New Court Decision Shows Importance Of Updated Transfer Pricing Documentation

In a recent court case1 about transfer pricing for interest rates on intra-group loans, the court ruled in favor of the Luxembourg Tax Authorities (LTA). The LTA had challenged the 12% interest rate payouts of the Luxembourg company (LuxCo), which were considered to deviate from the arm's length principle. The excessive interest was requalified as hidden dividend distribution on which withholding tax was assessed. This case law creates an additional incentive for Luxembourg taxpayers to prepare appropriate transfer pricing documentation to set the arm's length price of all their intra-group transactions prior to entering into the transaction.

About the case

The LuxCo acquired real estate in the south of France in 2008. The acquisition price of EUR 26 million was financed by a bank loan of EUR 20 million and a shareholder loan (SHL) of EUR 6 million. An interest rate of 12% was set on the SHL. There is no discussion on the comparison between the bank loan and the SHL.

The LTA issued a withholding tax assessment on 15 October 2014, qualifying part of the interest paid on the SHL for FY 2011 and 2012 as excessive. The LTA deemed an interest rate of 1.87% plus risk premium of 1.7% as arm's length for FY 2011 and a rate of 0.82% plus premium 1.7% for FY 2012; the LTA's risk premium was based on a court decision of the Cour administrative, n° 23053C from 13 June 2007. Therefore, the interest rates calculated by the LTA were 3.57% for FY 2011 and 2.52% for FY 2012. The remainder (in comparison to 12% applied by the LuxCo) was qualified as a hidden profit distribution and was subject to a 15% dividend withholding tax.

Following this decision, the LuxCo submitted its objections to the LTA including transfer pricing documentation prepared by an independent party on 7 October 2014 based on information and facts for FY 2011. The transfer pricing documentation estimated an interquartile range of interest rates between 3.21% and 7.88% to be applied on the SHL. The key arguments raised by the LuxCo against the LTA were that:

the risk premium applied by the LTA was based on outdated data (2007) and should therefore not be considered for the case under review a second set of transfer pricing documentation prepared by another independent party on behalf of the LuxCo in November 2017 estimated an interest rate of between 9.95% and 19.61% and therefore an interest rate of 12% applied for FY 2011 and FY 2012 could be considered as being at arm's length the...

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