management.
The CSSF’s main concern is the potential impact of tax risks on asset managers’ regulatory positions and the need to meet the necessary capital and liquidity requirements. These challenges have not only driven management and boards to firmly place tax on their governance agenda, the CSSF is also increasingly asking asset managers during their onsite visits to demonstrate compliance with TP regulations and to present TP documentation.
Going one step further, on July 3 2020, the CSSF published the new circular to complement Circular 17/650 of February 17 2017. It adds elements specific to investment fund managers (i.e. asset managers) and provides guidance on expanding the definition of money laundering to incorporate aggravated tax fraud and tax evasion.
One of the new indicators specifically refers to compliance with TP regulations:
The investment fund manager’s business model results in a significant decrease of the investment fund manager’s taxable earnings by using cross-border transfers, triggering questions regarding compliance with TP rules and more generally with Luxembourg laws implementing directly or indirectly BEPS related actions. Such cross-border transfers can be:
Financial flows (e.g. management or marketing commissions and/or retrocessions but also interest or dividend flows); and/or
The new circular confirms the CSSF’s previously informal tendency to check compliance with TP regulations when assessing regulated asset managers’ proper management and good governance. It also further emphasises the importance of adequate TP policies and documentation.
A call for proactivity
Tax authorities have also increased their focus on the financial services sector, specifically asset managers. This includes a recent upsurge in tax audits and information requests to assess asset managers’ tax positions and readiness on TP. The focus of these requests ranges from the existence of TP policies and legal agreements, to TP documentation.
However, tax authorities are not limiting their reviews to mere formal considerations. Instead, they are increasingly scrutinising, and challenging, the material aspects of existing TP models, such as the appropriateness of TP method(s), benchmarking approaches, or the reliability of comparables.
To proactively manage and respond to these challenges, asset managers should:
Involve the governance function in the development of the tax strategy and control framework;
Revisit the appropriateness and defensibility of existing TP models in light of recent operational, regulatory, and tax developments;
Ensure that TP policies are consistently implemented;
Prepare robust TP documentation;
Identify the compliance and reporting obligations of each jurisdiction (including registration, filing of tax returns, disclosure requirements in tax returns, local documentation, and country-by-country filing requirements); and
Manage tax controversy and mitigate potential double taxation, penalties, and interest.
Regulatory and tax/TP issues are becoming increasingly interconnected and complex. Financial regulators’ growing interest and local tax authorities’ greater scrutiny mean that management and boards should highlight tax in their governance agenda.
Moreover, the new circular means that every asset manager should consider their TP policy and the extent to which it complies with TP regulations. Failure to do so may trigger severe adverse consequences from both a regulatory and a tax perspective.
Assistant manager, Deloitte