This article was prepared together with Khyati Joneja.
Business restructurings are normally associated with a transfer of functions, risks, or assets between the entities of a group—and that means transfer pricing consequences. The restructured group entity is usually entitled to an (arm’s-length) compensation, the assessment of which requires the use transfer pricing principles.
These principles are elaborated on below, through examples in a Luxembourg context:
- Inbound/outbound transfer of intangible property: In a number of cases, an existing intangible property (IP) held overseas is transferred to a Luxembourg company (LuxCo). The LuxCo then significantly improves the IP by additional research and development work in Luxembourg, benefiting from the Luxembourg IP regime (under Article 50ter LITL). In such cases, the transfer of the IP needs to be priced for Luxembourg purposes as the acquisition value will affect the “nexus ratio” computed for the application of the Luxembourg IP regime. The same principles would apply in the context of an outbound IP transfer from a Luxembourg entity to related parties.
- Inbound/outbound transfer of loan assets: In the wake of recent developments in Luxembourg and globally (ATAD, BEPS, and so on), some taxpayers may be reorganizing their business structures in an intra-group setting. This might involve the transfer of a loan or portfolio of loans at the LuxCo level. Taxpayers should pay attention to the fact that this needs to take place at market (arm’s length) value.
- Inbound/outbound transfer of business: A transfer, termination, or renegotiation of a business arrangement may be regarded as an intercompany transaction and as such should be priced at arm’s length. The first element would be to appropriately delineate the intercompany transaction, and then to price the transaction according to market conditions. From a Luxembourg transfer pricing perspective, there should be transfer pricing documentation supporting the arm’s length character of the transaction (including citing the economic reasons of restructuring) and the pricing to be able to justify any charge incurred pursuant to the restructuring. When applying the arm’s length principle to business restructurings, the fundamental question is whether a transfer of something of value has occurred—since an independent enterprise does not necessarily need to receive compensation when a change in its business arrangement results in a reduction of its income potential or expected future income.
In the above examples, a valuation exercise can be performed to estimate “fair market value” or “arm’s length value” from a transfer pricing perspective aligned for Luxembourg purposes. Guidance is available from international organizations like the OECD, EU, and UN. Such a valuation exercise would typically consider elements like assessment of facts and assumptions, selection of an appropriate economic valuation technique, and description of the analysis in a narrative report.
Relevant court decisions
Furthermore, Luxembourg court cases that concern transfer pricing topics for business restructuring transactions notably include the following:
- In case n° 33611, dated 10 December 2015, a LuxCo sold trademarks to a newly established sister company. The parties set the purchase price for the trademarks at €975,000, while the tax authorities revalued the price at €6,475,000 and considered the difference to be hidden profit distribution. The court based its decision on the valuation presented by the tax authorities and dismissed the valuation of the taxpayer. The court concluded that the valuation report of the taxpayer was based on wrong facts and assumptions, was not signed, and did not provide any information about the authors.
- In case n° 40455, dated 10 December 2018, the Luxembourg tax authorities elaborated on which valuation methods for IP they favor, namely the (a) cost method, (b) income method, and (c) market method. Particularly the market method, which involves searching for similar IPs whose prices are known, poses a major problem in terms of collecting reliable data.
These cases illustrate a change in focus of Luxembourg tax authorities towards having a correct transfer pricing for business restructuring transactions.
Additionally, since transfer pricing is not limited to a restrictive (domestic) angle, the Amazon case is worth mentioning as it concerns a Luxembourg entity and deals with intangible valuations. When Amazon was restructuring its operations in Europe in FY 2004, it used a cost-sharing arrangement to transfer intangible assets such as IP, patents, and trade names to its European business in Luxembourg. The US Internal Revenue Service (IRS) argued that Amazon undervalued the assets, resulting in huge tax consequences for Amazon. Although a decision was rendered in favor of Amazon, the IRS is currently in appeal against it.
The big picture
Given the above, it is paramount that taxpayers comply with transfer pricing requirements in relation to business restructuring transactions to ensure that there is no automatic reversal of the burden of proof to the taxpayer.
KPMG Luxembourg’s dedicated transfer pricing team can assist taxpayers in assessing their transfer pricing positions resulting from intra-group business restructuring transactions to ensure that they meet the arm’s length principle and are in compliance with the Luxembourg transfer pricing requirements.
 Luxembourg transfer pricing rules are enshrined in Article 56 and 56bis of the Luxembourg Income Tax Law (LITL) and §171 of the Abgabenordnung, and require that “all transactions” between a Luxembourg entity and group companies should correspond to arm’s length market conditions (including business restructuring transactions).