Tag: Bargaining power

Czech Republic vs ANITA B s.r.o., November 2022, Supreme Administrative Court, Case No 4 Afs 381/2021-40

Following an audit the tax authorities issued an assessment of additional income resulting from an adjustment of the tax deductions related to marketing expenses. According to the tax authorities the price agreed between the related parties for advertising space was excessive and not determined in accordance with the arm’s length principle. ANITA B s.r.o. filed an appeal against the assessment. The Regional Court dismissed the appeal as unfounded by judgment of 26 October 2021, No. 62 Af 70/2019-48. The Court concluded that the tax authorities had established that the price agreed between ANITA B s.r.o. and its supplier (ELAPROMO) differed from the price that would have been agreed between unrelated parties. The Court upheld the method chosen by the tax authorities and concluded that ANITA B s.r.o. had failed to prove that the advertising costs claimed were justified in full. An appeal was then filed with the Supreme Administrative Court Judgement of the Supreme Administrative Court The court decided in favour of the tax authorities and upheld the decision from the Regional Court. Excerpt “[40] In its judgment of 26 March 2014, no. 9 Afs 87/2012-50, the Supreme Administrative Court explained that “[t]he purpose of the provision in question is to prevent the unwanted shifting of part of the income tax base between individual income taxpayers and to enable the sanctioning of abusive price speculation in business relations. It also concerns the so-called “profit shifting” between persons with different tax burdens, which usually occurs when such persons charge each other prices lower or higher than the prices used between independent persons in normal business relations, and the result of such transactions is an increase in costs or a decrease in sales for the company with the higher tax burden and a siphoning off of part of the profits to the company with the lower or zero income tax rate. It further summarised that ‘a material difference from normal prices occurs when sales are made too cheaply or purchases are made too expensively; in such cases, such a difference must always be satisfactorily documented’. [41] In that connection, the complainant pointed out that TOP Reklama was the exclusive purchaser of the advertising space, which significantly affected its subsequent bargaining position. However, that argument cannot be accepted. The Regional Court dealt with it in paragraph 29 of the judgment under appeal and the Supreme Administrative Court fully agrees with its view. That argument certainly cannot be regarded in the present case as satisfactory evidence of a price difference within the meaning of Article 23(7) of the ITA. As regards the argument concerning the importance and fame of the sports grounds in question, it cannot be accepted either, since any exclusivity is already included in the price at which SK Vodova Brno and FC Zbrojovka Brno lease the advertising space to TOP Reklama. The Supreme Administrative Court therefore has no other explanation than that the price was overestimated in order to obtain a tax advantage. [42] Furthermore, the complainant has repeatedly stated that it is an entrepreneur in the field of development, production and trade in sewing machines and cannot be required to have knowledge of the advertising market. However, this and subsequent arguments are again unhelpful as they do not explain the substantial difference from normal prices. At the same time, the Supreme Administrative Court reiterates at this point that it is irrelevant to the case whether the complainant was knowingly involved in the chain of connected persons. [43] In view of the foregoing, the tax administrator proved that the case involved related persons within the meaning of section 23(7)(b)(5) of the ITA, that the prices agreed between those persons differed from the prices that would have been agreed between independent persons in normal business relations under the same or similar conditions, and that the complainant did not specifically explain and document the difference between the agreed price and the normal price. In such a situation, the tax administrator was entitled to adjust the tax base by the difference between the above-mentioned prices in accordance with Article 23(7) of the ITA. [44] It can therefore be summarised that the Regional Court assessed the relevant legal issues correctly and based itself on the facts of the case duly established by the tax administration authorities. The grounds of appeal set out in Article 103(1)(a) and (b) of the Code of Civil Procedure were therefore not met.” Click here for English Translation Click here for other translation 0381_4Afs_2100040_20221121125825 ...

TPG2022 Chapter IX paragraph 9.129

In such an example, given that the relocated activity is a highly competitive one, it is likely that the enterprise in Country A has the option realistically available to it to use either the affiliate in Country B or a third party manufacturer. As a consequence, it should be possible to find comparables data to determine the conditions in which a third party would be willing at arm’s length to manufacture the clothes for the enterprise. In such a situation, a contract manufacturer at arm’s length would generally be attributed very little, if any, part of the location savings. Doing otherwise would put the associated manufacturer in a situation different from the situation of an independent manufacturer, and would be contrary to the arm’s length principle ...

TPG2022 Chapter VII paragraph 7.41

Research is similarly an example of an activity that may involve intra-group services. The terms of the activity can be set out in a detailed contract with the party commissioning the service, commonly known as contract research. The activity can involve highly skilled personnel and vary considerably both in its nature and in its importance to the success of the group. The actual arrangements can take a variety of forms from the undertaking of detailed programmes laid down by the principal party, extending to agreements where the research company has discretion to work within broadly defined categories. In the latter instance, the additional functions of identifying commercially valuable areas and assessing the risk of unsuccessful research can be a critical factor in the performance of the group as a whole. It is therefore crucial to undertake a detailed functional analysis and to obtain a clear understanding of the precise nature of the research, and of how the activities are being carried out by the company, prior to consideration of the appropriate transfer pricing methodology. The consideration of options realistically available to the party commissioning the research may also prove useful in selecting the most appropriate transfer pricing method. See Section B .2 of Chapter VI ...

Netherlands vs Hunkem̦ller B.V., January 2020, AG opinion Рbefore the Supreme Court, Case No ECLI:NL:PHR:2020:102

To acquire companies and resell them with capital gains a French Investment Fund distributed the capital of its investors (€ 5.4 billion in equity) between a French Fund Commun de Placement à Risques (FCPRs) and British Ltds managed by the French Investment Fund. For the purpose of acquiring the [X] group (the target), the French Investment Fund set up three legal entities in the Netherlands, [Y] UA, [B] BV, and [C] BV (the acquisition holding company). These three joint taxed entities are shown as Fiscal unit [A] below. The capital to be used for the acquisition of [X] group was divided into four FCPRs that held 30%, 30%, 30% and 10% in [Y] respectively. To get the full amount needed for the acquisition, [Y] members provided from their equity to [Y]: (i) member capital (€ 74.69 million by the FCPRs, € 1.96 million by the Fund Management, € 1.38 million by [D]) and (ii) investment in convertible instruments (hybrid loan at 13% per annum that is not paid, but added interest-bearing: € 60.4 million from the FCPRs and € 1.1 million from [D]). Within Fiscal unit [A], all amounts were paid in [B], which provided the acquisition holding company [C] with € 72.64 million as capital and € 62.36 million as loan. [C] also took out loans from third parties: (i) a senior facility of € 113.75 million from a bank syndicate and (ii) a mezzanine facility of € 35 million in total from [D] and [E]. On November 22, 2010, the French [F] Sàrl controlled by the French Investment Fund agreed on the acquisition with the owners of the target. “Before closing”, [F] transferred its rights and obligations under this agreement to [C], which purchased the target shares on January 21, 2011 for € 265 million, which were delivered and paid on January 31, 2011. As a result, the target was removed from the fiscal unit of the sellers [G] as of 31 January 2011 and was immediately included in the fiscal unit [A]. [C] on that day granted a loan of € 25 million at 9% to its German subsidiary [I] GmbH. Prior to the transaction the sellers and the target company had agreed that upon sale certain employees of the target would receive a bonus. The dispute is (i) whether the convertibles are a sham loan; (ii) if not, whether they actually function as equity under art. 10 (1) (d) Wet Vpb; (iii) if not, whether their interest charges are partly or fully deductible business expenses; (iv) if not, or art. 10a Wet Vpb stands in the way of deduction, and (v) if not, whether fraus legis stands in the way of interest deduction. Also in dispute is (vi) whether tax on the interest received on the loan to [I] GmbH violates EU freedom of establishment and (viii) whether the bonuses are deducted from the interested party or from [G]. Amsterdam Court of Appeal: The Court ruled that (i) it is a civil law loan that (ii) is not a participant loan and (iii) is not inconsistent or carries an arm’s length interest and that (iv) art. 10a Wet Vpb does not prevent interest deduction because the commitment requirement of paragraph 4 is not met, but (v) that the financing structure is set up in fraud legislation, which prevents interest deduction. The Court derived the motive from the artificiality and commercial futility of the financing scheme and the struggle with the aim and intent of the law from the (i) the norm of art. 10a Corporate Income Tax Act by avoiding its criteria artificially and (ii) the norm that an (interest) charge must have a non-fiscal cause in order to be recognized as a business expense for tax purposes. Re (vi), the Court holds that the difference in treatment between interest on a loan to a joined tax domestic subsidiary and interest on a loan to an non-joined tax German subsidiary is part of fiscal consolidation and therefore does not infringe the freedom of establishment. Contrary to the Rechtbank, the Court ruled ad (viii) that on the basis of the total profit concept, at least the realization principle, the bonuses are not borne by the interested party but by the sellers. Excerpts regarding the arm’s length principle “In principle, the assessment of transfer prices as agreed upon between affiliated parties will be based on the allocation of functions and risks as chosen by the parties. Any price adjustment by the Tax and Customs Administration will therefore be based on this allocation of functions and risks. In this respect it is not important whether comparable contracts would have been agreed between independent parties. For example, if a group decides to transfer the intangible assets to one group entity, it will not be objected that such a transaction would never have been agreed between independent third parties. However, it may happen that the contractual terms do not reflect economic reality. If this is the case, the economic reality will be taken into account, not the contractual stipulation. In addition, some risks cannot be separated from certain functions. After all, in independent relationships, a party will only be willing to take on a certain risk if it can manage and bear that risk.” “The arm’s-length principle implies that the conditions applicable to transactions between related parties are compared with the conditions agreed upon in similar situations between independent third parties. In very rare cases, similar situations between independent parties will result in a specific price. In the majority of cases, however, similar situations between independent third parties may result in a price within certain ranges. The final price agreed will depend on the circumstances, such as the bargaining power of each of the parties involved. It follows from the application of the arm’s-length principle that any price within those ranges will be considered an acceptable transfer price. Only if the price moves outside these margins, is there no longer talk of an arm’s-length price since a third party acting in ...

Netherlands vs Restructuring BV, September 2017, Rechtbank ZWB, No BRE 15/5683

A Dutch company was engaged in smelting of zinc. The business was then restructured, for which the company received a small compensation payment. Dutch tax authorities disagreed with both the amount of compensation payment and the arm’s-length remuneration of the post restructuring manufacturing activities. Until 2003 the Dutch Company was a fully fledged business. The company owned the assets and controlled the risks relating to the activities. In the years after 2003, the company was involved in several business restructurings: Activities other than the actual production activities were gradually transferred to other group companies, among others the global marketing and services team (GMS), took over purchasing, sales and deployment of personnel. After becoming part of another group in 2007, the company entered a consultancy agreement with another group company under witch strategic and business development, marketing, sales, finance, legal support, IT, staffing and environmental services was now provided on a cost plus 7.5% basis. Under ‘Project X’, a Belgian company was established in April 2009, which concluded both a business transfer agreement and a cooperation agreement with related smelting companies (including the taxpayer). Under the business transfer agreement, the Belgian company purchased the working capital, including raw materials, products and debtors from the smelting companies. Under the cooperation agreement, which had a term of two years, the Belgian company provided the smelting companies with raw materials. The smelting companies would then process the materials and transfer the final products back to the Belgian company. The Belgian company’s remuneration was based on a cost plus 7.5% mark-up and a 3.5% return on equity. Under ‘Project Y’, the group moved its headquarters to a Swiss company. In the new structure, the Swiss company managed the production planning, purchasing, logistics and sales. The former agreement was terminated, for which the Duch company received a compensation payment of about €28 illion. A manufacturing services agreement was concluded between the Swiss company and the Dutch company under which the smelting companies were compensated based on cost plus 10%. In 2010 the Dutch company reported a taxable amount of €32 million. The Dutch tax authorities increased this amount to €187 million, arguing that at arm’s length the compensation payment should have been €185 million instead of €28 million. The tax authorities argued that: The taxpayer unfairly assumed an expected loss of income for the period of only one year, the remaining term of the cooperation agreement; The compensation payment calculated by the taxpayer was lower than past actual annual profits. The tax authorities provided that the calculation should also consider the foregoing of profits and costs relating to activities such as purchasing and selling. The taxpayer incorrectly assumed that the activities of the GMS were not conducted for the account and risk of the taxpayer; The taxpayer made a calculation error of €50 million and the cash flows in a real sense had been discounted against a nominal discount factor; and The tax authorities referred to the uniqueness of activities conducted by the taxpayer based on the costliness of the factory with huge investments and complexity of the process. The tax authorities also argued that the key functions of the taxpayer had not actually changed after moving the headquarters to Switzerland, and that this should be considered in calculating the compensation payment following the transfer. The company argued that: Under Project X activities relating to purchasing, sales and logistics had already been gradually transferred to other group entities before 2010. In determining the compensation payment, it was therefore not necessary to consider the profit potential of these activities that were no longer being performed by the taxpayer. During the negotiation of the compensation payment, consideration was given to its bargaining position and possibilities to request compensation for a period of time longer than the remaining one year of the cooperation agreement. According to the taxpayer, however, it appeared that compensation, due to poor prospects, was not on the agenda. Although large investments were made in the smelting plant, the taxpayer suggested that these investments mainly related to an adjustment of the production process in line with the environmental standards at the time. The smelting plant of the taxpayer was otherwise not distinctive compared with other smelting plants so as to justify a higher compensation payment. As a result of the business restructuring, the functional profile of the taxpayer changed. The taxpayer regarded itself as a toll manufacturer to be remunerated based on a cost-based approach. However, the tax authorities suggested that a profit split method should be applied considering the strongly interrelated activities of the taxpayer and the Swiss headquarters and the ownership of unique intangibles by both sides. In the Court’s view, the Dutch company was a toll manufacturer in 2010, and therefore the net cost plus method was an acceptable method to determine an arm’s-length remuneration of the current and future activities. The Court  also found that the company had complied with the Dutch documentation requirements and had adequately substantiated the use of tcost plus method. The Court therefor ruled that the tax authorities did not meet the burden of proof and the income adjustment was thus annulled. (The decision has been appealed by the tax authorities) Click here for English translation Click here for other translation Netherlands vs Restr Corp September 2017 ...

TPG2017 Chapter IX paragraph 9.129

In such an example, given that the relocated activity is a highly competitive one, it is likely that the enterprise in Country A has the option realistically available to it to use either the affiliate in Country B or a third party manufacturer. As a consequence, it should be possible to find comparables data to determine the conditions in which a third party would be willing at arm’s length to manufacture the clothes for the enterprise. In such a situation, a contract manufacturer at arm’s length would generally be attributed very little, if any, part of the location savings. Doing otherwise would put the associated manufacturer in a situation different from the situation of an independent manufacturer, and would be contrary to the arm’s length principle ...

TPG2017 Chapter VII paragraph 7.41

Research is similarly an example of an activity that may involve intra-group services. The terms of the activity can be set out in a detailed contract with the party commissioning the service, commonly known as contract research. The activity can involve highly skilled personnel and vary considerably both in its nature and in its importance to the success of the group. The actual arrangements can take a variety of forms from the undertaking of detailed programmes laid down by the principal party, extending to agreements where the research company has discretion to work within broadly defined categories. In the latter instance, the additional functions of identifying commercially valuable areas and assessing the risk of unsuccessful research can be a critical factor in the performance of the group as a whole. It is therefore crucial to undertake a detailed functional analysis and to obtain a clear understanding of the precise nature of the research, and of how the activities are being carried out by the company, prior to consideration of the appropriate transfer pricing methodology. The consideration of options realistically available to the party commissioning the research may also prove useful in selecting the most appropriate transfer pricing method. See Section B .2 of Chapter VI ...

Italy vs GE TRANSPORTATION SYSTEMS SPA, December 2014, Supreme Court 27296

In this case the Italien tax administration concluded that transactions between an Italien company an a German sister company had been priced lower than the “normal value†of similar transactions. Judgement of the Supreme Court The Supreme Court ruled partly in favor of the GE Transportation Systems S.p.A. and partly in favour of the tax authorities. The case was remanded to the lower court for further considerations. In relation to intercompany transactions the court found that GE Transportation Systems S.p.A. had only limited risk and that the German company owned the intellectual property. In relation to transactions with independent companies, GE Transportation Systems S.p.A. assumed the risks of the transaction and had the rights to manufacture and sell the products. These differences justified different price and led to the transactions not being comparable. The Court concluded that the limited risk – contract manufacturing – transactions with the German parent could not be compared with the full-fledged manufacturing activities. In regards to the limited risk transactions, the court also stated that the Italien contract manufacturer is in a weaker bargaining position compared to a full-fledged manufacturer that owns the relevant intangibles. Excerpt “Since the case cannot be decided on the merits, it must be referred to the Regional Administrative Court of Tuscany in another composition, which will re-examine the accepted grounds and, therefore, in accordance with the above-mentioned principles, will decide on the merits and settle the costs of the present proceedings.” Click here for English translation Click here for other translation Italy Supreme-Court-23-December-2014-No.-27296 ...

Finland vs. Corp. March 2013, Supreme Administrative Court HFD 2013:36

A AB purchased manufacturing services of its subsidiary B AS, which had its headquarters in Estonia. The internal pricing of services had since July 2004 been under the net margin method. The price data beside B AS’s realized expenses also included half of the so-called location-savings. On taxation of A AB approved as deductible expenditure only B AS’s actual expenses plus a calculated profit margin. The Supreme Administrative Court stated that A AB in Finland did not have such manufacturing as B AS was conducted in Estonia during the tax year. B AS’s production of the products differed substantially from A ABs former manufacturing in Finland, where A AB had manufactured the products by hand. Most of the new working methods and stages developed in Estonia had never been used in Finland. Hence the situation was not comparable to the location savings by moving the activities as described in the OECD report, and the pricing of would not be judged on the basis of the principles according to the OECD report in such situations. The base price was not included, the calculated benefits for A AB of the subsidiary’s manufacturing costs being lower than the estimated costs that the company would have had if it had manufactured products in Finland. The market-based internal price for contract manufacturing could be determined by using the net margin method so that it was based on comparable companies’ profit margins. In assessing which companies were comparable, in addition to other factors would be taken into account that B AS had its business in a country where costs were low and therefore had the opportunity for a larger margin than companies in countries where costs were higher. In determining the profit margin had to take account of A ABs and B AS’s supposed negotiating power in the event that they had been independent company. B AS was not the holders of intellectual property rights or particularly high-class know-how or technology that would have formed the basis for a high profit margin. Within the company, however, were developed manufacturing processes so that it was suitable for large scale production, and B AS had acquired significant expertise in the production. It was therefore reasonable to expect a higher profit margin for the B AS than comparable companies in the A AB’s documentation. Click here for translation Finland-2013-March-Supreme-Administrative-Court-HFD2013-36 ...

Canada vs. General Electric Capital. November 2010

In the case of General Electric Capital, Canada, the issue was if a 1% guarantee fee  paid by General Electric Capital Canada Inc. to its AAA-rated US parent company satisfied the arm’s length test. The Canadian tax administration argued  that implicit support resulted in General Electric Canada having a AAA credit rating, so that the guarantee provided by the US parent had no value. Taxpayer argued that the 1% guarantee fee did not exceed arm’s length pricing and that implicit support from the US parent should be ignored since it stemmed from the non-arm’s length relationship. The Tax Court agreed with the tax administration that implicit support should be taken into account and applied a “yield approach,” comparing the interest rate the Canadian company would have paid with and without the guarantee. The Tax Court found that credit rating of the Canadian company – with implicit support but without the guarantee – was at most BBB-/BB+ and the 1% guarantee was arm’s length. The Federal Court of Appeal approved of both the Tax Court’s yield approach and its conclusion that the guarantee fee did not exceed an arm’s length price. On the issue of implicit support the Court concluded that under the arm´s length principle implicit support had to be taken into account . Determining arm’s length pricing “involves taking into account all the circumstances which bear on the price whether they arise from the relationship or otherwise.” Hence, Circumstances that are themselves inherently non-arm’s length in nature must also be considered. The relevant question is what an arm’s length guarantor would charge to provide a guarantee to a comparable subsidiary of a comparable AAA-rated US parent Company. Comparing prices of loans without regard to implicit support from the US parent, fails to recognize all of the relevant economic circumstances of the controlled transaction. Canada-vs-General-Electric-2010-federal-Court-of-Appeal-FCA-344 Canada_2010fca290 ...

UK vs. DSG Retail (Dixon case), Tax Tribunal, Case No. UKFT 31

This case concerns the sale of extended warranties to third-party customers of Dixons, a large retail chain in the UK selling white goods and home electrical products. The DSG group captive (re)insurer in the Isle of Man (DISL) insured these extended warranties for DSG’s UK customers. Until 1997 this was structured via a third-party insurer (Cornhill) that reinsured 95% on to DISL. From 1997 onwards the warranties were offered as service contracts that were 100% insured by DISL. The dispute concerned the level of sales commissions and profit commissions received by DSG. The Tax Tribunal rejected the taxpayer’s contentions that the transfer pricing legislation did not apply to the particular series of transactions (under ICTA 88 Section 770 and Schedule 28AA) – essentially the phrases ‘facility’ (Section 770) and ‘provision’ (Schedule 28AA) were interpreted broadly so that there was something to price between DSG and DISL, despite the insertion of a third party and the absence of a recognised transaction between DSG and the other parties involved. The Tax Tribunal also rejected potentially comparable contracts that the taxpayer had used to benchmark sales commissions on similar contracts on the basis that the commission rate depended on profitability, which itself depended on the different level of loss ratios expected in relation to the products covered. A much more robust looking comparable provider of extended warranty cover offered as a benchmark for the market return on capital of DISL was also rejected owing to its differing relative bargaining power compared to DISL. This third-party re-insurer was considered to be a powerful brand providing extended ‘off-the-shelf’ warranty cover through disparate distributors – the tribunal noted that DSG had a strong brand, powerful point of sales advantage through access to customers in their shops and could easily have sourced the basic insurance provided by DISL elsewhere. The overall finding of the Tax Tribunal was that, to the extent that ‘super profits’ were available, these should be distributed between the parties according to the ability of each party to protect itself from normal competitive forces and each party’s bargaining power. The Tax Tribunal noted in this context that DISL was entirely reliant on DSG for its business. According to the facts of this case, the super profits were deemed to arise because of DSG’s point-of-sale advantage as the largest retailer of domestic electrical goods in the UK and also DSG’s past claims data. DISL was considered to possess only routine actuarial know-how and adequate capital, both of which DSG could find for itself. As a result, the tribunal thought that a profit-split approach was the most appropriate, whereby DISL was entitled to a market return on capital, with residual profit over and above this amount being returned to DSG via a profit commission. This decision offers valuable insights into consideration of the level of comparability demanded to support the use of comparable uncontrolled prices; Selection of the appropriate ‘tested party’ in seeking to benchmark a transaction; The importance of bargaining power; Approval of profit split as the most appropriate methodology; That a captive insurer that is underwriting ‘simple’ risks, particularly where the loss ratios are relatively stable and predictable, and that does not possess significant intangibles or other negotiating power, should not expect to earn more than a market return to its economic capital. UK-vs.-DSG-Retail-and-others-DIXON ...