Eli Lilly ÄŒR imports pharmaceutical products purchased from Eli Lilly Export S.A. (Swiss sales and marketing hub) into the Czech Republic and Slovakia and distributes them to local distributors. The arrangement between the local company and Eli Lilly Export S.A. is based on a Service Contract in which Eli Lilly ÄŒR is named as the service provider to Eli Lilly Export S.A. (the principal).
Eli Lilly ÄŒR was selling the products at a lower price than the price it purchased them for from Eli Lilly Export S.A. According to the company this was due to local price controls of pharmaceuticals. At the same time, Eli Lilly ÄŒR was also paid for providing marketing services by the Swiss HQ, which ensured that Eli Lilly ÄŒR was profitable, despite selling the products at a loss. Eli Lilly ÄŒR reported the marketing services as a provision of services with the place of supply outside of the Czech Republic; therefore, the income from such supply was exempt from VAT in the Czech Republic.
In 2016 a tax assessment was issued for FY 2011 in which VAT was added to the marketing services-income and later similar assessments were issued for the following years.
An appeal was filed with the District Court by Eli Lilly which was dismissed by the Court.
An appeal was then filed with the Supreme Administrative Court.
Judgement of the Court
The Supreme Administrative Court ruled in favor of Eli Lilly – annulled the judgement of the District Court and set aside the assessment of the tax authorities.
“The Supreme Administrative Court found no reason to depart from the conclusions of the judgment in Case No 3 Afs 54/2020, even on the basis of the defendant’s additional arguments. Indeed, the applicant can be fully accepted that it is at odds with the reasoning of the Supreme Administrative Court and puts forward arguments on issues which are rather irrelevant to the assessment of the case. First of all, the defendant does not dispute in any relevant way that the disputed supplies were provided to two different entities (the distribution of medicines to the complainant’s customers and the provision of marketing services to Eli Lilly Export), and that the ‘average customer’ cannot perceive those supplies as a single supply. This conclusion does not in any way undermine the defendant’s reiteration of the complainant’s assertion at the income tax audit that, for the purposes of assessing the correctness of the transfer pricing set between the complainant and Eli Lilly Export in terms of section 23(7) of the Income Tax Act, the marketing service should be regarded as an integral part of the distribution of the medicines and cannot be viewed in isolation when assessing profitability. In terms of transfer pricing, the economic interdependence of the two activities was assessed, which was essential only to determine whether the profitability of each activity should be compared separately with entities carrying out only the relevant activity. However, the aggregate assessment of these activities in terms of Section 23(7) of the Income Tax Act, which involves offsetting profits and losses from different types of business activities and comparing profitability with entities performing a similar role (i.e. performing both marketing and distribution), does not necessarily mean that there is a single transaction for VAT purposes. This issue is assessed separately in accordance with the aspects of the VAT Act and the VAT Directive respectively.
[32] Nor can the defendant’s other arguments, which it repeats in support of the conclusion that the provision of marketing services constitutes a supply incidental to the domestic sale of medicines, be accepted. It does not follow from the judgment in Case 3 Afs 54/202073 that the concept of ‘third party consideration’ cannot exist. The Supreme Administrative Court has not denied that the total value of the consideration received from the final customer for the purposes of determining the tax base may, in general, also include payments from third parties (see, for example, paragraphs 62 et seq. of the judgment referred to above). However, in the context of the present case, in the case of the distribution of pharmaceuticals, the Court held that the consideration for marketing services could not be regarded as part of the value of the consideration, since those services were not provided to ‘customers’ who were merely recipients of marketing information. The consideration for those services was not then spent on behalf of or for the benefit of the customers. As regards the defendant’s reference to the judgment of the CJEU in Firma Z, the conclusions expressed there concern a different factual situation and legal issue. The substantive issue was the offsetting of a reduction in the taxable amount of one supply against the taxable amount of another supply, which is excluded under the common VAT system. However, as noted above, in the present case the complainant does not supply any other supply to its customers at the same time as the pharmaceuticals. Therefore, if the conclusion of the tax administration were accepted, it would have received a higher amount of VAT than the amount paid for the supply which was the only supply received by the customer from the complainant (the pharmaceuticals). The complainant’s final, potential or immediate customers cannot be the recipients of a marketing service at all (see above).
[33] Nor can the defendant’s view that the method of pricing the marketing services shows an ‘unquestionable link’ between the marketing services and the sale of medicines be accepted. In that connection, the defendant points out that the pricing of marketing services is not based solely on the costs of marketing, but also on the costs of distributing the goods (medicines). It therefore concludes that it is a payment by a third party (Eli Lilly Export) on top of the price of the medicines which the complainant sells at regulated prices. This argument of the defendant cannot stand. As a general rule, it is a matter for the parties to negotiate the price or the method of calculating it. Furthermore, this argument is not entirely consistent, since the defendant does not explain the logic of why the price paid by Eli Lilly Export, to the extent that it is based on the costs of marketing itself, should therefore be regarded as a payment in addition to the price of the medicines. First of all, it cannot be accepted in general terms that the individual price calculations are in themselves, by their very nature, payments made on behalf of others. In order to constitute remuneration for other persons, they must actually be made for or on behalf of those other persons. Nothing of that kind was proved in the proceedings. It does not appear from the evidence that the payments received from Eli Lilly Export were, to any extent, for anything other than the marketing service actually provided. The complainant priced the marketing services in such a way as to cover the costs of its distribution activities, which are loss-making as a result of the regulation of pharmaceutical prices. It was not, therefore, a payment by a third party (Eli Lilly Export) on top of the price of the medicines sold by the complainant at regulated prices, but an additional source of operational funding from another (separate) activity. A similar approach would be quite standard in any business involving multiple activities with different profitability. If an undertaking seeks to maintain its competitiveness and secure a relevant market share in a particular business area by reducing prices and compensates for this reduction by increasing prices in its other activities, this does not mean that part of the price increase can be regarded as payment for the goods whose (reduced) price is compensated for in this way at the level of the undertaking.
[34] The defendant’s argument that the principle of tax neutrality has been undermined is then based largely on speculative considerations as to what price the complainant would have charged for medicines in the absence of price regulation. However, this reasoning is in direct contradiction with the functioning of the Czech pharmaceutical market and there is no point in elaborating on it. It cannot, without more, lead to a breach of the principle of VAT neutrality simply because the selling prices of a particular supply are lower than the purchase prices, as the defendant essentially suggests.”
“[36] The Supreme Administrative Court finds that the defendant’s decision, as well as the contested judgment of the Municipal Court, are based on an incorrect assessment of a legal issue and therefore cannot stand up in law. The Supreme Administrative Court finds no reason to deal with the other cassation objections, since even their possible lack of merit (which, however, the Court does not prejudge) could not alter the conclusion that the contested judgment of the municipal court and the defendant’s decision are unlawful. Moreover, the Court has already commented on identical objections beyond the relevant legal issues in its judgment No 3 Afs 54/202073, to which it refers here for brevity. Similarly to the judgment of the Third Chamber, the Supreme Administrative Court then notes that it did not find grounds for referring the question to the CJEU for a preliminary ruling, since there is already settled case-law of the CJEU on the interpretation of Article 73 of the VAT Directive in the present case, and therefore it is a so-called acte éclairé.”
279_2021_ 65 ENG
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