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28.7 Transfer Pricing Considerations

Understanding Transfer Pricing​

Transfer pricing refers to the pricing of transactions between related parties (e.g., parent company and subsidiary, companies under common control). Luxembourg has transfer pricing rules to ensure that transactions between related parties are conducted at arm's length (as if between independent parties).

When Transfer Pricing Rules Apply​

Transfer pricing rules apply when:

  • Transactions between related companies
  • Transactions with foreign related parties
  • Transactions with companies under common control
  • Other related-party situations

Related Parties Include:

  • Parent and subsidiary companies
  • Companies under common control
  • Companies with significant ownership relationships
  • Other related entities

Arm's Length Principle​

Core Principle​

Arm's Length Principle:

  • Transactions must be priced as if between independent parties
  • Prices should reflect market conditions
  • No artificial profit shifting allowed

Purpose:

  • Prevent tax avoidance through profit shifting
  • Ensure fair tax allocation
  • Maintain tax base integrity

Transfer Pricing Methods​

1. Comparable Uncontrolled Price (CUP)​

Method:

  • Compare price with similar transactions between independent parties
  • Most direct method when comparables available
  • Preferred method when data available

Example:

  • Related-party sale: €100 per unit
  • Independent party sale: €100 per unit
  • Price is arm's length

2. Cost Plus Method​

Method:

  • Add appropriate markup to costs
  • Used for manufacturing or service transactions
  • Markup should reflect market rates

Example:

  • Manufacturing cost: €80
  • Market markup: 25%
  • Arm's length price: €100

3. Resale Price Method​

Method:

  • Start with resale price
  • Subtract appropriate gross margin
  • Used for distribution transactions

Example:

  • Resale price: €120
  • Market gross margin: 20%
  • Arm's length purchase price: €96

4. Transactional Net Margin Method (TNMM)​

Method:

  • Compare net profit margins
  • Used when other methods not applicable
  • Requires comparable company data

5. Profit Split Method​

Method:

  • Split profits based on contributions
  • Used for complex integrated transactions
  • Requires detailed analysis

Documentation Requirements​

Transfer Pricing Documentation​

Required Documentation:

  1. Master File: Group-wide transfer pricing policies
  2. Local File: Luxembourg-specific transactions
  3. Country-by-Country Report: For large groups (if applicable)

Documentation Must Include:

  • Description of related-party transactions
  • Transfer pricing method used
  • Comparability analysis
  • Economic analysis
  • Supporting data and calculations

Compliance Requirements​

Annual Requirements​

Annual Obligations:

  • Maintain transfer pricing documentation
  • Ensure arm's length pricing
  • Review and update documentation
  • Be prepared for tax authority review

Tax Authority Review​

Potential Reviews:

  • Tax authorities may review transfer pricing
  • May request documentation
  • May challenge pricing if not arm's length
  • May adjust prices and tax accordingly

Penalties for Non-Compliance​

Documentation Penalties​

Penalties:

  • €10,000 - €250,000: For missing or inadequate documentation
  • Additional penalties: For repeated failures
  • Interest: On additional tax assessed

Pricing Adjustment Penalties​

Penalties:

  • Tax adjustments if pricing not arm's length
  • Interest on additional tax
  • Potential penalties for deliberate non-compliance

Best Practices​

  • Maintain list of related parties
  • Identify all related-party transactions
  • Monitor for new relationships

2. Document Transactions​

  • Document all related-party transactions
  • Maintain pricing documentation
  • Keep supporting economic analysis

3. Use Appropriate Methods​

  • Select appropriate transfer pricing method
  • Apply method consistently
  • Update methods as needed

4. Regular Review​

  • Review transfer pricing annually
  • Update documentation
  • Ensure continued compliance

5. Professional Support​

  • Consult transfer pricing specialists
  • Get professional documentation
  • Ensure compliance with rules

Luxembourg Compliance Note​

Important Requirements:

  • Arm's length pricing: All related-party transactions must be arm's length
  • Documentation: Maintain proper transfer pricing documentation
  • Consistency: Apply methods consistently
  • Review: Regular review and update of documentation
  • Professional advice: Consult specialists for complex situations

Common Issues:

  • Missing documentation: Not maintaining required documentation
  • Non-arm's length pricing: Pricing not reflecting market conditions
  • Inconsistent methods: Changing methods without justification
  • Inadequate analysis: Insufficient economic analysis

Think It Through​

TechLux Solutions has a subsidiary in France. They sell products to the subsidiary at cost (no markup). Is this acceptable? What should they consider?

Concepts in Practice​

Transfer Pricing Compliance

TechLux Solutions related-party transaction:

Transaction:

  • Parent (Luxembourg) sells to subsidiary (France)
  • Product cost: €80
  • Market price: €100
  • Current price: €80 (at cost)

Analysis:

  • Current pricing: Not arm's length
  • Market price: €100
  • Required adjustment: Price should be €100

Documentation:

  • Comparable uncontrolled price analysis
  • Market price research
  • Economic justification
  • Transfer pricing documentation prepared

Result: Pricing adjusted to €100, documentation maintained, compliance ensured.