Luxembourg permits tax unity. Generally, the conditions to qualify for tax unity include that:
- each company that is part of the tax unity is a fully taxable company that is resident in Luxembourg (the top entity may be a Luxembourg PE of a fully taxable non-resident company)
- at least 95% of each subsidiary’s capital is directly or indirectly held by the head of the fiscal unity
- each company’s fiscal year starts and ends on the same date, and
- tax unity is requested jointly by the top company and each subsidiary that becomes a member of the group.
Tax unity lasts for a five-year period (minimum), and the taxable income/loss of the tax unity is computed as the sum of the taxable income/loss of each integrated entity. Tax losses incurred before the consolidation period may be offset only against tax profits of the company that incurred the loss. Tax losses that are sustained by a group member during the consolidation period are offset against the tax profits of the other group members. Tax losses arising during the consolidation period, if not used during the consolidation, remain attributed to the parent company.
The tax unity regime in Luxembourg has been extended since 1 January 2016 in accordance with a case law from the European Court of Justice in particular to allow horizontal integration. Qualifying companies that are held by a common parent company established in any EEA country, the latter being subject to a tax comparable to Luxembourg’s CIT in its country of residence, may now form a tax unity. In addition, a possibility to switch from an existing vertical tax unity to a horizontal one without triggering the retroactive cancellation of the existing tax unity is provided for, upon certain conditions. This possibility, introduced by the 2021 Budget law, follows the recent ECJ case-law C-749/18 judgement of 14 May 2020, and is limited to requests submitted before the end of the 2022 tax year.
A tax unity also may include a Luxembourg PE of a company established in any country that is subject to a tax comparable to Luxembourg’s CIT. The PE would be considered as the ‘integrated’ entity.
The Luxembourg transfer pricing regime is based on Article 56 of the LITL, which broadly replicates Article 9 of the OECD Model Tax Convention. Luxembourg transfer pricing legislation applies to all types of inter-company transactions, cross-border as well as domestic.
In summary, transactions between related parties (cross-border as well as domestic) have to be governed by the arm’s-length principle endorsed by the OECD. In essence, this means when the two enterprises are, within their commercial or financial relations, subject to conditions made or imposed that differ from those that would be made between independent enterprises, the profits of these enterprises are to be determined under conditions prevailing between independent enterprises.
Article 56bis of the LITL brings explicitly into the law some of the key principles set out in the revised version of the OECD Transfer Pricing Guidelines, following Action 8-10 Final Report of the Base Erosion and Profit Shifting (BEPS) Action Plan. It contains a GAAR measure that may disregard a transaction that has been made without any valid commercial rationality.
Luxembourg Transfer Pricing Guidelines
For Luxembourg entities engaged in intra-group financing transactions, specific guidelines are provided for in Circular LITL No. 56/1 - 56bis/1 (“TP Circular”). According to the TP Circular, the OECD arm’s-length principle should be applied to determine the compensation of such entities.
Luxembourg entities in the scope of the TP Circular have to comply with certain substance and equity at risk requirements. Absence of meeting such requirements may result in an exchange of information.
A written clearance (i.e. uni-, bi-, or multi-lateral advance pricing agreement [APA]) with the Luxembourg tax authorities on the set of criteria for the determination of the transfer pricing for the financial on-lending transactions can be requested, provided that the Luxembourg company meets certain substance and equity at risk requirements.
Section 3 of Paragraph 171 of the General Tax Law provides that, upon request of the Luxembourg tax authorities, taxpayers have to be able to support data included in their tax returns in respect to transactions between related parties. The absence of proper transfer pricing documentation may result in the reversal of the burden of proof towards the taxpayer (the draft bill n°8186 released on 28 March 2023 and proposing several changes to the Luxembourg law governing procedures in relation to direct taxes introduces among others the requirement of the preparation of a master file and local file based on a certain threshold).
To enhance transparency, taxpayers need to disclose whether during the year concerned they have been engaged in transactions with related parties and whether they engaged in transactions with related parties located in non-cooperative jurisdictions according to the EU list.
Country-by-country (CbC) reporting
Under the Luxembourg CbC legislation, a Luxembourg tax resident entity that is the ultimate parent entity of a multinational enterprise (MNE) group with consolidated group revenue of EUR 750 million or more in the preceding fiscal year and that prepares consolidated financial statements (or would be required to do so if its equity interests were traded on a public security exchange) is required to file a CbC report with the Luxembourg tax authorities. Other Luxembourg companies that are members of MNE groups may also have obligations to file CbC reports in Luxembourg under the so-called ‘surrogate parent entity’ regime or the ‘secondary’ mechanism. The filing is due 12 months after the last day of each fiscal year of an MNE group.
A Luxembourg resident entity affected by this legislation needs to notify the Luxembourg tax authorities of whether it is going to file a CbC report as the ultimate parent, under the secondary mechanism, or as a surrogate filer. Alternatively, if a Luxembourg entity is a constituent entity (this being defined as a Luxembourg tax resident entity forming part of an MNE group in scope of CbC reporting), each such entity must notify the Luxembourg tax authorities of which other entity in the MNE group is filing the CbC report and its residency. This notification is due by the last day of the fiscal year of the MNE group.
The Luxembourg tax authorities will exchange annually on an automatic basis the CbC report received from any Luxembourg reporting entity in an MNE group with all the authorities of other jurisdictions where that MNE group has activities. However, a CbC report can only be exchanged in cases where both tax authorities have agreed to automatic exchange, any mechanism for this is effective, and their respective jurisdictions have in place legislation that requires the filing of CbC reports with respect to that fiscal year to which the CbC report relates.
Luxembourg tax authorities may impose a penalty of up to EUR 250,000 in case of no filing, late filing, or incorrect filing of either the CbC report or notification(s).
Burden of proof, statute of limitation, and penalties
In terms of the burden of proof, taxpayers are required to provide the Luxembourg tax authorities with the documentation to demonstrate the application of the arm’s-length principle. In the absence of such documentation, the burden of proof can be reversed towards the taxpayer.
The statute of limitations is generally five years from the end of the year in which the tax liability arises. This period may be extended if a deferred payment is granted. In case of tax evasion or fraud, as well as in case of incomplete tax returns, the statute of limitations can be extended up to ten years.
There are no specific penalties in relation to transfer pricing in Luxembourg, but the penalty regime under the CIT will be applicable.
Advance pricing agreement (APA)
Taxpayers can file unilateral and bi- or multi-lateral APAs with the Luxembourg tax authorities. An administrative fee in the amount of EUR 10,000 is due to the Luxembourg tax authorities for the filing of the APAs under Paragraph 29a of the above-mentioned General Tax Law of 22 May 1931 (the above-referred draft bill proposing several changes to the Luxembourg law governing procedures in relation to direct taxes also introduces an application fee between EUR 10,000 and EUR 20,000).
An appropriate equity level should be respected by Luxembourg taxpayers, taking in consideration actual facts and circumstances. Transfer pricing documentation supporting the debt-to-equity ratio of a taxpayer (debt capacity analysis) may be requested by the Luxembourg tax authorities. Should an appropriate equity level not be complied with by the taxpayer, the resulting surplus of interest can be re-qualified by the tax authorities as a deemed distribution of profits that would be non-deductible and potentially subject to a 15% WHT.
Controlled foreign companies (CFCs)
Since 1 January 2019, Luxembourg tax law provides for CFC rules.
Luxembourg opted for option B under ATAD, thus targeting non-distributed income of CFCs arising from non-genuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage.
The following two cumulative conditions have to be fulfilled for an entity or PE to be considered as a CFC.
- Control test: An entity is a controlled entity if the taxpayer by itself or together with its associated enterprises holds a direct or indirect participation of more than 50% of the voting rights or capital, or is entitled to receive more than 50% of the profits of that entity. With respect to a PE, the control test is by definition met.
- Effective tax rate (ETR) test: There will be a CFC if the actual CIT paid by the entity or PE on its profits is lower than 50% percent of the CIT charge that would have been payable in Luxembourg under Luxembourg domestic tax rules had the entity or PE been resident or established in Luxembourg.
When an entity or PE meets the control test and the ETR test, the taxpayer should include in its taxable basis the non-distributed income of the entity or PE to the extent arising from non-genuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage.
The following CFCs are excluded from the scope of the application of these new rules:
- Those with accounting profits of no more than EUR 750,000.
- Those for which the accounting profits amount to no more than 10% of their operating costs for the period.
A Luxembourg taxpayer having a CFC with income arising from a non-genuine arrangement will have to include in its taxable base the non-distributed income of the CFC but within the limit of amounts generated through assets and risks that are linked to significant people functions carried out by the taxpayer.
On 4 March 2020, the Luxembourg tax authorities issued an administrative circular that has been updated on 17 June 2022, providing guidance on their interpretation of article 164ter of the LITL relating to CFC taxation.