Before the initial circular LIR 164/2, no transfer pricing legislation had been formalised. Given that the circular applies to all entities undertaking intra-group financing transactions and Luxembourg is a popular location for intermediary financing activities, the clarification on the guidance applies to a significant number of taxpayers.
The initial circular, issued January 28 2011, presented in broad terms the transfer pricing requirements that should be met by group financing companies. The second circular gives clarification on which tax period the first circular is applicable to. It also indicates an effort from Luxembourg’s tax authorities to confirm that their practices are in alignment with EU law and OECD principles.
“The issuance of the circulars could be viewed as a step undertaken by the Luxembourg government to ensure that the practice consisting in obtaining advance clearance agreement from the Luxembourg direct tax authorities regarding intra-group financing activities is fully compliant with EU law and especially the EU Code of Conduct,” said Jamal Afakir, from Atoz – Taxand.
The timing of the clarification ties in with more general efforts from Luxembourg to reduce complexity and increase transparency.
“Given the position Luxembourg is taking in the current financial market, Luxembourg becomes more and more visible internationally together with its laws, rules and practices. In reaction, a formalising and clarification like this should be welcomed by everyone,” said Ayzo van Eysinga, head of tax at Stibbe Luxembourg.
Advisers said there were a number of problems with the initial circular that necessitated the second circular being released.
“Some of the requirements provided for may be viewed as contravening either Luxembourg domestic tax provisions – residency of Luxembourg companies for instance – and/or EU law,” said Afakir. “It could be concluded that the step undertaken by the Luxembourg tax authorities was necessary, but the level of requirements probably goes beyond what was expected, sometimes in contradiction with existing laws.”
This step goes beyond merely explaining the application of the first circular, though. It also serves to make Luxembourg more attractive as a place of investment.
“Given the longstanding advance pricing agreement (APA) practice in Luxembourg, it could be questionable, from a pure Luxembourg domestic viewpoint, whether the clarification was necessary,” said Jean-Michel Chamonard, partner at Atoz – Taxand. “In practice however, this should help many Luxembourg taxpayers in implementing transfer pricing and in managing and organising best practises and, as such, will strengthen the position of Luxembourg as an ideal investment platform.”
In the context of both circulars, there are certain implications for Luxembourg-resident taxpayers. Taxpayers should carefully review their compliance process for accounting and tax filing obligations, as well as conforming to management and residency restrictions.
“It is crucial to ensure that the existing management organisation of the group financing company complies with the requirements set forth in the first circular. Specific constraints apply for individuals in terms of Luxembourg residency or, if non-resident, in terms of Luxembourg sourced taxable income. Requirements are less burdensome for corporate managers,” said Chamonard.
There is no new legislation and the circular constitutes a clarification so the implications should not be overly burdensome.
“The financial implications should not be dramatic at all. It is not a change of law; it is a formalising of the existing APA practice, providing guidelines under which an APA can now be obtained,” said Dirk Leermakers, leading partner of Stibbe Luxembourg. “Every Luxembourg company will have until January 1 2012 to either renegotiate its existing APA, or simply continue the existing intra-group financing without an APA, relying on the guidelines now published.”
“The general implication would be that for each intra-group financing activity, a transfer pricing report needs to be made, whether an APA is sought or not,” van Eysinga said.
For taxpayers who already have APAs in place, negotiated before January 28 2011, these will remain binding agreements until January 1 2012.
“Thereafter, it will depend on a case-by-case basis if a new APA should be obtained,” said van Eysinga.
New APAs will be valid for a maximum period of five years.
Existing advance tax clearances, obtained from the Luxembourg tax authorities on matters other than group financing activities, are not affected by the circulars.
Due to a clause in the initial circular, Afakir believes that companies are likely to increase their equity “so that they can demonstrate that the minimum equity at risk is available” (the lower of 1% of total financing activity or €2 million).
The general reaction to the second circular has been a positive one and highlights the willingness of Luxembourg to further comply with OECD guidelines. Companies in Luxembourg should welcome the increased stability and certainty this provides.
“Both circulars give a clear and positive message that Luxembourg is formalising its APA practice and confirms that such practice will continue to exist in line with the OECD transfer pricing guidelines. The significance of the circulars is that they confirm that the existing APA practice will be continued in the long term,” said van Eysinga. “This provides more security, stability and transparency for companies resident in Luxembourg engaged in intra-group financing activities.”
