Since 2012, the Company had rented out premises in its administrative building. Among the tenants were both independent parties, and a related party.
For the related party, the rent were 10-20 times lower than for the independents parties.
The related party tenant subleased, more than 97% of the space it had rented.
Furthermore, the cost of operating the building and utility payments were more than 4 times the rental income received.
Following an audit for FY 20XX-20XX the tax authority issued a tax assessment on the basis that the Company had received an unjustified tax benefit as a result of price manipulation in a transaction with an related party.
The income adjustment had been determined based on the cost plus method, as the tax authority claimed to have been unable to obtain information on rental prices of similar buildings
The Courts agreed that the lease agreement was concluded between related parties on non-arm’s length terms and that the Company had received an unjustified tax benefit as a result of the transaction. Nonetheless the tax assessment was declared invalid on formal grounds due to the incorrect application of the cost plus method, which led to unreliable results.
In accordance with paragraph 3 of Art. 105.7 of the Tax Code the CUP method has priority, and other methods are applicable only in cases where it is impossible to apply it or its use will not allow to draw a reasonable conclusion about the conformity of transaction prices to market prices.
The courts concluded that the tax authority had failed to prove that it was impossible to apply the CUP method. The inspection did not receive undisputed evidence of absence of publicly available information named in clause 1 of Article 105.6 of the Tax Code.
At the same time, the Inspectorate had also applied the cost plus method incorrectly: it examined the net profitability of costs rather than the gross profitability of costs, which is a violation of the paragraph (b). Art. 105.11 para. 1 of the Tax Code.
The Supreme Court review board agreed with the conclusions of the lower courts, stating in its ruling that an appeal should not be approved for consideration by the Supreme court, due to the incorrect application of methods of determining the income subject to taxation, which led to the unreliability of the tax liabilities calculations.