LUXEMBOURG - Transfer pricing and VAT
The Luxembourg VAT authorities published a new circular (n°790) on 18 January 2019 that relates to the taxable basis for transactions between related parties.
These administrative guidelines complement the implementation of article 80 of Directive 2006/112/EC into the Luxembourg VAT legislation by the law of 6 August 2018, which entered into force on 31 July 2018.
How the taxable basis is determined for transactions between related persons
Further to the amendment of article 28 of the Luxembourg VAT Law that relates to the concept of 'taxable basis’, a specific provision applies for the determination of the taxable amount for transactions between related persons.
To prevent tax evasion or avoidance, in respect of supplies of goods or services involving family or other close personal ties, management, ownership, membership, or financial or legal ties, the taxable amount imputed will be the normal value (that is the ‘open-market’ value) where any of the following apply:
- The consideration is lower than the ‘open market value’ and the recipient of the supply does not have a full right of deduction;
- The consideration is lower than the ‘open market value’ and the supplier does not have a full right of deduction and the supply is subject to an exemption under article 44 of the Luxembourg VAT;
- The consideration is higher than the ‘open market value’ and the supplier does not have a full right of deduction.
This provision specifically encompasses the relationships between an employer and employee, or someone in the employee’s family, as well as any other person with close personal ties.
What is the ‘normal value’?
Under article 32 of the Luxembourg VAT law, the ‘open-market value’ means the full amount that a customer would have to pay, under conditions of fair competition, to a supplier at arm's length within the country in order to obtain the goods or services.
Where no comparable supply of goods or services can be ascertained, ‘open market value’ means the following:
- In respect of goods, an amount that is not less than the purchase price of the goods or of similar goods or, in the absence of a purchase price, the cost determined at the time of supply;
- In respect of services, an amount that is not less than the full cost of providing the service to the taxable person.
How the new rules impact the right of deduction
The substitution of the normal value for the consideration retained by the parties might impact the right of deduction of the related input VAT for either the supplier or the purchaser of the goods and services as follows:
- A purchaser of goods or recipient of services that is not entitled to a full recovery of its input VAT will suffer an additional VAT burden if a higher ‘open market value’ is substituted for the initial consideration paid for the supplies. In such a situation, the person liable for the Luxembourg VAT (either the supplier in the case of domestic supplies or the recipient of the goods or services for cross-border transactions) must adjust the taxable basis and correct the initial invoice. The recovery of input VAT recovery by recipient is only available if the recipient possesses a correct invoice, in other words, a document that is based on the ‘open market value’ of the supplies.
- A supplier of goods and services that is not entitled to a full recovery of its input VAT might be tempted to artificially increase the value of its taxable supplies with related parties or to artificially decrease the value of its VAT exempt transactions the view to enhancing its overall recovery ratio (article 50 and 51 of the Luxembourg VAT). If a supplier does either of these, the circular provides for a mandatory adjustment of the taxable supplies through the issue of a corrected invoice (which allows the recipient of the supply to then adjust its input VAT recovery). The issue of a corrected invoice is not provided for in case of a VAT exempt supply.
How this will affect the businesses in Luxembourg
The new rules are principally aimed at taxpayers that are not fully entitled to an input VAT recovery. The transactions potentially at risk might be domestic (in other words, a supply between two Luxembourg-based companies) and also cross-border transactions, when either the Luxembourg-based supplier or the Luxembourg-based recipient is not entitled to a full input VAT recovery.
There are several industries or situations that can be affected. The financial sector (banks, insurance companies, and funds) is obviously within the scope of these provisions. Typically, a UK-based investment advisor that is providing services to a related management company in Luxembourg must consider these provisions when assessing the value of those services. But, these provisions have a far wider scope, for example, they apply to the supplies of cars or any other vehicles made by a company to the company’s beneficial owners or its employees.
In the real estate sector, for example, the new legislation will, affect the promoters that use corporate structures to separately transfer the land and the construction works of residual properties to private individuals. The valuation of intra-group rental agreements must also be correctly assessed in the light of these new provisions.
From a practical standpoint, we expect this issue of the ‘open-market value’ to be raised by the VAT authorities when assessing taxpayers’ VAT returns. Once transactions between related parties are identified, one can expect the VAT authorities to more systematically challenge the value claimed by the parties, leaving the burden of proof on taxpayers. The adjustments will be made at the time of the VAT audit, through the minutes (procès verbal), or via the issue of a VAT assessment (bulletins de taxation d’office ou bulletins de rectification d’office).
Taxpayers that are not fully entitled to a VAT recovery should anticipate such issues and, at least for their major transactions with related parties, make sure that they have information on file to support their position, including potential comparables related to similar transactions between unrelated parties.
Even taxpayers that are fully entitled to a full recovery of VAT in Luxembourg should review their transactions with their employees, their shareholders, and any person with close personal ties, and make sure that those transactions have been correctly valued.
The implementation of the new legal provisions that are based on article 80 of the Directive 2006/112/EC, combined with the position’s set out in this new circular (N° 790) are a clear signal to Luxembourg taxpayers. In VAT matters, the ‘open market value’ becomes the new normal in transactions between related parties, with the effect that transfer pricing discussions are no longer confined to corporate tax issues. The transfer pricing issues and the valuation methodologies that were, until now, principally relevant for corporate taxes will soon play a role in indirect tax matters as well. Even if not expressly referred to in the circular, to support the value of specific supplies or purchases, transfer pricing reports will become necessary for VAT purposes in certain circumstances.
With a strong and practical expertise in both VAT and transfer pricing, BDO Tax & Accounting can assist clients assess their risks of being challenged on transactions with related parties. We can also help with any kind of dispute with the VAT authorities.