Recent TP case: Economic rationality of some intra-group services

In a recent case, the Luxembourg Tax Authorities challenged the limited risk service approach used by a Company in Luxembourg to justify a remuneration allocation to an associated Company located in Switzerland.

Here some key points of this case:

A. Tax problem

On 22 June 2020, the Luxembourg tax authorities (LTA) informed to the Company A the payments performed to Company D concerning to some variable remuneration during the fiscal year 2015, 2016 and 2017 are not deductible for tax purposes because there is not economic justification.

B. Background

The Company A is a distributor of several pharmaceutical products in Luxembourg.

The Company D is a distributor of several pharmaceutical products in Switzerland.

In 2014, the rights and obligations of Company D's pharmaceutical contracts were transferred to Company A. The transfer included variable annual remuneration: payments made from Company A to Company D, determined by:

➡ product turnover generated by Company A,
➡ minus operational costs of Company A and a
➡ 4% profit margin of Company A.

C. LTA's main arguments

LTA contested Company A's lack of evidence regarding Company D's commitment and responsibility for operational risks post-formation. Company A presented operating expenses, including marketing, salaries, and other costs, contrasting with Company D's minimal overheads, devoid of similar expenses or remunerations.

D. Company A's main arguments

Company A negotiated significant concessions from Company D, reducing risks and securing favorable terms during the transfer of main contracts. Despite this transfer, Company D retained the primary obligations and strategic decision-making, including financial responsibilities and transaction risks, as confirmed by a transfer pricing study. According to this analysis, Company A functions as a limited risk distributor and legal asset owner, justifying routine remuneration, while the residual profit allocation belongs to Company D.

E. Tribunal decision

The Administrative Tribunal ruled in favor of Company A, validating the deductions.

The LTA can appeal the decision (role number 46054 dated 14 of June 2023).

F. Takeaways

This audit case allows us to have a view on the recent trends of transfer pricing audits of intercompany services in Luxembourg. This case confirms the importance of:

  • Performing a selection of the business model of the tested party should be in line with the actual conduct of the related parties and the economic rationality of the transactions.
  • Checking the alignment of functionalities expressed in transfer pricing documentation with the actual conduct of the related parties.
  • Confirming that the arm’s length remuneration is in accordance with the actual conduct of the related parties.
  • Validating the proper application of the transfer pricing policy within the Group.

Vanesa Ramos Ferrin - TransFair Pricing Solutions

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