RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish SKF group through (SAS) SKF Holding France. RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities took the view that the results reported by SAS RKS (losses since 2005) had not been determined in accordance with the arm’s length principle. It therefore increased SAS RKS’s results from 2006 to 2010 to the median net margin observed in a benchmark of eight comparable companies, equal to 4.17% in 2006, 4.32% in 2007, 3.38% in 2008, 2.33% in 2009 and 2.62% in 2010. SAS SKF France Holding applied to the Administrative Court for a discharge, and in judgment no. 1608939 of April 23, 2018, the Montreuil Administrative Court upheld the claim. In ruling no. 18VE02849 of June 22, 2020, the Versailles Administrative Court of Appeal upheld the appeal lodged by the the authorities against this ruling. By decision no. 443133 of October 4, 2021, the Conseil d’Etat, hearing an appeal lodged by SAS SKF France Holding, set aside the decision of the Versailles Administrative Court of Appeal and referred the case back to it. Judgement of the Administrative Court of Appeal In accordance with the guidance provided in the decision of the Conseil d’Etat, the Administrative Court of Appeal ruled in favor of SKF Holding and annulled the assessment of the additional taxable income. Excerpts in English “6. In addition, as mentioned above, the tax authorities have found that SAS RKS has had a negative net margin since 2005, with the exception of 2008. It then carried out a functional analysis of SAS RKS’s intra-group relations, taking the view that SAS RKS performed only limited production functions, and that it was therefore not likely to receive negative remuneration in view of the risks associated with this role. Lastly, it applied a “transactional net margin method” (MTMN), comparing SAS RKS’s ratio of net margin to sales for the operations in question with that of eight companies operating at arm’s length in similar fields. In doing so, it noted that the company’s net margin ratio was -19.32% in 2006, -6.44% in 2007, 1.41% in 2008, -10.46% in 2009 and -21.87% in 2010, compared with 4.17% in 2006, 4.32% in 2007, 3.38% in 2008, 2.33% in 2009 and 2.62% in 2010 for the median of the companies compared. In view of these factors, and as stated in the Conseil d’Etat’s decision of October 4, 2021, in the absence of any criticism of the comparables used by the tax authorities, the latter have established a presumption of profit transfer for the transactions in question, up to the difference between the amount of revenue recorded and that which would have resulted from the application of the average net margin rate of the panel of comparable companies. 7. However, SKF Holding France maintains that its subsidiary SAS RKS in fact assumes a more important functional role than that of a simple production unit within the SKF group, which meant that it had to assume higher development and commercial risks, which materialized in 2009 and 2010 and led to significant operating losses. 8. It is clear from the investigation that SAS RKS, founded in 1932 and acquired by the SKF group in 1965, has long-standing technical expertise and manufactures very specific products, often made-to-measure, for civil and military engineering, whose clientele, made up exclusively of professionals, is in fact limited to around fifteen companies, thus requiring no sales prospecting expenditure on the part of the distributing companies. In addition, SAS RKS owns all the tangible assets required for production, bears the risks associated with production, such as product quality defects, organizes the transport and logistics of its products at its own expense, and bears the inventory risk, as recognized by the French tax authorities when they accepted the principle of a provision for inventory depreciation during the audit. While it is common ground that the intangible assets, including patents, required for this production are held by AB SKF in Sweden, it is nevertheless clear from the investigation that SAS RKS carried out research and development work during the period under review, that it participated, through its parent company SKF Holding France, in an agreement to share research and development costs organized at group level, and that it therefore benefited free of charge from all the intangible assets thus held by the Swedish parent company. Furthermore, while it is common ground that the Swedish parent company periodically sends SAS RKS a schedule of margins to be applied to production costs, depending on the country of invoicing. This schedule is intended to guarantee a margin of 3% for the distribution companies, it is clear from the investigation that SAS RKS is free to determine its own production costs, known as “standard production costs”, which serve as the basis for negotiations with the end customer, carried out jointly with the distribution companies. It also emerges from the investigation, and in particular from the results of computer processing carried out by the tax authorities, that this scale, while applied in the majority of intra-group transactions, is not systematically applied. Furthermore, the company, which bears the exchange rate risk, maintains, without being contradicted, that it can freely refuse to contract with a customer if the final price negotiated does not suit it. On the other hand, it appears from the investigation that the distributing companies are limited to managing sales in practical terms, for example by drawing up contracts and invoices, and to assisting end customers in their negotiations with SAS RKS. As a result, SAS RKS enjoys relative autonomy within the Group, and assumes a high level of risk due to its production activities. Furthermore, it is clear from the investigation that the standard production cost defined by SAS RKS, which serves as the basis for the final price agreed with the customer, is determined at a very early ...

RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish group SKF through  (SAS) SKF Holding France. RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities adjusted the prices at which it had invoiced its products to the SKF group’s distribution companies abroad. According to the tax authorities, RKS was a simple manufacturing company that did not have control over strategic and operational risks, at therefore should not have losses resulting from such risks. As a result of the adjustment, SKF Holding France (the immediate parent of RKS) was subject to additional corporate income taxes amounting to EUR 5,385,325, including penalties. In a 2018 judgment the Montreuil Administrative Court discharged the additional taxes. However, this decision was set aside by the Versailles Administrative Court of Appeal in a judgment of 22 June 2020 in which the appeal of the tax authorities was granted. This judgement was then appealed by SKF to the Supreme Court. Judgement of the Supreme Court The Supreme Court decided in favor of SKF Holding and annulled the decision of the Versailles Administrative Court of Appeal. Excerpts from the Judgement “It is clear from the documents in the file submitted to the court that the administration applied a “transactional net margin method” (TNMM) during the audit of RKS, which consisted of comparing the ratio of net margin to turnover of this company for the transactions in question with that of eight companies operating at arm’s length and in similar fields of activity. In doing so, it found that the company’s net margin ratio was -10.46% in 2009 and -21.87% in 2010, whereas it was 2.33% in 2009 and 2.62% in 2010 for the average of the companies compared. Consequently, the administrative court of appeal was able to hold, without any error of law, that the service, at the end of this comparison, of which it noted that no criticism was addressed to it, had established a presumption of transfer of profits for the transactions in question, up to the difference between the amount of revenue recorded and that which would have resulted from the application of the average net margin rate of the panel of comparable companies. However, SKF Holding France argued before the court, in order to justify this difference, that RKS had a more important functional role than that of a simple production unit within the SKF group, which meant that it had to assume a development risk and a commercial risk and that this risk had affected its operating profit for the years in dispute. Firstly, as recommended by the OECD Transfer Pricing Guidelines, in order for it to be considered established that a company belonging to a group is in fact intended to assume an economic risk which the group’s transfer pricing policy leads it to bear, and that this policy is therefore consistent with the arm’s length principle, it is necessary for that company to have effective control and mitigation functions over that risk, as well as the financial capacity to assume it. In holding that RKS was not liable for economic losses related to the operation of its business on the sole ground that it did not have the status of ‘main contractor’ within the SKF group, without investigating whether its functional position within the SKF group was such that it could not be held liable, without investigating whether its functional position within the group gave it the right to bear the specific risks it invoked, namely, on the one hand, strategic risks linked to the choice to develop new products, and, on the other hand, operational risks linked to the efficiency of the production processes, the court vitiated its judgment with an error of law. Secondly, in holding that the negative margin rate of the company RKS was not the result of the realisation of a risk that it was intended to assume, the Administrative Court of Appeal noted that the consolidated result of the SKF group, all activities taken together, was at the same time between 6 and 14%, that the company’s purchases of raw materials had been stable and that its sales had not suffered any decrease in volume except for wind turbines. In so doing, it did not respond to the argument that SKF Holding France raised to justify the drop in RKS’s margin over the two financial years in question, according to which this company had suffered the consequences of a strategic risk linked to its choice to reorient its sole activity towards the wind power sector. It therefore vitiated its judgment by failing to state adequate reasons.” Click here for English translation Click here for other translation France vs SKF 041021 Conseil d'Etat Case no 443133 ...

RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish group SKF through (SAS) SKF Holding France. RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities adjusted the prices at which it had invoiced its products to the SKF group’s distribution companies abroad. According to the tax authorities, RKS was a simple manufacturing company that did not have control over strategic and operational risks, at therefore should not have losses resulting from such risks. In a 2018 judgment the Montreuil Administrative Court discharged the additional taxes. However, this decision was set aside by the Versailles Administrative Court of Appeal in a judgment of 22 June 2020 in which the appeal of the tax authorities was granted. This judgement was then appealed by SKF to the Supreme Court. Judgement of the Supreme Administrative Court The court decided in favor of SKF Holding and annulled the decision of the Versailles Administrative Court of Appeal. Excerpt “It is clear from the documents in the file submitted to the court that the administration applied a “transactional net margin method” (TNMM) during the audit of RKS, which consisted of comparing the ratio of net margin to turnover of this company for the transactions in question with that of eight companies operating at arm’s length and in similar fields of activity. In doing so, it found that the company’s net margin ratio was -10.46% in 2009 and -21.87% in 2010, whereas it was 2.33% in 2009 and 2.62% in 2010 for the average of the companies compared. Consequently, the administrative court of appeal was able to hold, without any error of law, that the service, at the end of this comparison, of which it noted that no criticism was addressed to it, had established a presumption of transfer of profits for the transactions in question, up to the difference between the amount of revenue recorded and that which would have resulted from the application of the average net margin rate of the panel of comparable companies. However, RKS argued before the court, in order to justify this difference, that it had a more important functional role than that of a simple production unit within the SKF group, which meant that it had to assume a development and commercial risk and that this risk had affected its operating profit for the years in dispute. Firstly, as recommended by the OECD Transfer Pricing Guidelines, in order for it to be considered established that a company belonging to a group is in fact intended to assume an economic risk which the group’s transfer pricing policy leads it to bear, and that this policy is therefore in accordance with the arm’s length principle, it is necessary for that company to have effective control and mitigation functions over that risk, as well as the financial capacity to assume it. In holding that RKS was not liable for economic losses related to the operation of its business on the sole ground that it did not have the status of ‘main contractor’ within the SKF group, without investigating whether its functional position within the SKF group was such that it could not be held liable, without investigating whether its functional position within the group gave it the right to bear the specific risks it invoked, namely, on the one hand, strategic risks linked to the choice to develop new products, and, on the other hand, operational risks linked to the efficiency of the production processes, the court vitiated its judgment with an error of law. Secondly, in holding that the negative margin rate of the company RKS was not the result of the realisation of a risk that it was intended to assume, the Administrative Court of Appeal noted that the consolidated result of the SKF group, all activities taken together, was at the same time between 6 and 14%, that the company’s purchases of raw materials had been stable and that its sales had not suffered a drop in volume except for wind turbines. In so doing, it did not respond to the argument that the company raised to justify the drop in margin over the two financial years in question, according to which it had suffered the consequences of a strategic risk linked to its choice to reorient its sole activity towards the wind power sector. It therefore vitiated its judgment by failing to state adequate reasons.” Click here for English translation Click here for other translation France vs RKS October 2021 Conseil d'État, 8ème - 3ème chambres réunies, 04_10_2021, 443130 ...

SAS RKS, a French subsidiary of the Swedish SKF group, was engaged in manufacturing of bearings. RKS had, with the exception of 2008, had a negative results since 2005. Following an audit for FY 2009 and 2010, the French tax administration by application of the TNMM method, determined that SAS RKS should have a net profit margin of 2.33% in 2009 and 2.62% in 2010. The tax assessment was brought to the Montreuil Administrative Court, and in April 2018 a judgement in favor of the company was issued. This judgement was appealed by the tax authorities to the CAA. The CAA overturned the judgment of the Administrative Court and found in favor of the tax authorities. “The administration has qualified as hidden income the profits mentioned in the preceding paragraphs, transferred by the company RKF to the business units of the SKF group, established abroad. While the applicant does not dispute that the reduction in its prices may constitute income distributed in a concealed manner, it submits that the administration has not adduced evidence of an intention to grant and receive a benefit without consideration. However, it follows from the above that RKS has sold its products at a loss since 2005 and that its purchasers have benefited, during the same period, from transfer prices decided each month by the Swedish parent company AB SFK in order to guarantee them a gross margin of 3 %, irrespective of the cost price of these products to their supplier. Under these conditions, which are unrelated to the formation and negotiation of prices in normal commercial relations, the intention to grant and receive a benefit is established.“ Click here for translation CAA de VERSAILLES, 1ère chambre, 22_06_2020, 18VE02848, Inédit au recueil Lebon _ Legifrance ...