TAX ALERT NEW CIRCULAR N 56/1 56BIS/1 ON THE TAX TREATMENT OF COMPANIES ENGAGED IN INTRA-GROUP FINANCING TRANSACTIONS JANUARY
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1 TAX ALERT NEW CIRCULAR N 56/1 56BIS/1 ON THE TAX TREATMENT OF COMPANIES ENGAGED IN INTRA-GROUP FINANCING TRANSACTIONS JANUARY ã2017
2 I. INTRODUCTION On 27 December 2016, the Luxembourg tax authorities (Administration des contributions directes) issued a new circular, Circular L.I.R. n 56/1 56bis/1 addressing the tax treatment of companies engaged in intra-group financing transactions (the New Intra Group Financing Circular ), which replaces and supersedes the existing circulars L.I.R. n 164/2 of 28 January 2011 and L.I.R. n 164/2bis of 8 April 2011 (the 2011 Circulars ). The 2011 Circulars together with article 56 of the Luxembourg income tax law ( LITL or LIR ), stating the arm s length principle, were ruling intra-group financing transactions, implying the granting of loans between related entities. The 2011 Circulars provided for minimum substance requirements, capital at risk of 1% of the amounts lent (capped at EUR 2 million), and transfer pricing documentations to claim for advance pricing agreements from the Luxembourg tax authorities. The New Intra Group Financing Circular, effective as from 1 January 2017 without grand-fathering provisions, complies with the arm s length principles of the OECD transfer pricing guidelines, and gives further details on the comparability analysis method, to be used in order to apply the arm s length principle. The New Intra Group Financing Circular is not referring anymore to a fixed level of credit at risk (1% of the on lent amounts or EUR 2 million) and underlines the need to perform a functional analysis and of an adequate substance to determine the appropriate equity at risk level. II. THE NEW INTRA-GROUP FINANCING CIRCULAR 1. Scope The New Intra Group Financing Circular applies to any entity conducting intra-group financing transactions, meaning any activity consisting of the granting of loans or cash advances to related entities remunerated by interest and financed out of financial instruments like shareholder loans, banking loans, cash advances or public offering. In this respect the definition of related entities means any direct or indirect participation in the management, control or capital of another company. 2. Arm s length principle The New Intra Group Financing Circular expressly states that the arm s length principle provided by article 9 of the OECD Model Convention is the international standard for the determination of transfer pricing remuneration in cross-border transaction between affiliated enterprises or related entities. Under Luxembourg domestic tax rules, the arm s length principle which lies under article 56 LITL has been completed by the newly article 56bis LITL, introduced by the budget law of 23 December Article 56bis LITL gives legal ground for the application of the OECD Transfer Pricing Guidelines and more precisely Actions 8 to 10 of the OECD BEPS Report which deal with the methodology to apply the arm s length principle. According to these guidelines the comparative analysis is the cornerstone of the arm s length principle application. The New Intra Group Financing Circular aims at providing details on how the comparative analysis should be carried out. 2
3 3. The comparability analysis The comparability analysis implies: An identification of the commercial and financial relations between affiliated enterprises and determination of the significant economic circumstances of those relations to clearly define the scope of the controlled transaction; and A comparison of the conditions and the economically significant circumstances applicable between controlled entities with those applicable under comparable transactions entered into by non-related parties. 3.1 Commercial and financial relations The preliminary step of the comparative analysis, and hence of the determination of an arm s length remuneration, implies inter alia an analysis of the structure, the organisation of the group and the role played by each concerned group companies. As mentioned in the circular the arm s length principle is closely linked to the economic context in which the transaction takes place. It is worthwhile to note that the New Intra Group Financing Circular focuses on the activities effectively performed (substance over form principle) rather than the legal documentation. To this end the following analysis should be performed: (i) A functional analysis meaning the identification of the activities, liabilities, the significant economic functions, the assets used and risks assumed by each parties to the transaction with regard to the financing activities. (ii) A risk analysis to ensure that the financing company has a sufficient amount of equity in relation to its functions (in line with the risks assumed). The level of the appropriate equity at risk will, from now on, have to be determined on a case-by-case basis and documented by an appropriate transfer pricing report. In this respect, the New Intra Group Financing Circular states that a remuneration of the equity at risk of 10% after tax, should be considered as an arm s length remuneration (subject to further market evolutions) if the financing company has a comparable profile to entities submitted to the European Regulation (EU) N 567/2013 of 26 June 2013 on prudential requirements for credit institutions and investments firms and has an equity amount in line with the solvency criteria determined by this EU Regulation. In order to properly bear the risks of the financing activity, a genuine presence in Luxembourg is necessary. Such presence should be recognized subject to the following substance requirements: The majority of the board members having the power to bind the company should be Luxembourg resident. Non-Luxembourg resident board members are considered as compliant if they carry out a professional activity in Luxembourg and are liable to tax in Luxembourg on at least 50% of their professional revenue derived from these activities. A company acting as board member should have its statutory seat or central administration in Luxembourg. The Company must have appropriate resources to control the financing transaction performed. It is however provided that the Company may outsourced functions that do not have a significant incidence on the risk management. Key decisions should be taken in Luxembourg and at least one shareholder meeting per year should be held at the place indicated in the act of incorporation. When functions are outsourced the financing company should be able to demonstrate its capacities to monitor such outsourcing. 3
4 The Company should not be tax resident in another State. 3.2 A comparison of the intra-group transaction with comparable transactions When determining the arm s length remuneration, it is of importance to identify comparable transactions performed between third parties (non-related). Whilst adjustments to improve the quality of the comparability analysis are allowed by the New Intra Group Financing Circular provided that such adjustments should be compliant with International accepted standards. Should a comparability analysis conclude that a controlled transaction would not have been entered into by non-related parties under the same conditions, such controlled transaction should be disregarded to safeguard the arm s length principle. 4. Simplification measure Financing companies acting as pure intermediary and complying with the above-mentioned substance requirements should be considering as fulfilling the arm s length principle if they report a financing remuneration of 2% after tax (reviewed periodically by the Luxembourg tax authorities subject to further market evolutions). In order to benefit from this simplified regime, an application should be made by the concerned companies in their annual tax return. It is worthwhile to note that financing companies applying for this simplified regime (i) are subject to the exchange of information with foreign tax authorities under the current Luxembourg international exchange of information rules (spontaneous or upon demand), and (ii) may alter their beneficial ownership position. 5. Content of advance transfer pricing request The New Intra Group Financing Circular furthermore details the required information to be included in any request for an advance transfer pricing agreement ( APA ), which should contain among other things: - A precise description of the applicant; - A detailed description of all the intra group financing transactions; - A description of legal structure of the group and the name of the beneficial owner; - A transfer pricing report, in line with the OECD recommendations including for example: a description of the computation of the appropriate equity at risk necessary to carry out the activity and assume the risks; a complete list of the comparable used and comparable rejected (and related explanations); a general description of the market at the date of the transaction; a report of all the tax issues which may arise from the transaction; the comparability analysis on the basis of which the arm s length remuneration of the company has been determined; projected financial accounts for the fiscal years covered by the APA. 6. Entry into force and existing APA The New Intra Group Financing Circular should be of application as of 1 January 2017 so that any existing APA will cease to bind the Luxembourg tax authorities as from 2017 fiscal years onwards. As a result, companies carrying out intra-group financing activities 4
5 will have to comply with the New Intra Group Financing Circular rules, without delays and should file a new request with the competent tax authorities if they wish to obtain an APA. For further information feel free to contact the following persons: Gaëlle FELLY (gfelly@bonnschmitt.net) Patrick ANDERSSON (pandersson@bonnschmitt.net) Pierre-Luc WOLFF (pwolff@bonnschmitt.net) *** BONN & SCHMITT IS A FULL SERVICE COMMERCIAL LAW FIRM THAT PRACTICES ALL ASPECTS OF BUSINESS LAW, WITH SPECIAL EXPERTISE IN: CORPORATE CORPORATE LAW MERGERS AND ACQUISITIONS CORPORATE FINANCE RESTRUCTURING TAX CORPORATE AND INTERNATIONAL TAX ADVISORY INDIRECT TAXES AND VAT TAX LITIGATION ESTATE PLANNING BANKING, CAPITAL MARKETS AND REGULATION BANKING AND FINANCE FINANCIAL SERVICES AND REGULATION CAPITAL MARKETS AND SECURITIES LAWS STRUCTURED FINANCE AND DERIVATIVES INVESTMENT MANAGEMENT AND PRIVATE EQUITY ASSET MANAGEMENT AND SERVICES INVESTMENT FUNDS ALTERNATIVE INVESTMENT FUNDS PRIVATE EQUITY INSURANCE AND REINSURANCE REGULATION AND LICENSING INSURANCE POLICIES LINKED PRODUCTS PROFESSIONAL LIABILITY INSURANCE 5
6 DISPUTE RESOLUTION GENERAL AND COMMERCIAL LITIGATION IP AND TRADEMARK LITIGATION CORPORATE AND FINANCIAL LITIGATION MEDIATION AND ARBITRATION REAL ESTATE IP AND IT REAL ESTATE ACQUISITIONS REAL ESTATE INVESTMENT STRUCTURES PROJECT FINANCE ENVIRONMENTAL LAW AND REGULATION INTELLECTUAL PROPERTY AND TRADEMARKS E-COMMERCE E-MONEY DATA PROTECTION INSOLVENCY AND RESTRUCTURING LOCAL INSOLVENCY AND REORGANIZATION CROSS-BORDER PROCEEDINGS REALIZATION OF SECURITY AND COLLATERAL REFINANCING AND RESTRUCTURING OF DEBT EMPLOYMENT AND BENEFITS INDIVIDUAL EMPLOYMENT LAW COLLECTIVE EMPLOYMENT LAW PARTICIPATION AND INCENTIVE SCHEMES LITIGATION 148, AVENUE DE LA FAÏENCERIE L-1511 LUXEMBOURG B.P. 522 L-2015 LUXEMBOURG TEL: FAX: Visit us at *** 6
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