The Importance of Being Capitalized – The Right Debt-to-Equity Level for Intercompany Financing in Luxembourg

The recent update of the OECD Guidelines provides long-awaited guidance as to how to apply the arm’s length principle in relation to financial transactions. An important element of this guidance covers the debt-and-equity balance from a transfer pricing perspective. From a Luxembourg point of view, absent any official regulations covering thin capitalization and in line with the OECD Guidelines, it is expected that the market practice of 85:15 will no longer be applicable, unless it can be supported by a proper transfer pricing analysis. Non-supported debt-to-equity ratios may lead to a shift in the burden of proof.