On 1 February 2010, E.K. and its subsidiary, E. S.A, concluded an agreement on the transfer of E.K.’s trade marks to E. S.A. Following the transfer (on the same day), E.K. concluded with E. S.A. an agreement to grant a licence for the use of the marks in return for payment to the licensor (E. S.A.) of a monthly remuneration. In 2011, E.K. recognised as a deductible expense the royalties paid to E. S.A.
According to the tax authorities this resulted in E.K. understating its corporate income tax liability for 2011. According to the tax authorities, E. S.A. did not participate in any way in the creation of revenue, with the result that the profits generated by E.K. were ‘passed on’ in the form of royalties to a related company – E. S.A. The remuneration payable to the legal owner of the trademarks did not take into account the very limited functions performed by that entity in creating the value of the trademarks. The only function performed by E. S.A. in 2011 was to manage the legal protection of the trade marks, for which it would be entitled to a limited remuneration appropriate to its function.
After receiving the resulting assessment of additional taxable income, a complaint was then filed by E.K. with the Director of the Tax Chamber which was later dismissed.
An appeal was then filed by E.K. with the Administrative Court.
Judgement of the Administrative Court.
The Administrative Court set aside the Decision of the Tax Chamber and referred the case back to the Tax Chamber.
Excerpts
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In the Court’s view, the faulty application of Article 11(1) and (4) of the u.p.d.o.p. affected the manner in which the applicant’s income was estimated and the estimation method adopted by the authorities, based on the erroneous assumption that the transaction analysed by the authorities consisted in the provision of trade mark administration services on behalf of the economic owner of those trade marks. In making that assumption, the authorities applied the net transaction margin method in order to determine the market level of the remuneration payable to the company for its trade mark administration functions.
Meanwhile, the applicant provided the tax authority with the data that formed the basis for the calculation of the royalties, as well as the licence agreement. In view of the repetitive nature of such transactions on the market, the applicant used the comparable uncontrolled price method as the correct approach. The Court notes that the estimation of income by the methods indicated in Article 11(2) of the u.p.d.o.p. (comparable uncontrolled price method, reasonable margin method, selling price method) should be considered first, and only when it is not possible to apply these methods, the methods indicated in Article 11(3) of that Act (net transaction margin method, profit sharing method) will be applied.
Furthermore, the applicant reasonably pointed out that in the comparability analysis the authorities should have taken into account the fact that intangible assets of significant value (trademarks) were involved in the examined transaction, being the only significant asset analysed by the parties to the examined transaction. As a result, the authorities incorrectly conducted the comparability analysis of the transaction involving the licence for the use of trademarks granted to the applicant by the limited partnership, which prejudges the validity of the allegation of a breach of Article 11(1)-(3) of the u.p.d.o.p. in conjunction with § 3, § 7, § 8, § 10 and § 11 of the MF Regulation.
In the opinion of the Court, the basis for the decision in this case was not the provision of Article 11c(4) of the u.p.d.o.p. in the 2019 wording, hence the allegation of violation of this provision contained in the complaint does not merit consideration.
In the opinion of the Court, the evidence gathered in the case allowed it to be resolved and, in this respect, the authorities did not fail to comply with Article 122 in conjunction with Article 187 § 1 of the Tax Ordinance. On the other hand, the allegation of a breach of Article 191 of the Tax Ordinance, consisting in the authorities’ faulty assessment of the market nature of the examined legal transactions, is justified. In the context of this allegation, however, it should be stipulated that the reclassification of a legal action by the authorities is not so much the result of a defective assessment of the evidence gathered, but results from the interpretation and manner of application of substantive law provisions adopted by the authorities (Article 11(1) and (4) of the u.p.d.o.p.). As aptly pointed out in the case law, in such a situation the state of facts was not so much established, but adopted by the tax authority. This is because the tax authority determines the factual state not on the basis of established circumstances, but reconstructs it, taking as a directional guideline the taxpayer’s intention to achieve the intended fiscal goal (unauthorised tax benefit). Thus, the state of facts adopted by the tax authorities does not so much result from the evidence gathered in the case, but from the assumption that if the taxpayer was guided only by economic and economic rationale and not by the intention to achieve an unauthorised tax benefit, it is precisely in the way the tax authority wants him to arrange his relations (judgment of the NSA of 8 May 2019, II FSK 2711/18).
On the other hand, the consequence of the violation of substantive law is the legitimacy of the allegations of violation of Articles 120 and 121 § 1 of the Tax Ordinance by the authorities. On the other hand, due to the voluminous nature of the complaint, the Court referred to the allegations contained therein and their justification to the extent necessary to conduct a review of the appealed decisions (judgment of the Supreme Administrative Court of 26 May 2017, I FSK 1660/15).
When re-examining the case, the authority will take into account the legal assessment presented above as to the interpretation and application, in the facts of this case, of the provision of Article 11(1)-(4) of the u.p.d.o.p., including the assessment as to the nature and meaning when applying this provision of the OECD Guidelines. The consequence of the tax authority’s acceptance in this case of the validity and effectiveness of the legal transactions performed by the applicant and the limited partnership, including the conclusion of the licence agreement, must be the application of the provision of Article 11(1) and (4) of the u.p.d.o.p. as an instrument for controlling the amount of the agreed licence fees between related parties, and not as a provision containing an anti-avoidance clause. When re-examining the correctness of the applicant’s tax settlement in the audited period and the legitimacy of the determination of the amount of the expenses as tax deductible costs (Article 15(1) of the u.p.d.o.p.), the authority will take into account the correct amount of the royalty expenses. As an aside to the considerations, the Court notes that the same position as regards the interpretation and manner of application of Article 11(1) and (4) of the u.p.d.o.p. was taken by the WSA in PoznaÅ„ (judgment of 26 April 2022, I SA/Po 788/21; judgment of 1 July 2022, I SA/Po 360/22; judgment of 5 August 2022, I SA/Po 1036/21, judgment of 18 November 2022, I SA/Po 407/22, judgment of 29 June 2023, file ref. I SA/Po 53/23, file ref. I SA/Po 964/22, file ref. I SA/Po 965/22) and the WSA in Gliwice (judgment of 31 August 2022, I SA/Gl 233/22). In turn, on the grounds of tax regulations on personal income tax and as regards the legal possibility to reclassify or recharacterise legal actions, a similar position was taken by the Supreme Administrative Court in the judgments of 9 June 2022, II FSK 2508/19 and 25 July 2023, II FSK 1352/22.
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