New Circular On Intra-Group Financing Activities

On 27 December, 2016 the Luxembourg Tax Authorities issued the new Circular LIR n°56/1-56bis/1 on the tax treatment of entities engaged in intra-group financing activities.

The new circular LIR n°56/1-56bis/1 (New Circular) responds to the introduction of the amended transfer pricing provisions into Luxembourg Income Tax Law (LIR) on 23 December, 2016 by means of Article 56bis, with the intention of clarifying the arm's length principle as previously provided by the law.

Since 1 January 2017, the New Circular has replaced Circulars LIR n°164/2 and LIR n° 164/2 which were issued in 2011 to provide guidance on intra-group financing activities.

The New Circular provides practical guidelines on the application of the arm's length principle to intra-group financing transactions and sets out the twofold comparability analysis to be performed.

Twofold Comparability Analysis

The twofold comparability analysis consists of:

Identifying the business or financial relations between related entities and thus determining the economically significant conditions and circumstances attached to such relations. Comparing the economically significant conditions and circumstances of controlled transactions with transactions between non-related entities. According to the New Circular, in order to perform intra-group financing activities, the following requirements must still be met:

Description of the role and function of the entities involved in transactions, the transactions' characteristics and purpose, the assets used and the supported risks. A minimum level of local presence/substance in Luxembourg. The transactions' specific economically significant risks must, however, be assessed and the level of equity determined on a case-by-case basis by using credit analysis methods. Consequently, the previous rule, which stated that equity at risk equalled at least 1% of the value of its loan receivables, capped at €2,000,000, is no longer applicable. An amount of equity that complies with the solvability rules of the European Parliament Regulation n° 575/2013 on prudential requirements for credit institutions and investment firms will be considered sufficient to cover the risk of a company engaging in intra-group financing activities.

In addition to the existing substance requirements, the New Circular states that companies must have qualified personnel to control the performed transactions. Companies may, however, outsource functions that do not have a significant...