On 28 January 2011, the Luxembourg direct tax authorities issued a circular (L.I.R n°164/2) (the "Circular"), which clarifies the tax treatment of Luxembourg companies that perform intra-group financing activities and sets out the framework for granting advance tax clearance concerning them. These guidelines are aimed at assisting the tax authorities and companies dealing with intra-group financing in determining their taxable basis in Luxembourg in accordance with OECD transfer pricing principles.
On 8 April 2011, the Luxembourg tax authorities issued an additional circular (L.I.R. n° 164/2 bis) (the "Additional Circular"), clarifying that existing advance tax agreements which fall within the scope of Circular will no longer be binding as of 1 January 2012 with regard to the remuneration of the intra-group financing activity. Taxpayers who wish to comply with the latest guidelines will have to file a new request with the Luxembourg competent tax authorities, covering the transfer pricing of the intra-group financing activity.
The Circular applies to all entities principally engaged in intra-group financing transactions. The activities related to the holding of participations are excluded from the scope of the Circular.
For the purpose of application of the Circular: "intra-group financing transactions refer to any activity consisting of granting loans or cash advances to related entities, refinanced by funds and financial instruments, such as public offerings, private loans, cash advances, or bank loans."
According to the Circular, two entities are related if one of them participates directly or indirectly in the management, control, or in the capital of the other entity; or, in the case where the same persons participate directly or indirectly in the management, control, or in the capital of these two entities.
In addition to the on-lending of funds, the Circular will only be applicable to the entities that are "principally" engaged in intra-group financing activity.
The circular does not clarify whether "principally" is based on the statutory annual accounts of the company or on any other criteria.
DETERMINATION OF THE ARM'S LENGTH REMUNERATION
The Circular refers to the application of the arm's length principle established in Article 9 of the OECD Model Tax Convention for the determination of the transfer price between related entities. The arm's-length principle states that transaction between two related parties must be established at a price, which two unrelated parties in uncontrolled conditions would have negotiated.'
An arm's length remuneration is deemed to be the one a financial independent entity that is subject to the regulatory requirements of the "Commission de Surveillance du Secteur Financier" (e.g. bank) will have applied to similar credit transactions.
"The remuneration of the financing party involved in the intra-group financing transaction should, therefore, be based on an analysis which takes into account the functions performed, risks borne, and assets utilised."
The remuneration should in particular include:
- any mark-up corresponding to fees and expenses incurred or implied by the transaction at the level of the financing party, as well as
- the cost borne by the financing party to put its capital at risk.
PROCEDURE TO OBTAIN A TAX CLEARANCE ON THE TAX TREATMENT OF INTRA-GROUP FINANCING COMPANIES
The Circular defines the conditions under which advance tax clearances are valid from a Luxembourg perspective.
The Luxembourg tax authorities could assess on a yearly basis, probably in the context of the tax filing obligations of each Luxembourg tax payer, the position of the Luxembourg entity in the light of transfer pricing requirements.
In general terms, an advance tax clearance for an intra-group financing company (Advance Pricing Agreements "APA") will be issued if, notably the Luxembourg company has:
- a real presence in Luxembourg (i.e. a minimum level of economic substance),
- the capacity to undertake the risks inherent to its financing activity (in general, a minimum level of equity), and if
- the tax clearance request complies with the formal requirements provided for in the Circular.
1. Substance Requirement
- The majority of the members of the board of directors or of the
managers who have the capacity to enter into binding agreements on
behalf of the company must be either
- Luxembourg residents, or
- non-residents carrying on a professional activity in Luxembourg
from which they derive:
- business income,
- income from agricultural and forestry activities,
- income from the exercise of an independent profession, or
- salary income, at least 50% of which should be taxable in
Luxembourg. In the case where companies are members of the board of
directors or the managers, that company must have its registered
office and central administration in Luxembourg.
- The directors and managers resident in Luxembourg or deriving more than 50% of their professional income from Luxembourg (in case of individual directors or managers) must have appropriate professional experience and competencies to carry out their duties. Moreover, they must at least have the power to engage the company and to ensure the proper execution of all transactions entered into by the intra-group financing company. The intra-group financing company must, moreover, have qualified personnel (either employees or outsourced) capable of executing and recording the transactions carried out. The company must be capable of supervising the work carried out by that personnel.
- The key decisions relating to the management of the intra-group financing company must be made in Luxembourg. In addition, for those companies which are required by law to hold shareholders meetings, at least one of the shareholder meetings must be held at the place indicated in the companies' articles of association.
- The intra-group financing company must have at least one bank account in its own name with a Luxembourg bank or with a Luxembourg branch of a bank established abroad.
- When the clearance request is filed with the Luxembourg tax administration, the intra-group financing company must be compliant with all filing obligations relating to income and net worth taxes.
- The intra-group financing company may not be considered to be tax resident abroad.
2. Equity Requirement
In relation to the risk level, the Circular expressly requires that the Luxembourg entity engaged in intra-group financing activity maintain an adequate level of equity with regard to the functions performed.
The Circular goes further in establishing that a Luxembourg entity engaged in intra-group financing must be considered to have sufficient equity at risk related to granting loans, if the equity equals 1% of the nominal value of the loan(s) granted or EUR 2 million and it is at risk.
The amount of equity at risk includes both share capital and share premium, but not profit reserves or other reserves.
For the Luxembourg entity, in order to consider the equity to be effectively at risk, it is required that the equity is connected with the loan granted in such a way that, in the event of default of the borrower, the Luxembourg entity either uses its own equity invested or has a legal obligation to partially repay the lender up to 1% of the nominal value of loan up to EUR 2 million. In other words, the equity should be used if the risk associated with the transactions materialises.
This implies that particular attention needs to be paid to the drafting of all intra-group liabilities documentation.
3. Guidance Regarding the Information Which Should be Provided with the Tax Clearance Application
The circular specifies the information that should be provided with the tax clearance application. Depending on the facts and circumstances of each specific transaction, the tax clearance application should include:
- The exact designation of the applicant and the parties to the transactions for which the tax clearance is sought;
- The detailed description of the transaction, and arrangements or legal documents for which tax clearance is sought;
- The states concerned by the transactions or arrangements;
- A legal structure chart of the group, including information on the beneficial owner of the taxpayer's equity;
- The fiscal years concerned by the tax clearance application;
- A transfer pricing analysis meeting the OECD standards and including, in particular, a complete description of the proposed methodology, as well as detailed information and analysis supporting the methodology applied;
- A general description of the market;
- An analysis of the tax issues incidental to the methodology proposed;
- A confirmation that the indications required for the evaluation of the facts are complete and accurate.
4. Duration of the Clearance and Renewal Application
The validity of the APA will depend on the facts and circumstances and should not exceed a duration of five (5) years. The APA will not be valid if the actual facts have not properly been disclosed or if the advance clearance is conflicting with international legislation.
Upon request, the application of the APA may be extended for additional period of five years.
5. Validity of the Ruling Obtained Before 28 January 2011
Luxembourg tax authorities have issued the Additional Circular clarifying the position of the companies engaged in intra-group financing, and which obtained a confirmation from the authorities before 28 January 2011. The Additional Circular clarifies that, where confirmation was obtained prior to 28 January 2011, it will no longer have effect after 1 January 2012 with regard to the remuneration of the intra-group financing activity; taxpayers who want ongoing comfort will need to submit a new ruling request covering the transfer pricing of the intra-group financing activity via a tax clearance application.
Despite the fact that the Circular raises some questions regarding its interpretation, the introduction of these guidelines, which are similar to those of other EU countries, such as the Netherlands, increases the transparency and the Luxembourg credibility in the international tax environment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Specific Questions relating to this article should be addressed directly to the author.