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 that remain after the consolidation remain attributed to the parent company.
The tax unity regime in Luxembourg has been extended since 1 January 2016 in accordance with 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.
At arm’s-length principle
Luxembourg transfer pricing legislation provides that 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.
Luxembourg also introduced Article 56bis LITL, which explicitly brings into the law some of the key principles and methodologies set out in the OECD transfer pricing guidelines. It implements the requirement for making an accurate delineation of controlled transactions and the OECD concept of comparability analysis. Article 56bis LITL further contains a GAAR measure that may disregard a transaction that has been made without any valid commercial rationality.
Luxembourg Transfer Pricing Guidelines
For intra-group financing on-lending 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 equity-at-risk and compensation of Luxembourg companies engaged in financial on-lending transactions. The remuneration of the Luxembourg companies should be determined based on a return-on-equity approach.
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.
In respect of the equity-at-risk requirement, the former requirement that a Luxembourg company must be at risk for an amount equal to, at least, the lower of (i) 1% of the nominal value of the loan intermediated or (ii) EUR 2 million is no longer applicable.
Absence of meeting the substance and equity risk requirements may result in an exchange of information. In addition, the arm’s-length remuneration has to be documented by way of a transfer pricing analysis.
For all other intra-group transactions, Luxembourg generally applies the OECD transfer pricing guidelines.
As far as transfer pricing documentation is concerned, Section 3 of Paragraph 171 of the General Tax Law of 22 May 1931 (Abgabenordnung) clarifies that taxpayers are required to:
- disclose their transactions with related parties and
- document their compliance with the arm’s-length principle.
No specific guidelines are provided on the nature and extent of the documentation required, which should depend on the circumstances of the case under consideration. In practice, the OECD transfer pricing guidelines should be applied.
Further to the documentation obligation, new disclosure requirements have been introduced, with the purpose to enhance transparency of taxpayers towards the tax authorities.
In detail, starting from the 2017 tax return, taxpayers shall disclose whether during the year concerned they have been engaged in transactions with related parties and/or if they have opted for the simplification measure stated in Section 4 of the TP Circular (i.e. measure allowing taxpayers, pursuing a purely intermediation activity in the context of financing transactions, to opt for a fixed ‘safe-harbour’ compensation).
In addition to the above, in the context of anti-base erosion and profit shifting (BEPS) measures, the Luxembourg tax authorities issued a Circular on 7 May 2018 that requires taxpayers to indicate in their tax return whether they have performed any transaction with related parties located in the non-cooperative jurisdictions listed in the EU list. This new disclosure requirement will apply from the 2018 tax return.
Country-by-country (CbC) reporting
On 13 December 2016, the Luxembourg Parliament passed legislation implementing CbC reporting requirements for Luxembourg entities that are part of a multinational enterprise (MNE) group. The CbC reporting legislation transposes into Luxembourg law part of the three-tiered standardised approach to transfer pricing documentation introduced in Action 13 of the OECD/G20 BEPS Project.
Under the Luxembourg CbC legislation, a Luxembourg tax resident entity that is the ultimate parent entity of an 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.
The list of such 'exchanging' jurisdictions is to be established by way of a grand-ducal regulation. A grand-ducal regulation has been issued on 12 March 2019 and published on 18 March 2019 (Mémorial A N° 163). It amends the revised grand-ducal regulation published on 20 February 2018.
As a consequence, in case the ultimate parent is resident in a jurisdiction that is not listed in the mentioned regulation, a CbC report will have to be filed either by a ‘surrogate entity’ resident in a jurisdiction listed in the grand-ducal regulation or by an affiliate in Luxembourg. Exceptions may apply, on a case-by-case basis, if countries mentioned in the regulation have CbC reporting obligations, but starting from a different fiscal year.
As concerns filings of CbC reporting and notifications finalised before the regulation, MNE groups shall review them to ensure they have been done in compliance with the list of 'exchanging' jurisdictions listed in the regulation.
The grand-ducal regulations only indicate that exchange of information will take place from Luxembourg to each of the other jurisdictions listed. It is important to note that there are jurisdictions that are exchanging CbC reports with Luxembourg, although Luxembourg may not be exchanging with such countries, i.e. so-called 'non-reciprocal' jurisdictions. In case MNE groups have the ultimate parent company in such jurisdictions, the Luxembourg tax authorities may not accept that those groups can satisfy their CbC reporting obligations by using a Luxembourg group entity as a 'surrogate entity' filing in Luxembourg.
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 Luxembourg tax authorities can challenge the correct application of the arm’s-length principle and, without giving precise explanations, presume a reduction of the taxable income and apply corrections. In effect, this would result in an ultimate reversal of the burden of proof 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 the Paragraph 29a of the above-mentioned General Tax Law of 22 May 1931.
No thin capitalisation ratio is specifically provided by the Luxembourg tax law.
In practice, the tax authorities apply an 85:15 debt-to-equity ratio for the intra-group financing of participations. Should the 85:15 ratio not be complied with by the taxpayer, the surplus of interest can be re-qualified by the tax authorities as a hidden 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 that 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 of 25 pages (the 'CFC Circular'), providing guidance on their interpretation of article 164ter of the LITL relating to CFC taxation.