AGEFI Luxembourg - juillet / août 2022

AGEFI Luxembourg 18 Juillet / Août 2022 Consultance ByNicolasGILLET,Partner,TransferPricing Leader ; PatriciaGUDINOJONAS, Partner, Tax and Chiara PALMIERI, Manager, Transfer Pricing at EYLuxembourg S ubstance” is a key topic in the setup of investment structures. However, the concept of substance is generic and could encompass various and potentially different items. It could also be interpreted dif- ferently between tax authorities and regulators. From a tax pers- pective, it usually describes be- neficial ownership require- ments and tax treaty access. From a regulatory perspective, decision-making functions are key areas of attention by regula- tors for Alternative Investment Funds (AIFs) managed by an In- vestment Fund Manager (IFM). From a tax perspective, the evolution of substance requirements is being placedmore andmore in the spotlight, both from a direct tax and transfer pri- cing perspective. The complexities of ensuring substance in investment structures From a direct tax perspective, the European Commission published a draft Directive on 22 December 2021, known as the Anti-Tax Avoidance Directive III ("ATAD III"), which aims to prevent the misuse of shell compa- nies for tax evasion and avoidance in the European Union. As part of the Directive, an entity should not out- source its day-to-day administration and decision-making to professional third-party service providers. This means that the entity should ensure it has the relevant substance for car- rying out its activities, otherwise access to a double tax treaty (1) could be jeopardized. Substance also plays an important role when looking at beneficial ownership and principal purpose tests (as per BEPS (2) Action 6). Different invest- ments and jurisdictions might require a different type and quality of subs- tance, which creates additional com- plexity in setting up the investment structure. It is possible to see a common deno- minator when talking about substance and access to a double tax treaty. A recent EU tax case law in Denmark (3) concluded that, in relation to withhol- ding tax exemption, an EU Member State must refuse to grant the benefit of EU Directives in case of fraud or “abuse of rights”. In the case under review, the “abuse of rights” was rela- ted to a holding company which did not qualify as beneficial owner since it was a mere conduit. In addition, another tax case law in Spain (4) also related to withholding tax, concluded that if there is no real business activity and substance in the holding company, the latter is not considered to be the beneficial owner, therefore the withholding tax exemption should be denied. In this case, the beneficial ownership assess- ment was based on transfer pricing considerations. The concept of substance is also crucial from a transfer pricing perspective The main references to substance from a transfer pricing perspective can be found in Chapter 1 of the OECD (5) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (“OECD TP Guidelines”) and BEPS Actions 8-10. As per OECD TP Guidelines, an entity performing intragroup transactions can perform the risk control functions when it has the capabilities to accept and manage the risk related to the transaction but also to take the neces- sary measures in case the risk materia- lizes. This entity should also have the financial capacity to assume the risk. It is interesting to note that BEPS Actions 8-10 do not speak about employees. The board of the company or a committee sitting at its level could be able to perform full or part of the risk control functions or its oversight. In Luxembourg, companies perfor- ming intragroup financing activities should perform the risk control func- tions in relation to the origination and the management of the transaction. Not meeting the requirements from a functional or economic standpoint could have an impact from a beneficial ownership perspective in foreign juris- dictions. Circular CSSF 18/698 (6) as a main reference in Luxembourg From a regulatory standpoint in Luxembourg, one of the main refe- rences for substance-relatedmatters is Circular CSSF 18/698 related to the IFM. To get the authorization to ope- rate as an IFM, the IFMmust maintain a sufficient level of substance in Luxembourg. Any delegation of functions which is of such a large scale that the IFM could no longer be considered as an IFM in substance must be considered as contravening the conditions which the IFM is required to meet in order to obtain and maintain its authorization. However, such level of substance merely depends on the decision- making functions in relation to invest- ment management, distribution and oversight activities that are different to the ones typically expected by tax authorities. How to implement substance requirements To face those increased and diverse substance requirements, market players use different types of models to comply with the rules formulated by the regulator and by tax authorities. When employees are providing ser- vices to several Luxembourg compa- nies, a global employment contract (GEC) is often used in practice since it is considered as an efficient way to allocate costs and resources to the rele- vant entities. The GEC allows companies to allocate the employee costs directly in their income statements without having VAT implications. Nevertheless, mar- ket players can find it challenging to establish the correct balance between the number of employees included in the GEC and the number of compa- nies for which the employees are wor- king. Before implementing a GEC in a structure with an IFM, a deep review should be performed to align with the CSSF requirements. Lastly, it is recommended that a review of the companies and employees involved in the GEC is performed every six months to one year. Another model used by market players involves having a “master” company employing the personnel providing the services and recharging their costs to the relevant Luxembourg entities. This model does not require a specific employment contract. However, there could be VAT impli- cations on the cost recharged, as the assignment of employees by one com- pany to another qualify as a supply of services for VAT purpose. Also, as the salary costs of the employees will not be directly disclosed in the income sta- tements of the companies receiving the services, this could trigger benefi- cial ownership questions by foreign tax authorities. Lastly, a group could set up a dedica- ted “service” company to provide the services to the relevant companies; this set-up has the same limitations as the “master” company mentioned above, and it allows for centralization of costs in one entity. Of course, depending on the needs of the group, it is possible to envisage a combination of the above solutions in order to tackle specific issues. Finding the best way to organize substance in the structure can be challenging In case of queries from local or foreign tax authorities, it can be hard to find a one-size-fits-all approach. Tax autho- rities could focus on different require- ments which could increase the diffi- culty in replying in an efficient and timely manner to various requests. In addition, following the COVID-19 out- break, more and more companies are envisaging a work-from-home policy. However, the functions performed by the employee working fromhome, but from another country, could play a role in the determination of substance in Luxembourg and on the allocation of the profit derived from the employee’s activities. In light of the above, to implement the most appropriate level of substance for the operation in place, it is advisable to perform a review of the type of substance already present at the level of each structure. Furthermore, the appropriate quality of substance should be implemented considering the different requirements per jurisdic- tion but also per type of investment. Lastly, the substance in place should be properly documented in the corpo- rate governance processes to be able to answer swiftly to any request from the competent authority. It is therefore key to have a holistic view of the various regulations in place, as the intent of the legislator to tackle artificial arrangements is reflec- ted in various actions including more tax and TP related legislations but also financial regulations, Directives and circulars issued by the regulator. 1) Double taxation agreements which distribute taxation rights among countries 2) Base Erosion and Profit Shifting 3) Published on 26 February 2019 by the Court of Justice of the European Union 4) Published on 16 December 2021 by an advi- sory committee consulted the Spanish Tax Authorities 5) Organization for Economic Co-operation and Development 6) Published on 23 August 2018 Substance: Juggling with tax, TP, regulatory and operational requirements ParSandraBIRTEL,Avocate&Fondatriceet AdrienMIGNAN,Gérant,BLLConsulting* D epuis sa création en 2019, BLLConsulting a toujours porté des valeurs d’éthique et d’intégrité dans l’ensemble de sesmissions et de ses communica- tions. Société de formation agréée, mais aussi cabinet de consulting, BLL a accompagné des centaines de clients privés, d’administrations oud’entités publiques sur leurs problématiques enmatière de compliance, deKYCou encore de lutte contre la fraude. Parmi les sujets regulatory, laprévention delacorruptionestunsujetfondamental auLuxembourg. Les récentes remontées du GRECO mais aussi l’objectif 16 de l’agenda 2030 adopté par le Gouvernement enConseil, endatedu12 mai 2017, le démontrent avec vigueur. Si les intentions sont là, jusqu’à ce jour les initiatives dans ce domaine restaient extrêmement parcellaires au Grand- Duché. Partant de ce constat, BLL Consulting a tout mis en œuvre pour obtenir cette certification internationale et pouvoir ainsi porter le sujet de la pré- vention de la corruption et accompa- gner toute structure luxembourgeoise dans l’obtention de ce fameux titre qui devient un prérequis indispensable, aussi bien à l’échelle européenne qu’in- ternationale Ainsi, nous pouvons désormais légiti- mement accompagner toute structure privée ou publique dans la mise en place d’un programme de conformité et d’éthique surmesure, qu’il s’agisse de l’élaboration de cartographies, de pro- cédures, oude l’organisationd’audits et de formations, et ce, selon les attentes internationales et européennes. Plus encore, afin de porter ces valeurs qui nous sont chères, nous avons décidé de créer LutCor, l’association luxem- bourgeoise pour lapréventionde la cor- ruption. Cette association a pour but de réunir tous les professionnels et tout autre intéressé par ces questions, afinde travailler ensemble à la création d’une réelle doctrine dans notre pays, notam- ment grâce à des évènements ou des groupes de travail: Nous sommes très fiers de pouvoir vous annoncer aujourd’hui être la pre- mière société luxembourgeoise à obte- nir une telle certification, et ce, en ayant été évaluée entièrement conforme à l’en- semble des critères d’audit ISO. Nous avons à cœur de porter ces valeurs fortes d’éthique et d’intégrité auGrand- Duché, et sommes ravis de partager cet engagement avec vous. * Prévention de la corruption BLLConsulting, première société luxembourgeoise à obtenir la certification iso 37001