CCompany A was active in the management and administration of trusts and companies; related advice and services. A held 99% of the shares in E, a Seychelles-based company. This subsidiary acted as a sub-contractor for company registrations and corporate affairs in the Seychelles. A and E had entered into a service contract dated 6 February 2009 under which the subsidiary provided these services to A.
Following an audit, tax assessments were issued for the tax years 2009 – 2012, in which the tax authorities (AFC-GE) had attributed a percentage of 5% of E’s expenses as the maximum allowable remuneration for the activities of the subsidiary. The remainder was added back to A’s taxable income.
An administrative appeal was lodged against these tax assessments, but the appeal was later dismissed in 2016.
A then appealed to the Administrative Court (TPAI), which, by judgment of 18 December 2017, upheld A’s appeal and annulled the assessments and fines.
The tax authorities appealed to the Court of Justice.
Judgment of the Court
The Court of Justice overturned the decision of the Administrative Court and ruled in favour of the tax authorities.
Excerpt
“6. a. Implementation of the arm’s length principle presupposes identification of the market value of the asset transferred or the service rendered. Where there is an open market, the prices on that market are decisive and allow for an effective comparison with the prices applied between associated companies (ATF 140 II 88 recital 4.2 and the references cited therein).
b. If there is no free market allowing an effective comparison, then the method of comparison with a comparable transaction (or comparable price method) should be used, which consists of making a comparison with the price applied between third parties in a transaction with the same characteristics, i.e. taking into account all the decisive circumstances (BGE 140 II 88 recital 4.2; 138 II 57 recital 2.2; Federal Court ruling 2C_674/2015 of 26 October 2017 recital 7.2). This method corresponds to the comparable open market price method presented in the OECD principles (n. 2.13 et seq.).
For this method to be applicable, the transaction with a third party or between third parties must be similar to the transaction under review, i.e. it must have been entered into in circumstances comparable to those of the transaction under review. However, the notion of “comparable transaction” is not easy to define. The relevance of the comparison with transactions concluded with third parties presupposes that the determining economic circumstances of these transactions are similar to those of the transaction under review (OECD principles, n. 1.33 et seq.). The comparability of transactions is determined according to their nature and in the light of all the circumstances of the particular case. If the relevant economic conditions differ from those of the transaction under review, adjustments must be made to eliminate the effects of these differences (OECD principles, 1.33 et seq.). However, it cannot be entirely ruled out that a comparable transaction would not have been concluded at the market price, since the formation of the price may be influenced by several factors, such as market conditions, contractual terms (for example, the existence of secondary services, the quantity of goods sold, payment terms), the commercial strategy pursued by the third-party purchaser or the economic functions of the parties. Nevertheless, the price charged in a comparable transaction is presumed to correspond to the market price; in the event of a dispute, the burden of proof to the contrary lies with the company (Federal Court ruling 2C_1082/2013 of 14 January 2015, para. 5.2 and the references cited).
c. In the absence of a comparable transaction, the arm’s length price is determined using other methods, such as the cost plus method. This method consists in determining the costs incurred by the company providing the service, to which an appropriate margin is added in order to obtain an appropriate profit taking into account the functions performed and the market conditions (ATF 140 II 88 rec. 4.2 p. 94; judgment of the Federal Court 2C_11/2018 of 10 December 2018 recital 7.4).
d. A concealed distribution of profits also presupposes that the unusual nature of the benefit was recognisable by the company’s governing bodies. This condition is presumed to have been met if the disproportion was clearly recognisable. In this respect, reference should be made to the case law and doctrine developed in private law concerning the imputation of knowledge of the corporate bodies to the legal person, which holds that this imputation does not apply in an absolute manner, but that it must only come into play for what is known to the body that is at least seized of the matter, or else when the information acquired by one body has not been passed on to another body, due to a defect in the organisation of the company (Federal Court ruling 2C_1082/2013 cited above, rec. 6.1 and references cited).
7. It is up to the taxing authority to establish the facts on which the tax claim is based or which increase it, whereas the taxpayer must allege and prove the facts which eliminate or reduce this claim, these rules also applying to proceedings before the appeal authorities (ATF 140 II 248 recital 3.5). In tax reminder and fine proceedings, the tax authority must prove that the assessment is incomplete (Federal Court ruling 2C_342/2017 of 12 April 2018, recital 4.1).
In the area of services that can be valued in money, the tax authorities must prove that the company has provided a service and that it has not received any consideration or has received insufficient consideration. If the evidence gathered by the tax authorities provides sufficient indications of the existence of such a disproportion, it is then up to the taxpayer to establish the accuracy of his allegations to the contrary (ATF 138 II 57 rec. 7.1 p. 66; Federal Court ruling 2C_814/2017 cited above, para. 8.1.3). Moreover, once a fact is considered to be established, the question of the burden of proof no longer arises (ATF 137 III 226, para. 4.3). The authorities must be able to ascertain that only commercial reasons, and not the close personal and economic relationship between the company and the beneficiary of the benefit, were decisive in the choice of the benefit of an unusual nature (Federal Court ruling 2C_18/2011 of 31 May 2011, recital 5.2 and the references cited; ATA/737/2018, recital 5c).
In company taxation, in the case of expenses representing unusual services, it is up to the taxpayer company to establish that they are justified by commercial usage, so that the tax authorities can be sure that only commercial reasons, and not close personal and economic relations between the company and the beneficiary of the service, led to the service in question (ATF 119 Ib 431 recital 2c; ATA/1487/2017 recital 7c and the references cited above).
General and unsubstantiated explanations are not sufficient to establish that commercial use justifies the costs in question. In accordance with the allocation of the burden of proof, it is up to the taxpayer to prove that all the expenses recorded in the accounts are directly related to the acquisition or maintenance of turnover (Federal Court ruling 2A.461/2001 of 21 February 2002, recital 3.1; ATA/1487/2017 cited above and the references cited).
8. a. The issue in this case is whether the “cost plus” method could be applied to determine whether the services invoiced by E to A constitute a hidden distribution of profit.
The first condition for determining the existence of a benefit that can be valued in money is to examine whether A provided a service without obtaining a corresponding benefit from the subsidiary. For the tax years 2009 to 2012, the appellant determined the tax recoveries owed by A as a result of the payments made to the subsidiary.
According to the FTA-GE, the prices charged did not take into account the allocation of costs within the group of companies, underlining the asymmetry of information in transfer pricing, which requires the taxpayer to provide all the information necessary to enable the tax authorities to verify compliance with the legal provisions. A’s refusal or inability to provide documents establishing that companies invoicing the same services have a similar structure in terms of the assumption of operating costs cannot, in its view, result in a reversal of the burden of proof.
In particular, it criticises A for not having submitted a comparability analysis in accordance with OECD principles, for not having provided any information concerning the existence and functions of Mr C and Ms D , for not having proved the commercial justification for the payments made to its subsidiary and for not having provided sufficient information to show that the prices charged to it by its subsidiary were in accordance with the arm’s length principle.
A argued that, although it did not have to bear the burden of proof, it had endeavoured to identify the public prices charged by its competitors for identical or similar services. In this respect, their structure was of little importance as long as the prices proposed corresponded. The reasoning proposed by the AFC-GE systematically made it impossible to compare the services and their invoicing, and thus tended to systematically rule out methods of comparison in favour of the arbitrary cost-plus method. While AFC-GE now seemed to be questioning its cooperation, AFC-GE itself had produced all the documents requested, establishing its financial situation and that of its subsidiary.
b. On reading the file, and in particular the documents submitted by A , it is not possible to assess whether the prices of the competing companies include the costs borne by A. Although A itself acknowledges that they are similar in percentage terms, it does not provide proof that they were established on the basis of identical or similar circumstances. It admits, however, that it bears all the marketing and canvassing costs, so that the role of its subsidiary is limited to performing the services requested, i.e. mainly the incorporation and registration of offshore companies.
However, both the case law and the OECD principles referred to above point out that price formation can be influenced by various factors, which must be taken into account. Contrary to the TAPI’s view, ignoring some of the circumstances involved in setting the price does not make it possible to apply an approach that is consistent with economic reality.
Thus, A’s arguments do not make it possible to overturn the subordination relationship existing between it and its subsidiary. In this context, it was up to A to establish that the prices paid to its subsidiary were justified by commercial usage. Even though it appears to have fulfilled its obligation to cooperate with the AFC-GE, it must be noted that it nevertheless refrained from providing any explanations regarding the functions of two of its employees, i.e. Mr C and Ms D . In addition, while it is true that it proposed to request, at its own expense, an expert opinion on the prices charged between it and its subsidiary under their contractual relationship, it is surprising that this was not carried out beforehand, when the subsidiary was set up, in order to ensure fair remuneration for its services. This seemed all the more necessary given that while A was almost systematically making losses, its subsidiary was increasing its profits at the same time.
As it did not have the information needed to make an appropriate comparison of the prices charged, the AFC-GE had no alternative but to use the “cost-plus” method, which is recommended for groups of companies.
Thus, the TAPI could not validly find that prices could be influenced by the different structures of the players operating on the same market, while holding that this did not inevitably imply that prices were not comparable and that there was not full competition.
In view of the foregoing, the AFC-GE was right to make the disputed tax reassessment equivalent to 5% of the subsidiary’s profit, by way of chargeable expenses.”
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