In a significant ruling on 6 June 2025 (Case n° 47100), the Luxembourg Lower Administrative Court (the "Lower Administrative Court"), ruled on the interest rates applied by a Luxembourg company performing financial intermediation activities (falling within the scope of the Luxembourg Circular L.I.R. n°56/1 – 56bis/1 issued on 27 December 2016 on the tax treatment of companies engaged in intra-group financing transactions, the "Circular") and their requalification into hidden dividend distributions/capital contributions.
The ruling, which upheld the position of the Luxembourg Tax Administration ("LTA"), illustrates the importance of updating the transfer pricing ("TP") documentation following an interest rate renegotiation.
Facts
In 2010, a Luxembourg company (the “Company”) granted fixed-interest EUR loans (“IBLs”) to its 65%-owned French subsidiary (“FrenchCo”) which were funded by USD-denominated bonds (“Bonds”) issued to its sole shareholder (the “Shareholder”). The IBLs carried a fixed interest rate of 12% p.a., while the Bonds bore a variable interest rate linked to the interest income and other gains derived from the IBLs (including foreign exchange).
In 2018, due to FrenchCo’s financial difficulties, the Company granted a partial waiver of accrued interest for 2017 and early 2018. The interest rate was then reduced from 12% to 6%, part of the loan was converted into equity and the shareholding was restructured. In return, the Company received certain guarantees and held FrenchCo through another company. All the amendments were documented by a settlement agreement and the negotiation process documented by a term sheet.
In 2020, the LTA issued a notice indicating its intention to adjust the 2017 tax return and raising concerns about the compliance of the Company with the arm’s length principle. In response, the Company submitted a rectified tax return along with a TP study supporting an arm’s length margin of 0.147% (or rounded to 0.15%) and an arm’s length interest rate ranging from 7.97% to 14.2% for the IBLs.
The LTA subsequently issued a 2017 tax assessment, requalifying (i) the debt waiver and rate reduction to 6% of the IBLs as hidden capital contributions and (ii) the excess interest deductions, arising from the application of an 11.85% interest rate on the Bonds as hidden dividend distributions. The Company filed a complaint and subsequently a petition before the Lower Administrative Court, which ultimately upheld the LTA’s position.
The decision of the Lower Administrative Court
On the substance of the case, the Lower Administrative Court held that the TP study submitted by the Company defined an arm’s length interest rate range between 7.97% and 14.2%, while the rate applied in 2017 following a debt waiver was 6% and thus, fell outside the defined range. As this reduced rate was lower than what independent parties would have agreed under comparable conditions, the Lower Administrative Court concluded that it conferred an advantage solely motivated by the shareholding relationship. Despite the argumentation put forward by the Company, pertaining to the financial distress of FrenchCo, its economic interest in the restructuring and the objective to “preserve its investment”, the Lower Administrative Court found no evidence that the consideration received was adequate or equivalent to the loss in net assets resulting from the debt reduction. It also considered that the Company had not demonstrated that a third-party lender would have accepted such a significant rate decrease.
The Lower Administrative Court furthermore emphasised the absence of an updated TP study that addressed the new economic circumstances and supported a revised arm’s length range justifying the application of a renegotiated interest rate. Without such documentation, neither the LTA nor the Lower Administrative Court could verify whether the 6% rate would have been acceptable under market conditions.
Finally, it rejected the claim that the involvement of a third-party shareholder in the restructuring altered the intragroup nature of the transaction or automatically made the revised interest rate compliant with the arm’s length principle.
Key takeaway
This decision serves as an important reminder for all companies with intra-group financing arrangements: renegotiating the terms of a loan requires an updated transfer pricing analysis.
Such update is required even when the negotiation is justified by significant economic changes; if a revised interest rate falls outside the arm’s length range of interest rates as determined by the original TP documentation, an updated transfer pricing analysis is essential.
The Tribunal’s decision is pending confirmation as an appeal has been lodged.
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