Get ready, Luxembourg-based multinationals !

Master and local file TP documentation requirements to be introduced 

Since 2015, the Luxembourg tax legislation (§171 of the General Law) clarified that taxpayers that have intercompany arrangements should be able to provide support on their intercompany transactions and provide it to the Luxembourg tax administration (LTA) upon request. In absence of further guidance, reference is made to the OECD TP guidelines and action 13 of the base erosion profit shifting (BEPS) action plan. Latter describes a three-tier documentation approach, i.e., a country-by-country reporting, Masterfile, and Local File. Since 2017, the Luxembourg tax legislation embedded more guidance on what would be expected from a taxpayer in terms of TP support. So far, the TP support consisted of a TP documentation, without specifying the actual format of the documentation to be provided. To date the LTA has accepted any type of TP documentation, as long as it supports appropriately the intercompany pricing. Hence, an all inclusive documentation, or a documentation that consists of a master file and local file would be acceptable based on the existing TP rules.

A master file contains an overview of the MNEs group’s global business operations, its organisational structure, including a description of its intercompany transactions, intangible assets, and its TP policies and methodologies. The master file is a key component of transfer pricing documentation that assists tax authorities determining whether the pricing of intercompany transactions is consistent with the arm’s length principle. It provides for a global context of the group and gives generally some insight on its value chain. 

A local file contains an overview of the local entities’ business operations, its local organisation, legal and management structure, including a description of its intercompany transactions, functional analysis, TP policies and methodologies, and economic analysis (i.e., comparable transactions, financial analysis).

The combination of a master file and local file should in general be considered a complete documentation required to assess the intercompany pricing.

The new Bill provides for requirements on when to prepare a master and/or local file documentation. The thresholds proposed in the new Bill refers to the country-by-country requirements (EU Directive 2016/88). On this basis, a master file and local file would only be required to be prepared if the consolidated revenues of the MNEs group would exceed 750 million € and the consolidated group has entities in at least two jurisdictions or more. In addition, a second threshold has been proposed to prepare a master file. A master file would be required for entities and permanent establishments that have a net turnover of at least 100 million € or assets of at least 400 million €.

Based on the proposed Bill, there would be different levels of TP documentation to be prepared depending on the abovementioned thresholds. The question is whether the thresholds in the proposed Bill make much sense. For example, MNEs that would have a consolidated revenue of over 750 million € in Luxembourg, but do not have foreign affiliated entities would fall outside the scope. Whereas such a situation would be unlikely, it may be questioned why domestic intercompany transactions would in such case be excluded from preparing a master file and local file. For certain MNEs, if the second threshold applicable for the master file would not be reached, no master file would then be required. This seems rather remarkable as a combined master file and local file constitutes an adequate TP documentation. Absence of a master file would imply that the LTA may not have all relevant elements to properly assess the intercompany pricing.

For entities not exceeding a consolidated turnover of 750 million €, no master file and/or local File would be required. Would this result in less administrative burden for these taxpayers?

Based on the current tax law, it is unclear what would be the difference in level of documentation if an entity does not fall within the new proposed TP documentation requirements. 

Firstly, based on §171 of the General Law (Abgabenordnung), any taxpayer should prepare TP documentation that supports their intercompany transactions. If a taxpayer would prepare an appropriate documentation, it should include the elements of both a master file and local file. Hence, it seems unclear what exactly is the intent of the new Bill.

Secondly, there is no minimum threshold for preparing TP documentation. Any small medium enterprise (SME) that has an intercompany arrangement outside Luxembourg or has more than one entity in Luxembourg should comply with the Luxembourg TP documentation requirements. Hence, if for instance a bakery decides to expand its activity outside of Luxembourg, the current tax law requires them to support their intercompany pricing through appropriate TP documentation. To mitigate the administrative burden going forward, it would be beneficial if a minimum threshold for TP documentation would be considered for SMEs. 

Conversely, the proposed different thresholds for a master file and local file should in our view be aligned as a local file without the elements of a master file would result in an incomplete documentation. Our recommendation would therefore be to apply this proposed documentation for all Luxembourg entities above a minimum threshold (e.g., excluding SMEs). Any entities below the threshold would either be excluded from TP documentation or only an absolute minimum would be required. 

If the proposed thresholds would remain, it would be essential that further guidance would be provided for the entities that do not have to prepare a master file and local file.

As a last point, the current tax law nor the draft Bill refers to a specific deadline for providing TP documentation to the LTA. Currently, the LTA are granting deadline extensions to taxpayers up to approximately 30 days on average. However, to provide taxpayers with more clear guidance and reduce the additional administrative burden for the LTA, it would in our view be a good step forward if a specific deadline would be considered for submitting the requested TP documentation. The proposed TP documentation requirements stated in the Bill will in principle apply as from tax year 2024 onwards.

New advance pricing agreement (APA) and mutual agreement procedures (MAP) 

The draft Bill provides for clarifications on bilateral and multilateral APAs as well as MAPs. 

In respect to bilateral and multilateral APAs, there is now a legal framework (§29c of the General Law) that is based on the double tax treaty containing a similar provision as article 25 (3) of the OECD Model Tax Convention on Income and on Capital. So far bilateral and multilateral APAs could already be requested and obtained from the LTA under the general legal framework. A major change is that the proposed fees for an APA application, depending on the complexity, will increase from 10,000 € to a range between 10,000 and 20,000 €.

In our view the application fee seems to be on the high side. Most European countries do not request for an application fee for APAs or apply significantly lower fees. Germany is one of the few countries applying a similar fee, but lower fees may apply for SMEs. In practice, it is expected that going forward the increase of APA application fees in Luxembourg will further reduce the number of APA requests. In particular, SMEs may consider it as a barrier to entry to have an upfront security on their intercompany pricing with the LTA.

The question is whether the draft Bill is intended to put extra hurdles for MNEs and in particular SMEs?

In respect to the MAP (§ 96a of the General Law), the draft Bill proposes that a tax assessment may be issued, amended or withdrawn based on a MAP or arbitration decision under the applicable double tax treaty between Luxembourg and a foreign country.

How will this impact the TP audits in Luxembourg? 

While the draft Bill aims to bring clarity, its proposed changes may actually stir up more questions and discussions. As we see it, taxpayers may face more challenges in determining what TP documentation would suffice if they fall below the threshold to prepare a master file or local file. The final Bill is expected to be approved later this year and is currently undergoing legislative procedure with expected enforcements as from 1 January 2024. There is still time to amend the new Bill to provide more clarity and guidance to both taxpayers and LTA. Without clear guidance, disagreements between LTA and taxpayers could arise, leading to more reassessments. It’s a bumpy road ahead, but with the right knowledge and preparation, you can navigate it smoothly.