Direct tax procedure: Commentary on upcoming amendments

On 28 March 2023, the Minister of Finance presented a new draft law n° 8186 (the “Draft Law”) to the Parliament which amends the Abgabenordnung (“AO”) as well as some other laws on tax procedure in order to simplify and modernise the rules governing the tax procedure in Luxembourg. Afterwards, drafts of Grand-Ducal Regulations aiming at implementing various provisions of the Draft Law were also released.

As we reported in our Alert on the subject, some provisions to be introduced are positive as they will bring more certainty for taxpayers. Nevertheless, it seems that the main purpose of the changes to be introduced is to ease the duties of the tax authorities or to relieve the tax authorities’ congestion rather than to increase the tax certainty for taxpayers. This is also the conclusion reached by the Council of State in its opinion on the Draft Law released on 11 July 20231.

Unfortunately, from our point of view, and also from the point of view of other commentators, this Draft Law clearly lacks ambition in respect of the current needs to modernise the Luxembourg tax procedure. In the press, a lot has been written about this Draft Law, and in Parliament the amendments have for the most part been criticised during the meetings of the Finance and Budget Committee held on 31 March, 24 April and 28 April 2023. In particular, the following comments were made, among others: the need to introduce clarity in the law regarding the deadlines to be respected by both parties, the failure to take into account the comments made by professional chambers in the past years, the limitation of the deadline for the taxpayer to appeal to the Tribunal in the event of silence of the Director of the Administration des Contributions Directes (“ACD”) rather than guaranteeing an answer from the Luxembourg tax authorities (“LTA”) (cf. infra), the necessity to introduce in the law the right for the taxpayer to ask for an oral exchange of view with the LTA (cf. infra), the 10% threshold for filing a claim against an automatic taxation, which can represent a substantial amount and looks like a kind of additional penalty (cf. infra), etc.

This article provides a commentary on the main changes proposed by the government and some of the shortcomings of the current direct tax procedure which, in our opinion, should be (should have been) amended.

Transfer pricing documentation requirements and new advance pricing procedures

Request for advanced bilateral or multilateral agreement on transfer pricing

The Draft Law introduces a new procedure (new § 29c AO) for requesting an advanced bilateral or multilateral agreement on transfer pricing pursuant to the double tax treaties (“DTT”) concluded by Luxembourg. The advanced agreement will be concluded between the competent authorities of the State(s) concerned based on the mutual agreement procedure (“MAP”) provided in DTTs concluded by Luxembourg with this/these State(s) (Article 25 (3) of the OECD Model Tax Convention (“OECD MTC”)).

To obtain an advanced bilateral or multilateral agreement on transfer pricing, a written request will have to be sent to the Director of the ACD. A Draft Grand-Ducal Regulation provides more details on the procedure to follow to obtain such advanced agreement and lists all the information the taxpayer’s request must contain. The request for an advanced bilateral or multilateral agreement on transfer pricing will be subject to a fee varying from EUR 10,000 to 20,000 depending on the level of complexity and amount of work required.

In our opinion, this price range is too wide, especially as the final price depends on abstract criteria left to the discretion of the LTA, such as the complexity and amount of work. Taxpayers should know the cost of such a procedure with certainty beforehand, for this procedure to be effective and prevent many litigations afterwards, which would be far more time-consuming for the LTA.

In addition, we find it regrettable that the Draft Grand-Ducal Regulation does not provide for a reasonable response time, nor for the possibility of a physical meeting with the LTA to present the various elements of the request or for a communication from the LTA on the status of the request.

We feel that these points are, however, essential to achieve the objectives of this new procedure and bring it in line with the constraints of economic operators.

Finally, it remains unclear how this new provision will be articulated in practice with the current provision according to which taxpayers can ask for advanced pricing agreements (“APA”).

Cooperation duty of taxpayers in transfer pricing matters

The Draft Law specifies the documentation requirements for associated enterprises in relation to transfer pricing, in line with the international standards developed by the OECD (Action 13 of the BEPS Action Plan). The proposed provision (new paragraph (4) to § 171 AO) complements paragraph (3) of § 171 according to which the taxpayers’ duty of cooperation applies to transactions between associated enterprises.

As a result, associated enterprises will be required to present, upon request, documentation to justify the transfer pricing policy applied. For this purpose, a Draft Grand- Ducal Regulation specifies the scope and content of this documentation for Luxembourg Constituent Entities of a Multinational Enterprise Group under the Luxembourg Country-by-Country Reporting legislation (i.e. Local File and Master File).

The provision of the new paragraph (4) to § 171 AO refers to the concept of associated enterprises, while the Draft Grand-Ducal Regulation refers to the concept of any constituent entity of a multinational enterprise group, as defined under the Country-by-Country Reporting legislation. Thus, this wording does not make it clear whether the Draft Law establishes a general obligation for all associated enterprises and whether the Draft Grand-Ducal Regulation then establishes specific obligations for the constituent entities of a multinational enterprise group falling within the scope of the Country-by-Country Reporting legislation, or whether the new provision of the Draft Law will only apply to the latter since they are the only ones covered by the Draft Grand-Ducal Regulation.

It seems important to us that the authors of the Draft Law clarify the application of the personal scope provided for in the two texts and that the concepts used therein are aligned. This is also the position of the Council of State, which understands that enterprises will be subject to different documentary obligations depending on whether § 171 (4) AO applies2. In addition, the Council of State requests that the terminology of § 171 (3) and (4) AO be amended to replace the term “entreprises associées” (associated enterprises) that is defined in the Luxembourg income tax law (“LITL”) in relation to the reverse hybrid rules with the term “entreprises liées” (related enterprises) that is used in and defined by Article 56 of the LITL in relation to transfer pricing rules and is thus more appropriate when it comes to transfer pricing.

In any event, the Council of State formally opposed the provision under review on the grounds that a documentary obligation constitutes a prerequisite to collection of taxes, which falls within the scope of a matter reserved to the law, and therefore cannot be prescribed by a Grand-Ducal Regulation.

Potential impact of MAP and arbitration decisions on tax assessments

The Draft Law clarifies the consequences of implementing a MAP or arbitration decision (based on Article 25 (1) (2) (3) and (5) of the OECD Model Tax Convention or based on the EU Arbitration Convention) by laying down explicitly that tax assessments may be issued, withdrawn or modified pursuant to MAP or arbitration decisions (new § 96a AO).

Unenforceability of unfiled annual accounts

The Draft Law envisages penalising the failure to file annual accounts in accordance with the legal requirements (i.e. filing seven months after the closing of the financial year) by making them unenforceable for tax purposes (new § 160, al. 1a AO). As indicated by the Council of State, both the failure to file and the late filing of annual accounts appear to be targeted. In our view, it would be much more consistent and logical if the penalty for failure to file or late filing of annual accounts were modelled on tax obligations, as the deadline for filing tax returns is generally 31 December of year N+1 (i.e. paragraph 167(3) AO).

This measure raises questions however, as this failure is already liable to criminal penalties. In addition, as pointed out by the Council of State, it will prevent the taxpayer from validly exercising their rights of defense by limiting their means of proof. While certain exceptional circumstances may be the cause of late filing of annual accounts, the consequences of such a delay would be disproportionate.

Formal conditions to challenge a tax assessment

The Draft Law amends the tax procedure rules in order to align the formal conditions for initiating a tax claim (réclamation) before the Director of the LTA with those applicable to appeal a decision given by the Director on a tax claim before the Administrative Tribunal. This is important for legal certainty for taxpayers as, currently, due to the lack of clear guidelines in respect to the form of a réclamation, there is a lot of debate on a case-by-case basis, in front of the Tribunal, on whether such a claim was effectively filed.

A tax claim will thus have to be made in writing and signed by the taxpayer or its representative. In addition, the request will have to mention expressly the following information in order to be admissible: the name and address of the claimant, a clear designation of the Administration’s decision at stake, the purpose of the request, a brief explanation of the facts and arguments of the claimant, the power of attorney if relevant and a list of evidence the taxpayer intends to make use of (new § 249 AO).

This last requirement to provide a list of evidence the taxpayer intends to make use of raises questions. Indeed, this requirement should apply without prejudice to the possibility, which remains open, of adding additional documents during the further administrative and judicial procedure. This would be consistent with the aim of making the procedure more respectful of taxpayers' rights, which is the objective expressed by the legislator. However, as it is not clear from the Draft Law that it would be effectively the case, the Council of State asked for this requirement to be deleted.

Automatic (estimated) taxation

In accordance with the current case law in relation to automatic (estimated) taxation (taxation d'office), the taxpayer is currently only allowed to file a claim if they prove that their real income or wealth deviates significantly from the tax base fixed by the challenged automatic tax assessment. The proposed amendment aims at defining the notion of significant deviation on the basis of objective and easily quantifiable criteria.

For that purpose, the Draft Law provides that an automatic tax assessment can only be challenged by the taxpayer if the difference between the income or wealth assessed and the real income or wealth exceeds 10%. This percentage seems quite arbitrary as 10% of an important amount can be quite significant. If it is understandable that in some cases the amount at stake is not worth a legal proceeding for the tax authorities, what about situations where amounts at stake are substantial? In this case, the real income or wealth of a taxpayer could effectively deviate significantly from the tax bases fixed by the automatic tax assessment challenged even if the difference between the two does not exceed 10% (i.e. 10% of 1,000,000 euros = 100,000 euros). This is also the view of the Council of State which considers that this provision could lead to situations in which the impossibility of filing a claim would be disproportionate. The Council of State also formally opposed this provision, which it considered to be imprecisely worded and therefore contrary to the principle of legal certainty.

New time limit in the event of silence of the Director of the ACD

The Draft Law amends the Law of 7 November 1996 on the organisation of the administrative courts concerning the introduction of a time limit for appeals before the Administrative Tribunal in the event of silence on the part of the Director of the ACD. Currently, if no decision has been taken within the six-month period, the taxpayer can appeal to the Administrative Tribunal without any time limit. This new time limit will apply in the context of requests made based on § 228 (claim against a tax assessment), § 131 (non-contentious appeal, demande de remise gracieuse) or § 237 (hierarchical appeal). It should be noted in this respect that the Draft Law opens the possibility of an appeal before the Administrative Tribunal after six months of directorial silence against discretionary decisions which the action is a formal hierarchical appeal against.

If the Director of the ACD does not decide on the claim/ appeal of the taxpayer within six months following the written request, the taxpayer can consider the claim/appeal as rejected (implicit decision of refusal). According to the Draft Law, at the end of this six-month period, a new twelve- month period (extended by six months if an investigating measure is taken by the Director) will start, during which the taxpayer will be required to take legal action before the Administrative Tribunal. In the absence of such action, the decision initially challenged (i.e. the tax assessment) will be considered as irrevocably confirmed.

While it is understandable that the aim of this new provision is to relieve the LTA of its workload, it is regrettable that the taxpayer should bear the consequences of the LTA's failure to provide a decision. In application of the principle of equality of arms, it would be more judicious to oblige the LTA to respond within a given timeframe. This seems even more reasonable now that the conditions for filing a tax claim are to be clarified and require the claimant to provide an explanation of the facts and arguments (cfr. supra).

Giving a contested decision the force of res judicata because of the inaction of the authority that issued the decision seems contrary to the Draft Law’s objective of putting in place a procedure that is more respectful of taxpayers' rights insofar as, in this case, it is above all a matter of denying the taxpayer the right to be heard and to have their claim duly dealt with by the authority which it was filed before, which seems very unbalanced. Failure to answer a taxpayer's claim deprives them, on the one hand, of a level of decision in the context of their claim and, on the other hand, if they wish to defend their rights, it obliges them to bring an action before the administrative tribunal, without being aware of the LTA's arguments. In its opinion, the Council of State considers that it is not conceivable that the tax authorities could take advantage of a foreclosure due to its own inaction, i.e. by not ruling on a request addressed to it. The Council asks that this draft provision be removed from the Draft Law.

Other changes to be introduced

The Draft Law also aims at introducing the following additional changes:

The application of tax law provisions which only apply upon request (e.g. the investment tax credit) has to be requested in the tax return and cannot be requested as part of a subsequent claim anymore (§ 85 AO). Again, the Council of State asks that this modification be dropped.
When they exist in an electronic form, the LTA may request to be provided with books, documents and information in such an electronic format (amendment of § 171 paragraph 2 AO).
Tax recovery: the Draft Law proposes to empower the tax collector to allow, under certain conditions, taxpayers with financial difficulties to pay the taxes due in instalments. However, in such a case, late payment interest remains due. The Draft Grand-Ducal regulation clarifies the procedure and methods of collection (i.e. that the request must be motivated; the instalment may not exceed six months; withholding taxes are excluded).
Administrative cooperation: the LTA will be allowed to exchange information necessary for the performance of their respective duties with both the Commission de Surveillance du Secteur Financier and the Commissariat aux Assurances.

Finally, the Draft Law repeals several provisions of the General Tax Law that have become obsolete.

Entry into force and next steps

While most of the new provisions to be introduced will apply as soon as the legislative procedure is finalised and the law is promulgated through the Journal Officiel (Memorial), other provisions will apply as from 1 January 2024 (e.g. time limit in the event of silence of the Director of the ACD; accounts unenforceable if not filed in time) or as from tax year 2024 (e.g. cooperation duty in transfer pricing matters).

However, taking into consideration the formal oppositions and the various amendment requests of the Council of State about the Draft Law, as well as the various criticism it raises in Luxembourg, we could expect that the Draft Law will not be adopted as such and that the government will reconsider its text significantly.

Suggestions of amendments

The current Luxembourg direct tax procedure still presents some shortcomings that should be addressed in priority, in line with procedures in neighbouring countries. We took advantage of the publication of this Draft Law to propose our own changes to the procedure, capitalising on our experience and the limits of the current operation, including in particular (without the list below being seen as exclusive):

the possibility to challenge a zero-tax assessment-and thus the amount of tax losses carried forward which should be confirmed annually given the massive importance of tax losses in the proper management of a Luxembourg fully taxable company;
the introduction of additional obligations on the part of the tax authorities such as: the obligation to answer advance tax ruling requests; to issue tax assessments and directorial decisions within a specified reasonable time limit; to justify the reasons for issuing a tax assessment that deviates from the tax return, and the opportunity given to the taxpayer to answer;
the taxp ayer’s right to be heard during the pre-litigation stage;
the extension of the tax payer’s time limit for filing a tax claim (from three to six months),which would make it easier
to submit a request in application of §94 AO (i.e. amendments to the tax return which the LTA agree with) and would thus help to achieve the objective of relieving congestion, since taxpayers would no longer have to lodge a claim “by default” in order to preserve their right of appeal;
adding more flexibility in the conditions to file an amended tax return when it is clear that unfortunate mistakes have been introduced in the accounts or the tax returns, even if the amendment would mean a decrease of the tax liability; etc.

You will find above a simplified chart of the suggested tax procedure timeline.

We will keep you informed of developments in the legislative procedure. In particular, it will be interesting to see to what extent the opinions of the Council of State and professional chambers will be taken into account.

1 Council of State, Opinion n°61.390 dated 11 July 2023, p. 3: “le Conseil d’État relève que de nombreuses modifications ont pour objet d’imposer des obligations procédurales plus strictes au contribuable”.
2 Council of State, Opinion n°61.390 dated 11 July 2023, p.11: “Le Conseil d’État comprend que les entreprises seront soumises à des obligations diffé- renciées en fonction de l’applicabilité ou non de l’alinéa 4 du §171 AO. Les entreprises soumises devront tenir la documentation requise à disposition. Les entreprises non soumises demeureront liées par les alinéas 1er et 2 du §171 AO, rendus applicables aux “transactions entre entreprises associées” par son alinéa 3. Ces entreprises seront dans l’obligation de pouvoir prouver l’exactitude de la déclaration fiscale et de mettre à disposition tous les éléments per- tinents, sans cependant que cette documentation doive répondre à des conditions de forme particulières. Le Conseil d’État précise qu’une attention par- ticulière devra être apportée à la définition, dans la loi, du champ d’application personnel de l’obligation de tenir la documentation requise à disposition.”