Netherlands: Transfer Pricing dispute regarding valuation for a transfer of business

Important lessons can be learned from a Dutch Court of Appeal case which dealt with a TP dispute regarding the (valuation for a) transfer of business, the burden of proof and the importance of transfer pricing documentation.

Please see below a summary and most relevant takeaways. 

Summary of the Court of Appeal case (appeal with Supreme Court to be awaited)

• The taxpayer, NL BV is part of a multinational group headquartered in the US. The activities in the Netherlands included, among other things, two entities acting as full-fledged manufacturers. As part of a (European) business restructuring, certain activities of the Dutch manufacturers were transferred to an affiliated company in Switzerland. As a result of this, the Dutch manufacturers were no longer entitled to residual profits in their capacity as full-fledged manufacturers, but were remunerated with a cost-plus margin in their capacity as toll manufacturers after the restructuring. 
  
• NL BV requested certainty in advance. These conversations assumed a transfer of a going concern. No certainty in advance was obtained.
• The taxpayer subsequently took the position in its CIT return that certain assets had been transferred to the affiliated party in Switzerland whereby any compensation payment / exit tax was limited to the transfer of those assets as opposed to a transfer of going concern. The latter was the position of the Dutch Tax Authority arguing that the business restructuring resulted in a transfer of going concern from NL BV to the affiliated party in Switzerland resulting in a significantly higher compensation payment in the CIT return. In practice the position of the tax inspector resulted in an upward correction of approximately €320 million.
• In assessing whether there was a mere transfer of assets or rather a transfer of an ongoing concern, the DTA and the courts used all available information to reach a conclusion and put emphasis on the internal documents that were prepared by the taxpayer and shared previously with the Dutch tax authorities in the context of an APA pre-filing meeting. 
• The Court of Appeal concludes that, in addition to the discrete assets, something else of value was transferred or something was given up for which a transfer pricing compensation is due and the taxpayer did not price the transaction in line with the arm’s length principle.
• The Court of Appeal has clarified that the reversal and increase of the burden of proof is applicable in transfer pricing cases. This occurs when a tax return position results in a significant correction and the taxpayer knew or should have known that the reported tax was substantially underestimated. 
• In the case of NL BV, the Court of Appeal reversed and increased of the burden of proof to the taxpayer as, given the positions during the certainty in advance discussions, the taxpayer should have known the reported tax was substantially underestimated. Consistency between the information provided during DTA discussions and the final tax return position is crucial for taxpayers.
• Ultimately, the Court of Appeal took the valuation of the Expert in the initial District Court proceedings as a starting point, and followed most of the adjustments proposed by the Dutch Tax Authority as the burden of proof was on the taxpayer. The Court of Appeal determined that the value of what was transferred from NL BV to the Swiss affiliate amounted to EUR 128 million, exceeding the initial valuation by the expert in the District Court proceedings.

Key Takeaways

1. When planning a business restructuring, understanding the potential for exit taxation is critical. Key to this assessment is reviewing the facts and circumstances and translating this into complete and accurate transfer pricing documentation. This court case stresses the importance of preparing thorough transfer pricing documentation which is also aligned with all other information of the taxpayer, including legal agreements, correspondence with the Dutch Tax Authority and internal documents and emails. Transfer pricing documentation that is prepared after the dispute with the Dutch Tax Authority started likely has less value when brought before a court compared to information that was available part of the regular transfer pricing documentation cycles.
2. Although the taxpayer was transparent and open to discussions with the Dutch Tax Authority, the Court of Appeal upheld that tax returns must be filed clearly and correctly, even during ongoing talks. Filing accurately is essential, as transparency alone doesn't excuse errors. Ensuring all positions in the tax return are within the arm’s length range is key.
3. In transfer pricing disputes revolving around a business restructuring, determining whether a transaction involves a simple asset transfer or the transfer of a business as a going concern is critical. The Dutch Tax Authority and the Dutch courts will examine all pertinent information, including internal company documents, to make this determination. Thus, entities involved in restructurings must ensure thorough and consistent documentation of these processes.
4. As a result of the reversal and increase of the burden of proof,  the Dutch Tax Authority can suffice with making a reasonable estimate. This puts a taxpayer in a difficult position as it must demonstrate (doen blijken) that its positions (including the values) are correct. As was the case in this decision, this high threshold is almost impossible to meet for taxpayers. 
5. The Expert's valuation was significantly higher than the taxpayer's due to using a much higher discount rate for post-restructuring activities. Engaging a valuation expert who understands transfer pricing risks is crucial to ensure these are accurately reflected in the discount rate.
6. The Court ruled that if a transfer price falls outside the arm’s length range, it may be adjusted to a central measure like the median or mean. As the Dutch TP Decree also refers to the use of the median, we expect that the Dutch Tax Authority will insist more on the median approach.

The above again stresses the importance of consistency between (TP) documentation and positions ultimately taken in the CIT return of the Dutch taxpayer.