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Tax Treatment for Financing Companies Clarified Affecting Multinationals
The Luxembourg direct tax authorities have released a circular that clarifies certain tax aspects regarding companies that perform financing activities within a group. The circular defines the entities concerned as well as the activities performed by these entities, which fall within the scope of the circular. The circular presents in broad terms the criteria and transfer pricing requirements that should be followed for financing companies. It also explains the substance requirements applicable to these entities and the procedure to follow in order to get a clearance from the tax authorities on the tax treatment of these companies. Taxand Luxembourg presents its view on the subject and how this new circular might affect multinationals.
Which companies are concerned by the circular?
The circular defines a financing entity as any entity, which performs mainly intra-group financing activities. This approach does not seem to be in line with the OECD principles, which focus on transactions and activities rather than on the nature of a company. The circular furthermore defines an intra-group financing activity as any activity, which consists of the granting of loans or cash advances to related companies, i.e. loans or cash advances being funded with financial instruments such as public loans, private loans, cash advances or bank loans.
At this stage, activities in relation to the holding of participations are not included.
The circular does not clarify whether "mainly" is based on the accounts of the Company or on any other criteria such as the bylaws of the Company. It can however be expected that the tax authorities will rather adopt a wide approach and we recommend that any Luxembourg entity, which acts as financing vehicle within a group of companies should take the necessary steps in order to fulfil the requirements of the circular.
How to determine the taxable income of these companies - transfer pricing requirements
The circular reiterates the general principles applicable to transactions amongst related parties and refers to article 9 of the OECD Model Tax Convention, based on which associated enterprises have to apply the transfer prices that would have applied amongst independent enterprises. Intra-group
services have therefore to be rendered under the same conditions as the ones which would have applied amongst unrelated parties.
As far as financing entities are concerned, the circular specifies that the situation of the intra-group financing entity has to be compared to the one of a regulated financing entity, i.e. financial institutions and the price should be determined based on the one that a bank would have applied to similar credit transactions. Important factors here are the risks taken by the financing entity which are being assessed based on data such as the financial statements of the borrower, the presence of guarantees or security granted, the purpose of the financing, its maturity and the sector in which the borrower is active.
The circular refers to the computation of the price applied by financial institutions (interest charges in relation with the granting of the financing) which are increased by a margin taking into account additional costs linked to the credit risk, the necessity to meet the solvency requirements, handling costs or exchange risks.
Intra-group financing entities should therefore analyse in the same way the risks related to the financing and take into account any relevant criteria, which might impact the transfer price.
Procedure to obtain a tax clearance on the tax treatment of intra-group financing companies
As far as financing companies are concerned, the tax authorities will in the future take a position only to the extent that the financing entities concerned fulfil a certain number of criteria and evidence that these criteria are met. These criteria relate to the level of substance of the company.
An intra-group financing company is considered as having a real presence in Luxembourg only to the extent that some conditions are fulfilled in respect of the composition of the board of directors / managers, the share capital, the location of the meetings where key decisions are taken, bank accounts, filing requirements for tax returns and tax residence.
The position taken by the tax authorities will only apply for a limited period of time of five tax years. When the five year period elapses, if the Company still performs an intra-group financing activity, it will have to file a new request, based on which the tax authorities will determine whether the same position can be taken for an additional five year time period and under the same conditions.
The circular is good news as it clarifies the requirements for financing companies to get a confirmation of their Luxembourg tax position. It also validates the legal value of the tax clearances obtained from the tax authorities, which are binding based on the good faith principle. It therefore means more legal security for the tax payer. All groups with a financing Company in Luxembourg should make sure that they follow the new guidelines as any change in their current situation (even an increase in the financing activity due to new investments performed by the group) should be subject to the requirements defined in the circular.
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