In a recent case, the Luxembourg Tax Authorities challenged the limited risk service approach used by a Company in Luxembourg to justify a remuneration allocation to an associated Company in Switzerland.
Here are some key points of this case:
A. 𝗧𝗮𝘅 𝗽𝗿𝗼𝗯𝗹𝗲𝗺
On 22 June 2020, the Luxembourg tax authorities (LTA) informed to the Company A the payments performed to Company D concerning to some variable remuneration during the fiscal year 2015, 2016 and 2017 are not deductible for tax purposes because there is no economic justification.
B. 𝗕𝗮𝗰𝗸𝗴𝗿𝗼𝘂𝗻𝗱
The Company A is a distributor of several pharmaceutical products in Luxembourg.
The Company D is a distributor of several pharmaceutical products in Switzerland.
In 2014, the rights and obligations of Company D’s pharmaceutical contracts were transferred to Company A. The transfer included variable annual remuneration: payments made from Company A to Company D, determined by:
➡ product turnover generated by Company A,
➡ minus operational costs of Company A and a
➡ 4% profit margin of Company A.
C. 𝗟𝗧𝗔’𝘀 𝗺𝗮𝗶𝗻 𝗮𝗿𝗴𝘂𝗺𝗲𝗻𝘁𝘀
LTA contested Company A’s lack of evidence regarding Company D’s commitment and responsibility for operational risks post-formation. Company A presented operating expenses, including marketing, salaries, and other costs, contrasting with Company D’s minimal overheads, devoid of similar expenses or remunerations.
D. 𝗖𝗼𝗺𝗽𝗮𝗻𝘆 𝗔’𝘀 𝗺𝗮𝗶𝗻 𝗮𝗿𝗴𝘂𝗺𝗲𝗻𝘁𝘀
Company A negotiated significant concessions from Company D, reducing risks and securing favorable terms during the transfer of main contracts. Despite this transfer, Company D retained the primary obligations and strategic decision-making, including financial responsibilities and transaction risks, as confirmed by a transfer pricing study. According to this analysis, Company A functions as a limited risk distributor and legal asset owner, justifying routine remuneration, while the residual profit allocation belongs to Company D.
E. 𝗧𝗿𝗶𝗯𝘂𝗻𝗮𝗹 𝗱𝗲𝗰𝗶𝘀𝗶𝗼𝗻
The Administrative Tribunal ruled in favor of Company A, validating the deductions.
The LTA can appeal the decision (role number 46054 dated 14 of June 2023).
F. Takeaways
This audit case allows us to have a view of the recent trends of transfer pricing audits of intercompany services in Luxembourg. This case confirms the importance of:
- Performing a selection of the business model of the tested party should be in line with the actual conduct of the related parties and the economic rationality of the transactions.
- Checking the alignment of functionalities expressed in transfer pricing documentation with the actual conduct of the related parties.
- Confirming that the arm’s length remuneration is in accordance with the actual conduct of the related parties.
- Validating the proper application of the transfer pricing policy within the Group.
