Court cases update

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.

On 16 December 2020, the Higher Administrative Court (“HAC”) ruled in favour of the Luxembourg Tax Authorities (“LTA”) in an appeal (N ° 45072) initiated by an Anonymous Company (“Luxembourg Company”), requesting an annulment of an information injunction arising from an exchange of information procedure between Luxembourg and Belgium.

The information injunction includes the request of information and documents of a related party in Belgium (“Belgium Company”) in connection with certain services received by the Luxembourg Company.

A. Background and facts

• On 21 August 2020, the competent authority of the Belgian tax administration sent to the LTA a request for information of the Luxembourg Company under the tax convention between Luxembourg and Belgium.
• On 7 September 2020, the director of the LTA addressed to the Luxembourg Company an information injunction to request different information and documents in connection with certain services received by the Luxembourg Company from the Belgium Company for the period from 1st January 2017 to 31st December 2019. In a nutshell, the request concerns to the employees, management, functions, contact details, facilities, and activities of the Belgium Company.
• On 7 October 2020, the Luxembourg Company requested to the HAC the annulment of the information injunction by arguing among others a failure to state the reasons or motivation of the request and a violation of its rights of defense.
• On 22 October 2020, the delegate of the LTA requested that the appeal should be dismissed. He refuted the arguments expressed by the Luxembourg Company and added among others the following:
  • Description of the circumstances provided and carried out by the Belgian tax administration during its investigation on Belgian territory. In brief, the description includes:
    • Background of the activities of the Group,
    • Re-invoicing of services with a low margin,
    • Nonalignment of functionalities described in the transfer pricing study (“first TP Study”) versus actual conduct of the parties, and
    • Discrepancies with regards to the invoices issued by the Belgium Company (containing fictitious invoices for purchase of products and provision of services).
  • The request should allow the Belgian tax administration to determine with precision the activities and functions carried out and the real profit of the companies, as well as the part of its taxable basis in Belgium.
• On 9 November 2020, the Luxembourg Company filed an additional brief and added among others the following:
  • Failure by the Belgian tax authorities to have exhausted all the internal means of investigation, including the obtention of an updated version of the transfer pricing study (“second TP Study”) and other documents justifying the adoption of its transfer pricing policy.
  • Reliance on an opinion drawn up by an independent auditor according to which the transfer pricing policy applied by the group would comply with the TP Study.
  • The perception of a low margin could be explained by the fact that Belgium Company would have been qualified as a tested party with limited functions and risks.
  • Allegation that the activities and functions were carried out by the Belgium Company would be described in the said second TP Study.
• On 23 November 2020, the delegate of the LTA filed an additional brief for adding among others:
  • the request would indicate that the competent authority of Belgium had exhausted its usual sources of information.
  • the role of the Luxembourg authorities would be limited to verifying the consistency of all the explanations presented by the requesting authority based on its request.
  • The purpose of the request would be to verify whether:
    • the activities of the Belgium Company were carried out, organized, diligent, and monitored from the Luxembourg Company during the period concerned and
    • the profits of the Belgium Company should, at least partially, be reallocated either in the accounts of the said Company or taxed in a permanent establishment in Belgium for the period concerned.

B. The Court’s decision

On 16 December 2020, the HAC concluded that the appeal is dismissed due to lack of foundation. Therefore, the HAC rejected it and ruled the following:

• Failure to state reasons for the information injunction must be rejected to be unfounded.
• The information injunction is based on a sufficiently reasoned request from the Belgian tax administration, it must therefore be considered having been validly issued with regard to the Luxembourg Company.

 C. Takeaways

• Action for annulment of an injunction decision requires careful consideration and precaution.
• Transfer pricing audits continue to be one of the drivers of international cooperation between tax authorities via exchange of information procedures.
• The information requested via the injunction allows us to have a view on the recent trends of transfer pricing audits of intercompany services. The request confirms the importance of:
• Verifying 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.
• Ensuring that the provision of information during a transfer pricing audit is carefully managed in each jurisdiction. It would allow to limit risk exposure with other tax authorities in all countries where the associated enterprises have activities.

Transfer Pricing Webinar

Register for our Webinar on 29^th January at 10h00 AM to learn more about this recent court case.