In 2020, the Luxembourg tax authorities (LTA) launched a wave of tax audits with a focus on financial transactions. These audits are not yet closed but based on observations regarding how the audits are being conducted it is possible to describe some practical lessons learned that are relevant for taxpayers facing a tax audit in Luxembourg.
Some of these lessons may appear to be rather basic to readers that are located in jurisdictions where tax audits are a common and recurring practice, but it is important to understand that, until recently, this often was not the case in Luxembourg.
A Luxembourg tax audit starts with a long list of information that the taxpayer must submit to allow the LTA to carry out an extensive investigation of the taxpayer’s tax position. This part of the process tests the taxpayer’s ability to respond to such a request.
The pace at which the taxpayer is able to gather and submit the information and the completeness and quality of the information submitted, especially with regards to the books and records of the company, provide an indication of the taxpayer’s operational capabilities to run its financing or holding business under genuine business conditions.
Consistency between the profile of the taxpayer reflected in the transfer pricing (TP) documentation and the behaviour demonstrated through its board activities is a key initial test to pass when it comes to group financing operations under a tax audit in Luxembourg. As an example, the taxpayer may be requested to submit copies of the minutes of the board meetings that took place during the period under audit, which are expected to provide an indication of the level of management of the financing operations, with the focus on the risk of such business.
A company engaged in a genuine lending business would not be expected to fail to monitor the risk of the borrower defaulting on its obligation. In other words, if the TP documentation reflects a genuine lender taking risk on its funding operations and seeking risk-weighted remuneration, the minutes of the board meetings should cover risk-monitoring and risk-mitigating activities.
A further area of focus of the LTA is the completeness of the documentation with respect to the related party transactions under review. Lending transactions, even long-term ones, often evolve quickly.
New loans may be extended and existing loans refinanced or completely or partially repaid, which calls for prompt adjustments to maintain documentation sufficient to support each of the lending transactions.
Submitting documentation that covers only part of the operations or that is outdated could give the impression to the LTA of a lack of documentation capabilities with respect to related party operations. Depending on the facts and circumstances, the taxpayer could be in a better position by requesting a deadline extension from the LTA to allow it to close any such gaps, even if the request could be interpreted as a lack of preparedness.
The authorities generally seek direct contact with the taxpayer’s representatives (even though, during the COVID-19 situation, a live meeting often was not possible). Even for an initial ‘kick-off’ meeting, a company should not hesitate to invite tax specialists, whether they are the group’s tax director/manager or an external service provider.
The management of the company is not expected to be able to address any technical questions that the authorities may have in light of the documentation already received. The presence of external tax specialists should not be viewed as a lack of internal capabilities (which often is referred to as “substance” in the field of international tax), but rather as a sign that the taxpayer is willing to address any technical questions that may arise in the conversation.
Interactions with the authorities, including phone calls, should always be documented to ensure a common understanding of requests or of mutual positions expressed during calls and meetings. Correspondence still often occurs by mail, so a company should be proactive in ensuring that the post is being regularly collected.
We hope the discussion provided allows taxpayers to better navigate any future TP audits in Luxembourg. The learning curve on both sides (tax authorities and taxpayers) may make the process rather challenging, but an awareness of the basics described above should help avoid unnecessary escalations that are unlikely to favour the taxpayer.
Balazs Majoros
Partner, Deloitte Luxembourg
Adam Wojewoda
Manager, Deloitte Luxembourg
