Last Wednesday, 12 October 2016, the Luxembourg Minister of Finance presented the 2017 budget and the related draft bill to the parliament. Among social, environmental, and investment provisions, tax professionals and taxpayers spotted the tax section introducing a new set of rules for transfer pricing practice, in the form of the new Article 56 bis LITL with new guidance and clarification on transfer pricing regulations in Luxembourg.
After having introduced the basic principle of arm's length into Article 56 ITL based on Article 9 of the OECD Model Convention back in January 2015, this new article intends to add further guidance on how to practically apply this principle based on the latest version of Section D of Chapter I of the OECD Transfer Pricing Guidelines.
In the Declaration of Intent, the government intends to incorporate some conclusions ("des conclusions tirées dans le cadre des actions BEPS 8-10") and basis criterions (des critères de base à respecter) drawn by the OECD under its BEPS initiative (action 8-10) into domestic law.
The draft bill introduces a more granular functional and risk analysis based on the latest Transfer Pricing Guidelines for MNEs and Tax Authorities (hereafter OECD Guidelines) with a focus on the comparability analysis and the new tests as revised per the BEPS initiative to delineate controlled transactions.
Once the definitions are set in paragraph 1, it is worth mentioning that paragraph 2, 3, and 4 introduce commonly applied concepts of comparability analysis into the law. It therefore confirms that:
- Should a related transaction not be observable between independent parties does not mean this transaction does not comply with the arm's length principle.
- Conditions between controlled transactions and transactions between third parties should be comparable, and economic characteristics should be comparable.
- When adjustments are required for comparability purposes, these should be reasonably reliable in order to eliminate the impact on the pricing.
- Taxpayers should identify the transactions and determine the economically significant characteristics and conditions in order to delineate the controlled transactions and then compare them to the open market.
More practically speaking, it lists two key aspects for the comparability analysis:
- Identify the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attached to those relations so that the controlled transaction is accurately delineated; and
- Compare the conditions and the economically significant circumstances of the controlled transaction as accurately delineated with those between independent parties.
The delineation process is further detailed under paragraph 5 through a series of steps, again largely inspired by the words of the OECD under BEPS action 8-10:
- the contractual terms of the transaction;
- the functions performed by each of the parties to the transaction, considering assets used and risks managed and assumed;
- the characteristics of the transaction;
- the economic circumstances of the parties and of the market in which the parties operate;
- the business strategies pursued by the parties.
Finally, once the transaction is adequately delineated, the choice of the method (being any method detailed under chapters 2 and 3 of the OECD Guidelines) should allow the best approximation of the arm's length price.
Last but certainly not least, the new paragraph 7 introduces a general anti-abuse measure specifically for transfer pricing purposes. In the event that a controlled transaction, or a part of it, does not embed valid business rationale, taxpayers and tax authorities should disregard it to determine the arm's length price.
Conclusions and take-aways
The proposed Article 56 bis strengthens the Luxembourg transfer pricing rules and practice as it gives clarifications of the methodologies available to reach conclusions on the arm's length price when testing or setting prices in a related party context.
Taking into account the latest works under the BEPS initiative, it will also introduce an anti-abuse rule specifically for TP purposes.
Regarding the specific point of documentation as laid down under action 13 of the BEPS initiative, one may expect further regulations introducing local and master file requirements while a draft law on CbC Reporting is already available.
Taxpayers should therefore be prepared from FY 2017, and upon request of the tax authorities, to sustain their controlled transactions (including valid business rationale behind such a transaction or series of transactions) through TP documentation based on a more granular functional and risk analysis.
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.