I) Transfer pricing

Pursuant to Paragraph 11 of the preface of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017:

“transfer prices are those at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises”.

II) Associated enterprises

Pursuant to Article 9, sub-Paragraphs 1a) and 1b) of the OECD Model Tax Convention on Income and on Capital 2017 (the “OECD Model Tax Convention”):

“An enterprise of a Contracting State that participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or the same persons [that] participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State”

III) Arm’s length principle

Pursuant to Article 9 of the OECD Model Tax Convention :

“Where conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly”

IV) Intercompany transactions

Transfer pricing analysis can involve a wide variety of cross-border transactions between associated enterprises, such as:

  1. Financing (e.g. intermediary financing services, debt pricing, management services, guarantee, deposits, cash pooling, swaps)
  2. Intellectual property (e.g. know how, trade marks, patents)
  3. Services (e.g. marketing, back office services, technical assistance, IT, research and development)
  4. Goods (i.e. raw materials, intermediate goods, finished goods, commodities and complex differentiated products)

V) Importance of transfer pricing

The importance of transfer pricing is mainly driven by various domestic and international initiatives aiming at setting out rules to address tax avoidance. The following presentation provides further information.

VI) Transfer pricing methods

Two types of methods may be used to determine the application of the arm’s length principle for tax purposes to cross-border transactions between associated enterprises. They are the traditional transaction methods and the transactional profit methods.

  • Traditional transaction methods: They require the use of prices of gross margins agreed by third parties as the basis of testing the arm’s length character of related party prices. Traditional transaction methods are regarded as the most direct means of establishing whether conditions in the commercial and financial relations between associated enterprises are conducted at arm’s length. They include the following methods: Comparable Uncontrolled Price Method (CUP), Cost-Plus Method (CP) and Resale Price Method (RP)
  • Transactional profit methods: They require the use of prices of profit margins agreed by third parties as the basis of testing the arm’s length character of related party prices. They include the following methods: Profit Split Method (PS) and Transactional Net Margin Method (TNM)

VII) Transfer pricing country profile

The transfer pricing country profile provides a further understanding of the transfer pricing requirements in other jurisdictions via the OECD website

VIII) Transfer pricing legislation

The transfer pricing legislation provides guidance on the application of the arm’s length principle for tax purposes to cross-border transactions between associated enterprises. The following documents provide a further understanding of transfer pricing-related domestic and international legislation and of related topics.

  • Transfer Pricing Luxembourg Circular (FR) / (EN)
  • OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 (FR) / (EN)
  • Base Erosion and Profit Shifting (BEPS) actions (FR) / (EN)
  • Manual on Information Exchange (FR) / (EN)
  • Anti Tax Avoidance Directive (FR) / (EN)
  • OECD Transfer Pricing Guidelines on Financial Transactions (FR) / (EN)
  • Controlled Foreign Company Circular (FR)
  • Disclosure of cross-border arrangements (FR)

IX) Glossary of tax terms

You can browse the  OECD website for general information regarding tax terms

X) Risk assessment

Are you willing to determine, on a general basis, whether the conditions governing your intra-group transactions are in line with economic substance and transfer pricing requirements in Luxembourg? Do the tests !

Transfer pricing example

For an example of intermediary financing services, you can download this presentation.

Intermediary Financing Services

1. Entities background

  • ParentCo is a company loctaed in the United Kingdom
  • LuxCo is a Luxembourg company, which was incorporated as a Societe Anonyme, for an unlimited period and with a share capital of EUR 31,000,
  • GermCo is a German Company, which was incorporated in order to act as a special purpose vehicle to perform the acquisition of a real estate building located in Germany.

II. Transaction details

  • ParentCo has subscribed Convertible Preferred Equity Certificates (Loan Payable) from LuxCo for an amount of EUR 10,000,000. In exchange, Luxco has paid interest expense for an amount of EUR 148,000 (for the first year).
  • LuxCo has granted a loan Agreement (Loan Receivable) to GermCo for the same amount. In exchange, LuxCo has received interest income for an amount of EUR 150,000 (for the first year).

III. Caractherization of the transaction

  • LuxCo is receiving funds on behalf of GermCo in order to perform the acquisition of a real estate building located in Germany (investment). Therefore, it should be treated as the equivalent to one single incoming and outgoing transaction and considered as intra-group financing services provided by LuxCo to GermCo.
  • LuxCo is performing loan origination activities and assuming equity at risk on behalf of GermCo. Accordingly, this transaction falls in the scope of the Circular’ requirements. Hence, a transfer pricing study should be performed in order to determine the arm’s length remuneration (also called “equity at risk remuneration”).

IV. No Transfer Pricing Study

  • If LuxCo does not prepare a Transfer Pricing Study, LuxCo is exposed to the following:

Transfer pricing adjustment*: A minimum return after taxes equal to 2% on the assets financed based upon the circular (one year). For LuxCo, It means a transfer pricing adjustment of EUR 274,273.

V. Transfer Pricing Study

  • If LuxCo prepares a Transfer Pricing Study**, LuxCo is not exposed to transfer pricing adjustments and shoud determine the following components:
    • Amount of equity at risk: Based on a credit risk analysis of GermCo, it was determined that the amount of equity that LuxCo is assuming risk on behalf of GermCo is equal to EUR 101,581.
    • Equity at risk remuneration: Based on the Capital Asset Pricing Model, it was determined that the remuneration on the amount of equity at risk  to be paid by GermCo to LuxCo is equal to EUR 156,613.
    • Taxable income: given this equity at risk remuneration of EUR 156,613 , it was determined that the amount of taxable income is equal to EUR 8,613 (156,613 – 148,000).

* The paragraph 27 of the Circular L.I.R. 56/1 – 56bis/1 states:

“In case the finance company does not have a profile of an intra-group bank, but rather intervenes as an “agent” in a financing transaction, the arm’s length remuneration should be equal to a return of 2% (after tax) on the assets financed (i.e. loan agreement)”

** The paragraph 28 of the Circular L.I.R. 56/1 – 56bis/1 states:

“However, that remuneration does not apply if a transfer pricing report is prepared according to the OECD Guidelines and the Luxembourg Circular, which determines a different return”

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