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On 6 June 2025, the Administrative Tribunal (the “Tribunal”) ruled on the interest rates applied under debt instruments in an intra-group context, and the consecutive tax consequences arising from the non-respect of the supporting transfer pricing documentation.
A Luxembourg company (“LuxCo”) financed its majority-owned French subsidiary (“FrenchCo”) with interest-bearing loan (“IBLs”), which were themselves funded by bonds (the “Bonds”) fully subscribed for by LuxCo’s sole shareholder (the “Shareholder”).
The interest under the Bonds tracked the income received by LuxCo under the IBLs, as well as any other related income, including potential foreign exchange gains. The interest on the IBLs was set at 12%, which was supported by a transfer pricing analysis. Such transfer pricing analysis had concluded that any interest rate within a range of 7.97% and 14.2%.
Due to its intra-group financing activity, LuxCo was also expected to realise an arm’s length margin of 0.147%, which was likewise supported by a transfer pricing analysis.
In 2018, due to the financial situation of FrenchCo, LuxCo agreed to restructure its financing, and an agreement was entered into, under which LuxCo and FrenchCo agreed on the amount of interest due for a certain period preceding such agreement. Part of the IBLs was capitalised, and the remaining portion was amended, in particular the interest rate, which this time was set at 6%.
LuxCo also applied a reading of the formula under the Bonds that lead to payment to the Shareholder of interests in excess of 11.85%.
On this basis, the tax authorities challenged the company’s 2017 tax return, considering that there was:
The tax consequences identified by the tax authorities in this case were as follows:
To determine whether there was a hidden capital contribution and a hidden distribution, the main issue for the Tribunal was to assess whether the amounts received and paid were supported by a transfer pricing analysis, and whether these amounts were consistent with such analysis.
Regarding the ‘taxable’ hidden capital contribution, which was alleged to be justified by the under-reporting of interest income under the IBLs to FrenchCo, the Tribunal recalls that a hidden capital contribution does not only regard asset contributions but can also relate to the reduction of a company’s debts. Provided that the waiver is motivated by the relationship between the parties and the forgiven receivable still has value, the transaction may be requalified as a hidden capital contribution, resulting in a decrease in the company’s taxable profit and an increase in the shareholder’s taxable profit.
The Tribunal noted that the company did not comply with the 12% interest rate under the IBLs following the restructuring, as the transfer pricing analysis recommended a rate between 7.97% and 14.2%, while the rate applied by LuxCo to FrenchCo was only 6%. While the 12% would have fallen within the acceptable range, the 6% rate did not.
On this basis, the Tribunal therefore found that an advantage was granted without consideration, solely motivated by the relationship between the parties, and concluded that the tax authorities had provided sufficient evidence of the conditions required to identify a hidden capital contribution in this case.
Regarding the hidden distribution to the Shareholder under the Bonds, the Tribunal recalled that in order for a payment to qualify as a hidden distribution of profits, the tax authorities must prove both:
(i) that the payments were made for the benefit of a shareholder, a member, or an interested third party; and
(ii) that the company suffered a reduction, or a lack of increase, in its net assets.
In the case at hand, the first condition was clearly met, as LuxCo was wholly owned by the Shareholder.
For the second condition, it was not challenged that LuxCo paid a higher amount of interest than 11.85%, thus highlighting an excess interest payment to the Shareholder, resulting in a reduction in the net assets of the company.
LuxCo’s argument that the 11.85% rate depended on other factors was dismissed by the Tribunal, which concluded that the only rates supported by a transfer pricing analysis submitted by LuxCo during these proceedings was the 7.97% -14.2% range applicable to the intra-group financing, and the 0.147% taxable margin. To the extent that 12% was the initially chosen rate for the interest income, then 11.85% was necessarily the rate applicable for the interest payable.
Accordingly, in the absence of additional evidence, the Tribunal found that LuxCo failed to challenge succesfully the existence of an advantage granted to its Shareholder. Therefore, the second condition for the finding of a hidden distribution was also satisfied, and the Tribunal concluded that there was indeed a hidden distribution of profits between LuxCo and the Shareholder.
Once again, in the context of intra-group financing, the judges emphasised the importance of documentation supporting the financing conditions, i.e. interest rates, margins, and so forth: the Luxembourg entities involved must be able to demonstrate that the financing terms are at arm’s length, meaning that they could have been granted by an independent third party.
Moreover, it is clear from this decision that any substantial change in the circumstances of the entities involved (in this case, the restructuring) must be accompanied by a corresponding update to the transfer pricing documentation.
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