We were mandated by a client for documenting that the interest received from its subsidiary in Spain was arm’s length and that the revenue left in his Luxembourg company was also arm’s length for Luxembourg tax purposes.
Those transactions were falling within the scope of articles 56 and 56bis of the Luxembourg income tax Law. In addition, the activity of borrowing and lending money to a group company was falling within the “Circulaire du Directeur des Contributions LIR n°56-56bis dated December 27, 2016 (the “Circular”).
First, we determined the credit scoring of the Spanish subsidiary by using a tool provided by one of the rating company.
Then, we went to a well-known financial database in order to find comparable with that financing transaction. This allowed us to determine the arm’s length range of interest. The criteria used were documented into the transfer pricing report of the financial transaction.
It is critical to document that the Luxembourg company was actually controlling that credit risks. Indeed, according to the Circular, without the control of the risk in Luxembourg there is no need to leave a remuneration for that intra-group financing activity. This may have implications in case of questions from foreign tax authorities on substance and beneficial ownership.
On the basis of the credit scoring previously found, we could determine the required capital to sustain a credit loss and the relevant net remuneration to be left in Luxembourg.
