KPMG Luxembourg in February 2024 published the first edition of its . The poll features insights from 36 respondents in Luxembourg who either operate as a standalone asset manager or as a unit of a bank--including input from alternative investment fund managers in the real estate, private equity, debt and infrastructure domains--and collectively have more than €7.8trn in assets under management.
The survey covers transfer pricing policies and documentation, audit readiness and more. KPMG transfer pricing partner Sophie Boulanger sat down with Delano to share some key takeaways from the report.
83% have TP policies for intercompany transactions
One of the topics covered in the survey was the readiness of financial players in case of an audit. “When you have a transfer pricing audit, the first documents that you will hand over to the tax administration--be it in Luxembourg or anywhere else in Europe--is your transfer pricing policy,” explained Boulanger.
That’s the “manual that says, for each and every intercompany transaction, what is the price that you set, on one side. And on the other side, the transfer pricing documentation, which you produce at the end of the year and that proves that the policy you have implemented is indeed in line with the market.”
What does “in line with the market” mean? Let’s say, for example, that “you have an investment manager that you remunerate with, say, 50% of the total management fee. What we have to do in the documentation is to try to find evidence that on the market, when the management company engages a third-party investment manager, that it would also give to the third party 50% of the total management fee,” said Boulanger. “Usually we say between 45% and 55%… There’s never one price that’s correct; it’s always a range of prices.”
When it came to transfer pricing documentation, the survey found that 83% of respondents have general TP policies for intercompany transactions. “The market is particularly ready,” commented Boulanger. “Much more than what I would have expected.”
So if “you’re part of the 20% that are not documenting, and you are audited by the tax administration, you look rather weak compared to your peers,” she noted. “Because your peers are able--right away--to give documents to the tax administration. And on your side, you don’t have anything and you need to run around.”
95% review TP policies at least every three years
The survey also found that around six in 10 companies (61.9%) review their transfer pricing policies every year. Nearly 10% do so ever two years and around one-quarter (23.81%) of respondents review their TP policies every three years.
Germany the “winner” for transfer pricing audits
The survey also included questions on audits. It found that over the past five years, 53% of the respondents had undergone a TP audit, with real estate groups experiencing the highest frequency of audits.
“We have a number of audits in Luxembourg, but it is nothing compared to what our clients experience in other countries,” noted Boulanger. “Clearly, the ‘winners’ were Germany, by far.” Three-quarters (76%) of respondents who faced transfer pricing audits in the last five years were audited by the German tax authorities. “It is huge,” she commented.
“One reason for that is that we had a lot of alternative investment managers using debt when they invest into German real estate, for example, or portfolio companies in Germany. So they push down debt from the investment fund, down to the propco [property company] or down to the portfolio company.”
“We had a very big representation of participants investing in Germany. That’s also why we have this high percentage. There’s a lot of activity on financial transactions when it comes to transfer pricing,” added Boulanger. Many are audited on “financial transactions,” meaning loans and, to a certain extent, guarantees.
“When we say loans, it means: is the interest rate paid by the German subsidiary, for example, not excessive? Would the German company have paid the same interest rate if a bank had lent that loan? So they want to verify that you don’t transfer profits out of Germany, for the sake of the example, through the interest rate.”
Another point relates to debt capacity, which was part of an on financial transactions released in 2020. “Now we see it in action in audits,” said Boulanger. In cases concerning debt capacity, “what we want to know first is: would a third party have lent to that entity in the first place? Does this specific company have the capacity to repay its debt, or are you in a way loaning while there is no capacity to serve the debt--what a third party would never do.”
“So you need first to prove that there’s a capacity to serve the debt before thinking of the question of the interest rate,” said Boulanger. “It was interesting to see that tax administrations are starting to ask those questions.”
Only 19% paid exit tax after business restructurings
The survey asked asset managers: have you conducted a business restructuring in the past five years, and if yes, did this lead to exit taxes? “When you have an activity in a country that generates profit, and you decide to transfer this activity out of the country in question, you have what we call a loss of profit potential. The activity disappears. So there are no profits that will be generated anymore in this country. So, this is the last moment, in a way, where tax administrations can capture a bit of taxes--and that’s what we call exit taxes,” explained Boulanger. “They want to analyse what is this loss of profit potential, and can they tax a part of this?”
Questions to consider, she said, include: “What is the reason for the restructuring? Would a third party have restructured in the same way? And in the context of a third party-transaction, would you have an indemnity or a compensation to pay for that restructuring?” And if the answer to that last question is yes, the company would need to pay an exit tax.
What’s interesting, noted Boulanger, is that the survey found that nearly 60% of participants said that they have indeed conducted restructurings in the last five years, but less than 20% of them paid exit taxes. “So it’s very, very low. In my view, it should be higher than this.”
These restructurings happen for business and operational reasons, said Boulanger, and not for tax reasons. “The best example is Brexit. A number of [companies] were saying, ‘Yes, we conducted business restructuring because we had our manco [management company] in the UK; because of Brexit, we needed to be in the EU, we transferred the activities of the manco to Luxembourg or to Frankfurt or to Paris.” Around half (47%) of respondents said that Brexit or other regulatory constraints were the “driving force” behind business restructurings.
“Because this is so much conducted by the business, for the business, if you will, I think that quite often the transfer pricing question is a bit eluded. It is not necessarily asked,” said Boulanger. Say, for example, a fund has mandated a Luxembourg manco to manage their assets, then decides to give the mandate to an Irish manco. “For me, there’s a real question of transfer pricing there. Should the Luxembourg manco be remunerated for this termination of the mandate? Could be yes, most of them are saying no because the Luxembourg manco continues to have certain activities.”
“I think there’s very much an operational angle in those restructurings, which puts transfer pricing really on the side, while, in my view, it should be studied a bit more.”
Things to watch out for in the future
KPMG’s survey also touched on the transfer pricing aspects of intellectual property, carried interest and ESG considerations.
Some asset managers develop software or internal investment platforms, for example, which could give rise to a licence. About one in five respondents (19%) said they had IP developed within the group, said the survey. Firms need to consider whether the software is a “value driver” for the group, and if so, it would deserve remuneration. “This is probably to watch out for in the future, because IP is a very hot topic in transfer pricing. It’s, again, an area where you can have a lot of subjectivity.”
When it comes to carried interest, an individual that benefits from carried interest is “probably one of the most important value drivers in your group; otherwise, you would not have structured the carried interest for him or for her,” said Boulanger. That being said, none of the survey respondents said they considered transfer pricing when structuring carried interest, even though 58% of respondents managing AIFs said they had structured carried interest. “In practice, we start to see a number of audits where tax administrations” are paying more attention. “There’s a trend on the tax administration side that is absolutely not reflected at the moment among our clients” and it’s something to watch out for.
With the growing importance of ESG considerations, these teams are starting to be seen as “value drivers” in the group, said Boulanger. And if they are indeed value drivers, “from the transfer pricing perspective, you need to think of how much you remunerate those teams.” Only 25% of survey participants said they have ESG considerations “on their radar” but they have not made “concrete adjustments to their TP policy to accommodate or quantify the ESG value added.”
Many said they don’t allocate a specific fee to this team because they’re not just a separate team in the corner of the office, explained Boulanger. “They are entirely integrated into our portfolio management team. Without them, the portfolio management team does not work, cannot work. They cannot make decisions on which asset to acquire if they don’t have the ESG specialists telling them, ‘Be careful, you have some problems there, or you need to restructure, and so on.’” The ESG teams are already part of the portfolio management teams and are recognised in this manner.
“For me, there’s the same conclusion for these three topics which are completely unrelated,” she said. “I think in the next editions that we’ll do of the survey, the percentages will increase because of the trends we see on the market, because of market forces, which have nothing to do in themselves with transfer pricing, but which have impacts on the way groups work.”
More and more value in Luxembourg
Finally, “more than half of respondents were saying that they were really recognising, clearly, the value of the regulated mancos and the AIFMs--the value that they were bringing by being the entity holding the licence, being the face to the regulator, enabling the group to distribute across the EU,” noted Boulanger,
“So remunerating the companies for this value that they bring, and all the risk management that entails, all the control over the risks that they have to do--which is extremely important to be able to keep this licence, because without the licence, there’s nothing left to distribute”--is key.
They really look at Luxembourg as a centre without which there’s not much that can happen
Boulanger mentioned that she was in London for a conference a few weeks ago, during which she discussed this topic with her UK colleagues. “Since Brexit, you have had a very clear movement of regulated mancos which were in the UK and which moved to Luxembourg, because they wanted to keep the EU passport--which they could not keep anymore with the UK leaving the EU.”
For many years, the mancos were not necessarily seen as a “core function for the group,” she said. “Now they really look at Luxembourg as a centre without which there’s not much that can happen.”
Find the full results of the survey .
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .