Written by Philippe Neefs, KPMG Luxembourg Transfer Pricing Leader

Since 1 January 2015, Luxembourg’s transfer pricing regime has been based on article 56 of the Luxembourg Income Tax Law (LITL), which introduced the arm’s length principle into local Luxembourg law. In addition, the Luxembourg tax authorities could also refer to article 171 of the Abgabenordnung, modified by the Law of 19 December 2014, which essentially states that taxpayers should be able to provide transfer pricing documentation sustaining the arm’s length character of all intercompany transactions.

On 27 December 2016 article 56bis was introduced, together with the publication of a new transfer pricing circular for companies principally performing intra-group financing activities. This new article, applicable as from 1 January 2017, gives taxpayers and Luxembourg tax authorities more guidance on how to apply the arm’s length principle in the context of a wider value chain analysis. It focuses on the comparability analysis based on the OECD’s five comparability factors approach. The comparability factors to be taken into account are the following:

1. Contractual terms of the transaction: the contractual terms should be found not only in the legal documentation, but should also be reflected in the accounting statements.
2. Functional analysis: a wider value chain analysis, as well as the ability to control the risks, should be outlined.
3. Characteristics of goods and services: differences in quality or availability of a product or a service should be considered.
4. Economic circumstances: product life cycle, market size, and the extent of competition should be taken into consideration.
5. Business strategies: risk diversification and innovation strategies that have a possible impact on transfer pricing should be examined.

The commercial rationale behind each intercompany transaction is also of outmost importance. If the commercial rationale is lacking, then a transaction could be disregarded. This has a critical impact as taxpayers must now be prepared to be able to document the commercial rationale as part of the transfer pricing documentation. Attention will need to be paid to pre-structuring documentation. Therefore a description of the Luxembourg value chain should take any no-tax reasons into account.

The circular published on the same day as article 56bis clarifies the transfer pricing rules applicable to entities principally performing intra-group financing activities (Circulaire du directeur des contributions LIR n° 56/1-56bis/1 of 27 December 2016). The scope of the application of the circular remains the same as under the 2011 transfer pricing circulars previously applicable in Luxembourg. Notably, it applies to all entities realising intra-group financing transactions, while holding activities remain out of its scope. The definitions of “intra-group financing transactions” and “associated enterprises” remain unchanged.

In this new circular, strong emphasis is put on the analysis of the risks assumed by the companies. In that regard, different factors need to be taken into account such as the solvency of the borrower, the potential guarantees for specific financing transactions, the costs in relation to the financing transactions, and the actual value of the underlying assets.

The circular further provides that if a company has a similar functional profile to the entities regulated under EU Regulation n° 575/2013 that transposes the Basel Accords, and the company has an amount of equity complying with the solvency requirements under this regulation, then it is considered to have enough capital to support the risks assumed. Moreover, as a safe harbour, it is considered that such a company complies with the arm’s length principle if its remuneration corresponds to a return on equity equal to 10% after taxes. In practice, it is not expected that many Luxembourg companies will fall into this category due to the particular nature of the required functional profile.

All other companies should perform an analysis to determine the necessary capital at risk using the widely accepted methodologies in this area. These companies must have the financial capacity to assume such risks. The level of capital at risk should correspond to the functional profile under review, meaning that the required capital at risk should decrease when the risks borne become more limited. It must be noted that there is no reference anymore to the minimum required capital at risk of 1% of the financing volume (capped at €2 million) that could be derived from the application of the 2011 transfer pricing circulars.

Furthermore, the circular provides that in order to be able to control the risks (i.e. the decision-making capacity), the company performing the intra-group financing transaction should comply with the following substance requirements:

1. The members of the board of directors, or the managers empowered to engage the entity in particular, must be residents of Luxembourg; the majority of the board members should also be Luxembourg resident or, if non-Luxembourg resident, should be taxable for at least 50% of their income (listed in the circular) in Luxembourg.
2. The company should have qualified personnel to control the performed transactions. However, the company could outsource some functions that do not have a significant impact on the control of the risks. This latter item still under debate.
3. The entity must not be considered a tax resident of a foreign jurisdiction.

The circular additionally provides for a measure of simplification, which a taxpayer can opt for should the following conditions be fulfilled:

1. No transfer pricing study has been prepared.
2. The intra-group debt receivables are financed by intra-group debt payables.
3. The company fulfils the substance requirements (as outlined above).

It will be considered that these taxpayers comply with the arm’s length principle if their remuneration corresponds to a return on the financed assets of at least 2% after taxes. However, these cases will be subject to exchange of information.

The circular specifies that it remains possible to obtain an Advanced Pricing Agreement based on the facts and circumstances of each case if the conditions outlined in the circular are respected. It further stipulates that any Advanced Pricing Agreement issued before the entry into force of article 56bis LITL should not be binding by the Luxembourg tax authorities as from 1 January 2017 for the fiscal years following 2016.

Although it is not indicated, it can be interpreted that a Luxembourg entity carrying out an intra-group financing activity that does not have the so-called organisational and economic substance would be considered a conduit entity and that this information can be exchanged spontaneously with concerned jurisdictions. It can be anticipated that tax audits in source jurisdictions may be initiated and that the beneficial owner status of the Luxembourg entity may be questioned.

In light of these developments, previous Advanced Pricing Agreements and defensive transfer pricing documentation need to be reviewed and possibly updated.

Additionally, on 27 December 2016 the law on non-public country-by-country (CbC) reporting transposing the EU Directive 2016/881 of 25 May 2016 into domestic law was published. This measure reflects OECD/G20 BEPS Action 13. On 12 July 2017 the Luxembourg tax authorities acknowledged and explicitly referred to the OECD’s guidance on the implementation of the CbC reporting. Nevertheless, it is important to note that Luxembourg has not yet implemented any measures that would transpose the Master File and the Local File requirements under OECD/G20 BEPS Action 13. The author hopes that Luxembourg will transpose these measures into its domestic law in order to fully comply with the multi-tier transfer pricing documentation standard. This would further confirm Luxembourg’s commitment to the greater transparency that is required today.

Notably, CbC reporting requirements apply to multinational enterprise (MNE) groups whose total consolidated group revenue exceeds €750 million (or an amount in local currency approximately equivalent to €750 million) during the previous fiscal year.

As a result of this legislation, constituent Luxembourg entities must notify the Luxembourg tax authorities as to whether they are an ultimate parent entity, surrogate parent entity, or constituent entity. If the constituent entity is not the reporting entity that will be filing the group's 2016 CbC report, they must provide the identity and tax residence of the actual reporting entity to the tax authorities. MNE groups with a fiscal year-end in 2016 had to provide this notification by 31 March 2017 (instead of 31 December 2016, which was originally the deadline). This notification procedure is performed online on a specifically dedicated website of the Luxembourg tax authorities. Luxembourg's new law requires the first CbC reports to be filed for fiscal year 2016 within 12 months of the last day of the reporting fiscal year of the group (e.g. 31 December 2017 if the 2016 accounting year of the MNE group ends on 31 December 2016). Failure to do so may entail a fine of up to €250,000!

As a conclusion, the above mentioned measures are welcome on the Luxembourg market, as they provide additional guidance on the application of the arm’s length principle. The new article 56bis LITL can be seen as a transposition of OECD/G20 Base Erosion and Profit Shifting (“BEPS”) Actions 8-10. These developments mirror international and European ones, putting Luxembourg on a level playing field. The author, however, anticipates an increase in tax audits and would advise the preparation of agile transfer pricing documentation. In this respect, readers must ask themselves the following questions with respect to their Luxembourg investment structures:

• Is your company engaged in any intercompany transactions (e.g. intercompany loans, management fees, license fees, etc.)?
• Are your intercompany transactions covered by a legal arrangement/part of your transfer pricing policy and are these agreements also reflected in your accounting system?
• Is there any transfer pricing policy available on the group/local level that covers all your intercompany transactions?
• Have you entered into any Advance Pricing Agreements with the tax authorities and have you checked whether the facts are still applicable?
• Does your group qualify for the country-by-country reporting requirements?

Business leaders are skeptical of Congressional predictions that US tax reform will come by this summer, with more than half (53%) predicting that significant business tax reform won't arrive until 2018, according to a recent poll by KPMG LLP, the US audit, tax, and advisory firm.

Only 16% of more than 1,000 respondents polled during a recent webcast expect tax reform to be achieved in 2017.  In addition, 11% do not expect reform until 2019, and 21% are unsure of the timing.

"While many factors could affect the timing and eventual content of the tax reform proposal, the legislative process clearly needs to be a key area of focus for business leaders," said Jeffrey C. LeSage, Vice Chairman – Tax at KPMG. "Although the outcome is uncertain, we are looking at the best chance for meaningful tax reform in decades, so attention will likely continue to be high as developments unfold," he added.

When asked which of the proposals in the current House Republican tax plan would have the greatest anticipated impact on their business, 41% cited the proposal's new reduced corporate tax rate structure.  From an industry perspective, respondents from the retail and industrial manufacturing sectors selected the hotly-debated border adjustment proposal as likely having the greatest impact on their organizations, at 38% and 37%, respectively.

"Developments on the tax reform front could evolve quickly," said John Gimigliano, principal in charge of Federal Tax Legislative and Regulatory Services in the Washington National Tax practice of KPMG. "That's why business leaders need to stay engaged, consider how the current House GOP Blueprint may affect them, and be ready to respond quickly as tax reform advances through the legislative process."

The poll of more than 1,000 tax, financial and other business professionals was conducted during a March 2 KPMG TaxWatch webcast that is part of the firm's Tax Reform Thursdays webcast series.

(Source: KPMG LLP)

With CEO’s citing growth as top priority for the coming years, CFOs are to be strongly impacted. Finance Monthly here benefits from an exclusive outlook on the future of CFOs by Mark Nittler, VP Enterprise Strategy at Workday, who discusses the changing role of finance and how CFOs can better prepare themselves for the future.

The role of the CFO is going through a period of significant change. It’s no longer just a numbers game, but CEOs are calling on the finance team to play a bigger role in decision-making, technology, and data governance.

CFOs need to ensure they’re ready for such major levels of change, which are only exacerbated further by an intensely competitive digital business landscape. And despite CFOs now needing a more strategic approach to decision making, recent research suggests that many still rely on gut feel rather than hard data. Many also admit they neglect innovation and process improvement, and have not mastered how to manage and analyse the volume and variety of business data available to them.

So what are the business priorities impacting the focus of the finance function? This article looks at how CFOs can best prepare themselves – and their teams – to become a more strategic partner able to meet the changing needs of a modern organisation.

Multiple growth strategies

It will come as no surprise that many CEOs cite growth as their top priority for the next three years, a move set to strongly impact the CFO. It’s now expected that CFOs will play a core part in driving growth strategies across the company, which makes good business sense given the insight they have into every part of the organisation.

This growth will be the result of numerous different approaches – from organic growth to geographic expansion and acquisition – so the CFO will need to drive multiple growth strategies. In today’s dynamic business environment this will be no easy task, but it’s vital CFOs embrace this new role, supporting the CEO in the pursuit of growth and becoming a strategic partner to the business.

Regulation, regulation, regulation

The CFO has an important part to play when it comes to the regulatory environment. This not only applies when considering how to adapt to new regulations but also to ascertain where the potential value lies for the business. CFOs have the ‘big picture’ view and should look at incoming regulation beyond the core issue of compliance – how these could potentially provide more insights into the business or streamline additional processes, for example.

One example here comes from the changing reporting requirements within financial services. These requirements led to more standardisation across the industry, and a new focus on building data-warehouse environments to meet these regulations. For many organisations, this actually presents an opportunity to better understand the company’s data and in turn grow the business.

CFO decision making

Modern businesses are under constant pressure to operate quickly and efficiently, and CEOs are demanding more real-time data from their CFOs in order to make the best possible decisions. In turn, they’re looking for analysis and insights from the finance function, as well as guidance on future strategy.

As a result, the finance organisation will need to spend more time on insights and analysis, and less time on processing transactions than it has done in the past. Looking at historical data alone is no longer enough. Finance now needs a holistic view of the business, combining various streams of live and historical data, if they’re to better understand the business as a whole. They will then be able to provide insights into how various parts of the business – such as HR and finance – impact each other, and advise on future strategies based on these insights.

Ongoing transformation

A recent KPMG report found that one in three CEOs see experience with transformation as one of the top attributes for a CFO. And with business leaders focused on beating the competition and ensuring their products or services stay ahead of the curve, the pressure is on for CFOs to support in business innovation and transformation efforts.

Organisations are being disrupted from all sides, whether it’s changing consumer demands, new regulation coming into effect, or innovative competitors coming onto the scene. This also comes largely from changes within specific industries – from the growth of omnichannel in retail to the evolution of connectivity in the automotive industry.

These changes often push businesses to innovate if they’re to remain competitive and continue to grow, and the CFO can support considerably on this journey. The CFO and finance team can identify growth opportunities and inform key business decisions by providing the relevant insights and data they have access to. The finance function should also be able to scale quickly – entering new markets, for example – in order to support certain areas of growth.

The current burden of transaction processing and audit and control tasks felt by many finance teams leaves little room for strategic partnership and the ability to influence decision-making. As such, it’s vital that organisations across the globe embrace new ways of thinking about the role of finance in today’s highly disruptive business landscape, and that CFOs keep these considerations front of mind if they are to be successful with new future growth strategies.

A majority of real estate industry leaders polled plan to increase their US investments this year, as they expect continued growth in the US real estate market in 2017 and beyond, according to KPMG's 2017 Real Estate Industry Outlook Survey: Real Estate Expansion Lives On.

52% of real estate executives polled believe that improving real estate fundamentals in 2017 will be the biggest driver of their company's revenue growth. 91% of investors are bullish on access to equity capital, with 25% expecting an improvement in 2017 and 66% believing that the positive trend will remain the same. 51% of survey respondents also indicated that foreign investment in US real estate will increase in 2017.

"A growing US economy, coupled with healthy real estate fundamentals and strong access to financing and capital, make real estate leaders optimistic about a continued 'boom' in the US market," said Greg Williams, National Sector Leader, Building, Construction & Real Estate, KPMG LLP. "Although prices of Class A assets in the US are high and yields are lower, the promise of reliable returns leads to sustained interest in the sector overall, especially when compared to other global markets."

2017 Strategic Initiatives for US Real Estate Companies According to the survey, 41% of real estate company executives are planning for a significant investment in organic growth in 2017, including product development, pricing strategies and geographic expansion.

"We anticipate continued growth in the open-ended fund and debt fund spaces, as these vehicles may enable investors to obtain a stable yield, diversification, and, if they invest in an open-ended format, higher levels of liquidity," said Phil Marra, National Real Estate Funds Leader, KPMG LLP. "We also expect to see an influx of new investment in real estate, both from existing investors as well as new entrants."

58% of survey participants also indicated that they are pursuing cost-related strategies to improve bottom-line results, including the implementation of new technology to address inefficiencies and process improvements.

Three Uncertainties Real Estate Executives will face in 2017:

• Regulatory: The new US administration's intent to lower taxes, deregulate business and increase infrastructure expenditures, may lead to job creation and consequently to increases in homebuilding and home sales. The promise to bring companies back to the US may increase demand for office space, manufacturing facilities, data centers and other property types.

• Interest Rates: Higher interest rates may impede first-time home buying, but a healthy economy may lead to sustained job growth and potentially to increasing activity in the multi-family, retail and industrial sectors.

• Cybersecurity: Approximately half of the survey respondents said that their organizations are not adequately prepared to prevent or mitigate a cyber-attack. Cyber threats facing the real estate industry include: Tenants' vulnerability to intrusions through connected technologies such as smart alarms, stealing of tenants' personally identifiable information (PII) maintained by property managers, and targeting of internal systems for their data or even their cash, such as REIT's confidential information on financing deals.

(Source: KPMG)

According to the Pulse of FinTech, the quarterly global report on FinTech VC trends published jointly by KPMG International and CB Insights, Asia’s FinTech funding has risen to US$2.6b in the first quarter of 2016. Following a significant pullback in funding in Q4’15, mega-rounds lifted quarterly investment into VC-backed FinTech companies by over 150%.

Global investment in private FinTech companies is said to have totalled US$5.7 billion in Q1’16, with US$4.9 billion specifically invested in VC-backed FinTech companies across 218 deals, a 96% jump in comparison to the same quarter last year. The fact that three mega-rounds accounted for 54% of VC FinTech investment in Q1’16 has resulted in the increase in funding. On a quarter-over-quarter basis, VC-backed FinTech deal activity rose 22% in Q1’16.

Warren Mead, Global Co-Leader of FinTech, KPMG International said: “Global VC investment into the technology sector may be experiencing a bit of a pause, however FinTech, propelled by some very large mega-rounds, has proven to be an exception to the rule. Investors are putting money into FinTech companies all over the world – from the traditional strongholds of China, the US and the UK – to up and coming FinTech hubs like Singapore, Australia and Ireland.”

“While FinTech startups continue to attract large investment both in the US and abroad, and investors gravitate to areas yet untouched by much tech innovation including insurance, recent events and public market performance suggest that growth-stage FinTech fundraising will be harder to come by moving forward in 2016.” commented Anand Sanwal, CEO at CB Insights.

Lyon Poh, Head of Digital + Innovation, KPMG in Singapore, added: “In Singapore, we have seen a flurry of activities in line with the government’s push for financial institutions to adopt innovative technology. For example, many insurers are building innovation centres and programmes to rapidly identify and adopt FinTech solutions to bring innovation back into their core businesses. This has in turn encouraged more FinTech startups to come to Singapore and use it as a base for developing their propositions, and for fund raising.”

The UK challenger banking sector is outperforming the ‘Big Five’ UK high street banks, however, the Large Challenger banks need to accelerate how they stand out in the market, according to a new KPMG report.

The new annual report, The Game Changers, analyses the full-year results of some of the largest UK challenger banks, grouped in three categories – the ‘Large Challengers’, ‘Small Challengers’ and ‘Retailer-owned’ banks.

The report makes reference to the 2014 results of the UK headquartered banks grouped as follows:

• ‘Big 5’ banks: Barclays, HSBC, Lloyds, Royal Bank of Scotland (RBS) and Santander.
• Large Challengers: BoI UK (Post Office), National Australia Bank (NAB), TSB and Virgin Money.
• Small Challengers: Aldermore Group, Handelsbanken, Metro Bank, OneSavings Bank, Shawbrook Group and Secure Trust Bank.
• Retailer-owned banks: Asda Money, M&S Bank, Tesco Bank and Sainsbury’s Bank.

The report reveals that while Small Challenger banks are securing stellar returns, key financial indicators of the Large Challengers such as the return on equity, are becoming very similar to the ‘Big Five’ – Barclays, HSBC, Lloyds, RBS and Santander.

Warren Mead, head of challenger banking and alternative finance at KPMG, said “Although the overall challenger banking sector is growing rapidly and securing greater returns, it is the Small Challengers who are driving its growth.

“Small Challengers are securing high returns and have better cost optimisation. If this trend were to continue, as the challengers grow and benefit from economies of scale, it poses an interesting question for the Big Five as to whether too big to fail, becomes too big to compete?

“Digital banking is a great example. Our report found that the mobile functionality of the challengers is at best equal to, but often worse than, the ‘Big Five’. For those challengers focusing on customer service or cost as a differentiator, this could be a major hurdle for the future.”

These figures paint a picture of the challenger banks picking-up the whitespace left behind following the financial crisis. This includes areas such as small business lending, second charge mortgages, invoice financing and unsecured lending.

Lord Livingston, Minister for Trade & Investment

KPMG has entered into a strategic partnership with UK Trade & Investment (UKTI), which will see the two organisations supporting the growth of UK exports of goods and expertise. Both organisations have signalled an intent to collaborate together offering support to what is a vital part of the UK's economic growth targets. UKTI and KPMG will work together over the coming months on a number of initiatives to support current and new exporters.

The first initiative to be announced involves a continuation of work with the NHS Leadership Academy. With the support of Healthcare UK, the government body which supports the UK health sector to do business overseas, KPMG will work with the NHS Leadership Academy to take their successful training programmes to countries where there is growing demand for the UK's proven expertise in healthcare leadership. Created in 2012, the Leadership Academy has already trained over 36,000 leaders at all levels in the NHS in England at www.davidsoncolaw.com.

Lord Livingston, Minister for Trade & Investment, said: “It's great to see UKTI and KPMG come together to present this vision for how we can work in partnership over the next two years. In particular, the plans to work with the NHS to extend the NHS Leadership Academy across the globe are an excellent example of how Government and the private sector can work together to encourage economic growth."

KPMG will also work with the wider UKTI team to address the challenges facing SMEs in identifying opportunities to export. KPMG will promote the UKTI Business Opportunities Programme (Bizopps) to its clients and contacts.

Simon Collins, Chairman of KPMG in the UK, said: “SMEs are the beating heart of our growing economy. The Bizopps programme will really boost small businesses across the UK, helping them access international markets to drive the UK's export growth.”

Oil traders and tanker-owners are set to cash-in on falling oil prices as tumbling prices have caused the market to move into a steep ‘contango’, meaning that investors are willing to pay a premium to receive oil at a later date, according to KPMG.

The depressed demand picture coupled with the abundant global oil supply has seen oil prices fall to near six-year lows. As a result of this, the price for oil in the spot market has traded below the price of oil for future delivery, a market condition known as contango. This differs to a normal backwardation structure where the price of a futures contract trades below the expected spot price.

KPMG says that traders with storage ability will be able to cash-in on the contango market by storing the oil and locking-in higher future prices. At today's prices, September 2015 Brent crude oil futures are trading at a $6.35/barrel (€5.4/barrel) premium to February 2015.

George Johnson, Executive Advisor in KPMG's oil and gas practice said: “The widening contango we've seen over the last few weeks will benefit traders with access to storage facilities. This means traders are not forced to sell at the current spot price; instead, they can store the oil and lock-in a higher future price - providing shareholders with almost risk-free profits. In a contango market the trader with storage options is the one holding the aces.

“Over the coming weeks traders will be reviewing their storage economics with a view to capitalising on this market phenomenon which looks set to stick around for a while.

“Tanker-owners also look set to benefit from the Brent crude oil contango situation as traders seek alternative storage options. Further weakness in the Brent structure will almost certainly make floating storage a viable option”

However, while traders and tanker-owners are set to benefit from the situation, KPMG warns that smaller upstream oil companies operating below break-even levels may struggle.

Anthony Lobo, Head of UK oil and gas at KPMG, said: “There's little comfort out there to suggest prices are due for a significant upside correction any time soon – so further selling pressure is a real possibility. Smaller companies and marginal shale producers without strong balance sheets and access to funding, may struggle to weather the storm, particularly if there are further price falls in the pipeline. We've already seen significant cutbacks to capital expenditure for 2015 across the industry as a whole; however, we're yet to see scale-backs to production.”