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Executive summary

The Luxembourg Government recently submitted to Parliament draft legislation to introduce and modernize certain tax procedural rules, including by requiring taxpayers with related enterprises to provide, upon request, certain documentation on their transfer pricing policy and imposing a specific procedure for requesting a bilateral or multilateral APA.

Two recently published draft Grand-Ducal regulations¹,² provide additional details, which are summarized in this Alert.

Detailed discussion

Transfer pricing documentation — Master file and local file

In accordance with the international standards resulting from the work of the Organisation for Economic Co-operation and Development (OECD) on Action 13 of the Base Erosion and Profit Shifting (BEPS) Action Plan,³ the draft Grand-Ducal regulation provides for mandatory transfer pricing documentation applicable to multinational entities (MNEs).

The regulation requires MNEs to provide information regarding their global business operations and transfer pricing policies in a master file and detailed transactional transfer pricing documentation in a local file.

Master file

Any Luxembourg tax resident entity meeting the following cumulative criteria must have documentation available regarding the activities of the MNE group to which it belongs:

• The entity is subject to Country-by-Country Reporting (CbCR) based on the Luxembourg Law transposing the European Union (EU) Directive on CbCR (CbCR Law)⁴
• The entity has a net turnover in a financial year of at least €100 million or a balance sheet total at closing date of at least €400 million

In line with the international standards resulting from the OECD's work on Action 13, the master file must include information on the MNE's:

• Structure: Illustrated in a chart showing the MNE's legal and ownership structure and geographical location of operating entities
• Business: With information on the important drivers of business profit, a description of the supply chain for the group's five largest products and/or service offerings by turnover plus any other products and/or services amounting to more than 5% of group turnover, including:
• A description of the main geographical markets for these products and services
• A list and brief description of important service arrangements between members of the MNE group, other than research and development (R&D) services, including a description of the capabilities of the principal locations providing important services and transfer pricing policies for allocating services costs and determining prices to be paid for intra-group services
• A functional analysis describing the principal contributions to value creation by individual entities within the group (i.e., key functions performed, important risks assumed, important assets used)
• A description of important business restructuring transactions, acquisitions and disposals of assets occurred during the fiscal year
• Intangibles: A general description of the MNE's overall strategy for the development, ownership and exploitation of intangibles, including:
• The location of principal R&D facilities and location of R&D management
• A list of intangibles or groups of intangibles of the MNE group that are important for transfer pricing purposes and which entities legally own them
• A list of important agreements among identified related enterprises related to intangibles, including cost contribution arrangements, principal research service agreements and license agreements
• A general description of the group's transfer pricing policies related to R&D and intangibles
• A general description of any important transfers of interests in intangibles among related enterprises during the fiscal year concerned, including the entities, countries, and compensation involved
• Intercompany financial activities: Covering a general description of how the group is financed, including:
• Important financing arrangements with unrelated lenders
• The identification of any members of the MNE group that provide a central financing function for the group, including the country under whose laws the entity is organized and the place of effective management of such entities
• A general description of the group's transfer pricing policies related to financing arrangements between related enterprises
• Financial and tax positions: The MNE group's annual consolidated financial statement for the fiscal year if otherwise prepared for financial reporting, regulatory, internal management, tax or other purposes and a list and brief description of the MNE group's existing unilateral APAs and other tax rulings relating to the allocation of income among countries

Local file

Any Luxembourg tax resident Constituent Entity of an MNE group, within the meaning of the CbCR Law, must maintain a local file documenting the transfer pricing analysis of transactions with other entities of the MNE group.

In line with Annex II to Chapter V of Action 13, the information to be included in the local file includes:

• A description of the local entity, including:
• The local entity's management structure
• A local organization chart
• A description of the individuals to whom local management reports and the country(ies) in which such individuals maintain their principal offices
• A detailed description of the business and business strategy pursued by the local entity including:
• An indication whether the local entity has been involved in or affected by business restructurings or intangibles transfers in the present or immediately past financial year
• An explanation of those aspects of such transactions affecting the local entity
• A list of the key competitors
• Information regarding controlled transactions: Providing for each material category of controlled transactions in which the Constituent Entity is involved:
• A description of the material-controlled transactions (e.g., procurement of manufacturing services, purchase of goods, provision of services, loans, financial and performance guarantees, licenses of intangibles, etc.) and the context in which such transactions take place
• The total intra-group payments and receipts for each category of controlled transactions involving the Constituent Entity (i.e., payments and receipts for products, services, royalties, interest, etc.) broken down by tax jurisdiction of the foreign payor or recipient
• An identification of related enterprises involved in each category of controlled transactions and the relationship with the Constituent Entity
• Copies of all material intercompany agreements concluded by the Constituent Entity, a detailed comparability and functional analysis of the Constituent Entity and relevant related enterprises with respect to each category of controlled transactions, including any changes compared to prior years
• An indication of the most appropriate transfer pricing method with regard to the category of transaction and the reasons for selecting that method
• An indication of which related enterprise is selected as the tested party, if applicable, and an explanation of the reasons for this selection
• A summary of the important assumptions made in applying the transfer pricing methodology
• An explanation (if relevant) of the reasons for performing a multi-year analysis
• A list and description of selected comparable uncontrolled transactions (internal or external), if any, and information on relevant financial indicators for independent enterprises relied on in the transfer pricing analysis, including a description of the comparable search methodology and the source of such information
• A description of any comparability adjustments performed, and an indication of whether adjustments have been made to the results of the tested party, the comparable uncontrolled transactions, or both,
• A description of the reasons for concluding that relevant transactions were priced on an arm's-length basis based on the application of the selected transfer pricing method
• A summary of financial information used in applying the transfer pricing methodology
• A copy of existing unilateral and bilateral/multilateral APAs and tax rulings issued by other tax authorities, and which are related to controlled transactions described above
• Financial information: Annual financial accounts of the Constituent Entity, information and allocation schedules showing how the financial data used in applying the transfer pricing method may be tied to the annual financial statements and summary schedules of relevant financial data for comparables used in the analysis and the sources from which that data was obtained

Entry into effect

The requirement to maintain transfer pricing documentation in line with the provisions of the draft Grand-Ducal regulation should apply from tax year 2024 onward.

Implications

With the proposed law and Grand-Ducal regulation, the transfer pricing documentation requirements are brought into line with the international standards resulting from the OECD's work on BEPS Action 13. Taxpayers that are in scope will have to review their transfer pricing documentation and should prepare the relevant master and local files. Even though these files only have to be provided to the tax authorities on request, deadlines may be short.

Given that the new requirements should apply as from tax year 2024 (i.e., to any financial year closing during calendar year 2024), relevant entities should take immediate action to ensure compliance with the new rules, especially entities with diverging financial years.

Although there is no monetary penalty foreseen for noncompliance with the requirements set forth by the draft Grand-Ducal regulation, an incomplete master or/and local file may lead tax authorities to challenge transfer pricing positions within the tax assessment process, to increase the tax base and ultimately the tax burden of a Luxembourg resident entity, which may in turn trigger double taxation issues between Luxembourg and the country of residence of the relevant related enterprise(s).

Bilateral or multilateral APAs

Application formalities

According to the draft Grand-Ducal regulation, the request for a bilateral or multilateral APA must be addressed in writing to the Director of the Direct Tax Administration or his/her delegate. The bilateral or multilateral APA will be based on the relevant tax treaty(ies) containing a provision equivalent to article 25, paragraph 3 of the OECD Model Tax Convention on Income and on Capital.

The request must be reasoned and contain at least the following particulars:

• Applicant: Information on the applicant (i.e., name, domicile, where applicable the tax identification number) and all the entities concerned by the envisaged transactions
• Transaction: A detailed description of the envisaged transaction(s) which must be seriously and concretely considered (including, where applicable, a brief description of the reasons why only part of the transactions involving the applicant has been included in the request), and the arrangements or legal acts covered by the request, together with a comprehensive motivation of the legal position
• Jurisdictions concerned: The other jurisdiction(s) that are concerned by the transaction(s) and requested to participate in the APA
• Time frame: The tax years covered by the request
• Transfer pricing study: A transfer pricing study in line with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration as regularly updated, including specific details such as information about the worldwide organizational structure, the accurate delineation of the transactions, a description of the methodology used, etc.
• Existing rulings: A list of the tax rulings issued by Luxembourg and any other jurisdiction in relation with the entities concerned by the transaction
• Bona fide statement: An assurance that all the information required for the assessment of the facts is complete and consistent with reality

Decision process

The Luxembourg competent authority will approach the competent authority of the other jurisdiction(s) concerned. Where an agreement is reached, the competent authority transmits it to the competent taxation office for execution (who will then respond to the taxpayer).

Administrative fee

Any request for a bilateral or multilateral APA triggers an administrative fee amounting to between €10,000 and €20,000, depending on the complexity of the request. The fee is due and payable in full within one month following the receipt of the decision determining the amount and the APA request will only be processed once the payment has been received. Liability for payment of the fee rests with the applicant; this is also the case for requests introduced on behalf of several taxpayers. The fee is final and nonrefundable, including in the event that the applicant withdraws the request or receives a negative response.

Entry into effect

The new provisions should enter into effect from their date of publication in the Official Gazette and will apply to requests introduced from that date. Requests that are pending with the Director when the new provisions are published will not have to be refiled.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Advisory Services Sàrl, Luxembourg City

• Bart Van Droogenbroek, EY Luxembourg Tax Leader I bart.van.droogenbroek@lu.ey.com
• Nicolas Gillet, Transfer Pricing Leader | nicolas.gillet@lu.ey.com
• Fernando Longares, ITTS Transfer Pricing | fernando.longares@lu.ey.com
• Renaud Labye, Asset Servicing Tax Leader — ITTS Transfer Pricing | renaud.labye@lu.ey.com
• Eduardo Medina, ITTS Transfer Pricing | eduardo.medina@lu.ey.com
• Jean-Bernard Dussert, ITTS Transfer Pricing | jean-bernard.dussert@.lu.ey.com

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

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ENDNOTES

¹ Draft grand-ducal regulation implementing specific procedure for requesting a bi- lateral or multilateral APA (available in French only)

² Draft grand-ducal regulation on mandatory transfer pricing documentation applicable to multinational enterprises (available in French only)

³ OECD/G20 Base Erosion and Profit Shifting Project, Transfer Pricing Documentation and Country-by-Country Reporting, Action 13 - 2015 Final Report.

⁴ Council Directive (EU) 2016/881 of 25 May 2016 amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation.