In a judgment of 11 January 2024, the Luxembourg Higher Administrative Court annulled tax assessments issued to a taxpayer for breach of the adversarial principle set out in §205(3) AO (the Abgabenordnung), which foresees the right for the taxpayer to be heard by the tax office before issuance of an unfavourable tax assessment.
The case concerned royalties paid to the Luxembourg taxpayer. In his Luxembourg tax return the taxpayer requested the application of the partial exemption on intellectual property income applicable at the relevant time. The tax office was of the opinion that the taxpayer was not entitled to benefit from the preferential regime for intellectual property income. In the first two letters issued by the tax office, it had based its refusal on the absence of justification for the application of the regime due to a lack of sufficient accounting documentation. Following the second letter issued by the tax office, the taxpayer was able to retrieve the necessary accounting documents from his former accountant and forward them to the tax office.
Once the tax office had received the documents, it could no longer base its refusal to apply the favourable regime on the absence of the accounting documents. As a consequence, in a third letter sent to the taxpayer, the tax office justified its refusal to apply the favourable regime on the grounds that the arm's length principle had not been respected, arguing that the royalties had been paid between related parties on terms that would not have applied between unrelated parties. In his reply to this third letter the taxpayer requested, in a 65-page response, a reasonable extension of the deadline in order to be able to prove, with the help of an external expert, that the royalties paid complied with the arm's length principle. The tax office refused to grant an extension and issued the tax assessments in accordance with the announced adjustments shortly thereafter. The Lower Administrative Court ruled in favour of the tax office, confirming that the taxpayer did not meet the conditions for benefiting from the favourable regime.
According to the Higher Administrative Court, the tax office's approach violated the adversarial principle and the taxpayer's right to be heard. According to that Court, the tax office should have granted the request for additional time to allow the taxpayer to express his views on the arm's length nature of the royalties, in particular by requesting an external expert opinion. Indeed, the previous exchanges did not concern the same aspects raised by the tax authorities at the subsequent stage and on those new aspects the taxpayer did not have the possibility to fully share his observations, thus disallowing the right for the taxpayer to be heard before issuance of an unfavourable tax assessment. The Higher Administrative Court also rejected the tax authority's argument that the tax return filed had not been signed. According to the Higher Administrative Court, this argument should have been raised before the issuance of the tax assessments and can no longer be raised in the litigation phase to deny the taxpayer a procedural guarantee intended to protect his interests.
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