Administrative circulars LIR no. 164/2 dated 28 January 2011 and LIR 164/2bis dated 8 April 2011

In an administrative circular dated 28 January 2011, the Luxembourg tax authorities target the tax treatment of Luxembourg intra-group financing companies. Luxembourg is a popular location for conduit financing mechanisms. The circular deals with intra group lending activities financed by financial instruments in public or private offerings/financing or bank credit facilities. The circular confirms that financing companies are required to be compensated with an arm’s length price that should be based on third-party transactions provided by credit institutions in comparable situations. All ruling requests will have to enclose a detailed and sound transfer pricing analysis.

The circular states that no ruling will be issued should a taxpayer fail to meet defined substance requirements. Beside the classical majority of Luxembourgish directors with the necessary professional qualifications and the fact that decisions of the company should be taken in Luxembourg, the circular requires the applicant to demonstrate that its capital is commensurate with the functions exercised, risks assumed and assets used. The circular states that, in principle, intra-group financing companies should be deemed to have an appropriate capital when it represents at least 1% of the nominal value of granted loans or EUR 2,000,000.

By formalizing and strengthening the substance requirement in Luxembourg, and by publicly disclosing conditions which until now resulted from a private discussion with the competent tax inspector, the circular was potentially affecting existing structures. The circular 164/2bis issued on 8 April confirms this point by stating that rulings issued prior to the circular 164/2 will elapse on 31 December 2011. After this date, the tax authorities will only be bound provided a new ruling, meeting the conditions set forth by the circular 164/2, is obtained. Taxpayers are urged to analyze existing structures.