BEPS, related EU developments, and Luxembourg’s response

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It has been now more than a year since the Organisation for Economic Cooperation and Development (OECD) issued its recommendations addressing base erosion and profit shifting (BEPS). Following this initiative, Europe has embraced the BEPS Project and has passed various directives at a rapid pace, thus actively contributing to changing the international tax landscape. One of the biggest milestones reached so far is the Anti-Tax Avoidance Directive, which was passed by the Economic and Financial Affairs Council (ECOFIN) in July this year.

The measures of this Directive are expected to have a significant impact on the tax landscape in Europe. Most EU countries are thus already reforming their taxation systems and proposing new tax incentives in compliance with the latest standards.

Luxembourg has not escaped this trend and is adapting its tax framework to both the OECD-BEPS standards and the new EU requirements, while also ensuring that it remains attractive. Luxembourg’s recent announcement of a progressive decrease in the corporate income tax rate, from 21% to 18%, marks one of the first steps towards remaining competitive, and will lead to a global income tax rate of circa 26% in 2018. The government is already considering a further decrease in the corporate income tax rate, but a final decision will not be taken before an assessment of the effects of the BEPS Project and related measures on the State budget is made.

Bearing in mind the above developments, a key element of the country’s competitiveness undoubtedly remains its economic strength and stability. Major rating agencies have confirmed the country’s ‘AAA’ rating with a stable outlook. And it is further expected that Luxembourg will continue to experience growth superior to the European Union and Eurozone average, which is particularly noteworthy given the current changes in the international corporate tax framework. Additionally, in the context of Brexit, Luxembourg is well positioned compared to other EU countries as a leading centre in Europe for investment funds (in second place worldwide after the USA), and investors can rely on its long-standing business-friendly environment as well as on fewer bureaucratic and administrative hurdles.

Looking into the future, it is clear that the Luxembourg tax landscape will continue to evolve to keep pace with international tax changes. In the short term, the main trends that are likely to remain dominant are a continuing and increased focus, by the Luxembourg and other local tax authorities, on transfer pricing and substance requirements. This has already resulted in the recent release of a new bill in Luxembourg providing further guidance on applying the arm’s length principle from 2017 onwards, in line with the work on Actions 8-10 of the BEPS Project (on ‘Aligning Transfer Pricing Outcomes with Value Creation’). The bill outlines the legal framework for a comparability analysis and emphasises that the arm’s length principle must be applied to all controlled transactions. Another trend that will inevitably derive from all these evolutions, and from tax transparency and automatic exchange of information becoming the new normal, is the increase in tax audits and cross-border tax disputes.

These international developments will heavily affect multinational groups, which face the challenge of understanding the changes, delineating the unique ways in which their organisations are affected, and mapping out the best way to respond. Companies must therefore start reshaping their structures and business models, where appropriate. They must also ensure that they have adequate transfer pricing and supporting documentation to outline how they have determined the arm’s length principle for their intra-group transactions in the context of a wider value chain analysis, and to demonstrate that they have the right economic substance and business rationales underlying their transactions. This will definitely be key in a world in which tax authorities worldwide have, more rapidly than ever, greater access to all taxpayers’ data.

 

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