NSS k nesprávnému postupu správce daně při stanovení referenční ceny

NSS on the incorrect approach by the tax administrator to setting the reference price

We bring you another interesting judgment of the Supreme Administrative Court (SAC) on the topic of setting transfer prices in a group and the requirements for the tax administrator when setting the reference price.

Situation

• From 1 January 2013 to 30 November 2013, a Czech company provided production and repair of upholstery products for the automotive industry for its foreign sister company.
• The company provided services in the form of stitching and sewing on parts supplied by its sister company, with the Czech company providing this 'wage labour' at a certain price per minute of work (it had no other customers).
• In December 2013, the company changed this business model. It no longer simply processed materials for the sister company, but instead took over sister company’s role. It was therefore responsible for the production of the entire specific automotive part, which it then supplied as an independent manufacturer and final supplier (i.e. outside the group).
• The tax authority assessed the company for corporate tax for 2013 on the basis that - in its view - the company had supplied services to a related party from January to November 2013 at a price lower than would have been agreed between independent parties.
• The tax authority first intended to adjust the company's tax base according to the reference price determined by the net transaction margin method (TNMM). However, it then proceeded to establish a new benchmark price using the comparable arm's length price (CUP) method, comparing the original transaction between the company and the affiliate (i.e. the provision of services from January to November 2013) with the subsequent transaction between the company and the external customer when establishing this second benchmark price. It then attempted to 'adjust' the independent customer transaction so that it only compared comparable activities, i.e. the part of the production that the company was also providing before December 2013.
• However, the company succeeded in the regional court. According to the Regional Court, the tax authority did not bear the burden of proof regarding the determination of the reference price and did not deal with the argument that the agreed price for the services provided to the sister company covered all of its costs as well as a reasonable profit, while failing to take into account that the company acted as a subcontractor in the controlled transaction, whereas in the independent transaction it was already acting as an independent producer.

The view of the SAC

The SAC also sided with the company - below we select from its arguments:

• The choice of an independent transaction in the case at hand is already problematic because the tax authorities chose a single transaction.
• As regards the adjustment of the chosen transaction itself, the tax authority did not take sufficient account of the difference between the company's position in the controlled and independent transaction when setting the reference price.
• The company's position in the controlled transaction and in the arm's length transaction was substantially different. On the one hand, the company was a subcontractor 'working' for a sister company, providing a single activity, and normally in a virtually risk-free position. On the other hand, the company was already providing the entire production of the car part and thus (arguably) a much wider range of activities. In addition, it bore all the risk inherent in such a position. By the nature of things, the profit margins or the various costs involved cannot be the same in the two situations. This is because they will be influenced both by the different 'risk profile' of the transaction as a whole and by the size of the arm's length transaction.
• The SAC accepts that the tax authorities were correct to exclude from the reference price, for example, the effect of 'material costs' (i.e. the purchase of materials and all related costs). Or that, to the extent possible, in 'adjusting' the arm's length transaction, it sought to focus only on those activities that the company demonstrably carried out in the controlled transaction. However, these sub-steps alone cannot make the Company's sale of parts since December 2013 a transaction comparable in substance to the controlled transaction.
• The Supreme Administrative Court (in agreement with the Regional Court) also criticised the tax authority for failing to deal sufficiently and convincingly with the company's explanation of the difference between the agreed price and the reference price.

If you have any questions, please contact the authors of the article or the EY advisory team you are working with.

Authors:

Libor Frýzek

Lucie Karpíšková