Tag: Cost of closing

Czech Republic vs Mayer & Cie. CZ, s.r.o., August 2023, Supreme Administrative Court, Case No. 10 Afs 162/2021 – 50

Mayer & Cie is one of the world’s leading suppliers of industrial knitting machines. Following an audit, the tax authorities disallowed a tax deduction of CZK 4,066,097 in FY2014, which Mayer & Cie. had incurred as a result of the disposal of unusable material. According to the tax authorities, the disposal was made on the basis of a controlled transaction in the form of an order from the parent company to cease production of certain knitting machines. Mayer & Cie. appealed to the Regional Court, which ruled in its favour. The court concluded that the Czech arm’s length principle did not apply to the transaction in question, as it did not involve a price agreed between related parties. The tax authorities then appealed to the Supreme Administrative Court. Judgement of the court The Supreme Administrative Court upheld the decision of the Regional Court and ruled in favour of Mayer & Cie. However, the Court’s reasoning was very different with regard to the application of the arm’s length principle. Excerpts “[26] Section 23(7) of the Income Tax Act or Article 9(1) of the Double Taxation Treaty apply to contractual obligations. Section 23(7) of the Income Tax Act refers to ordinary commercial relations and Article 9(1) of the Double Taxation Treaty to conditions in commercial or financial relations which are nothing other than contractual obligations. In the present case, however, in the view of the SAC, no multilateral legal transaction (commercial or financial relationship) and no fixed (agreed) price or non-standard terms can be identified in the parent company’s decision to liquidate the stock, which was made in the course of the applicant’s business management. [27] The parent company’s order against the applicant did not constitute any contractual obligation, since it was merely a decision by the parent company on the commercial management of the applicant’s subsidiary. It should be emphasised that a distinction must be drawn between ‘direct or indirect participation in the management, control or assets of an undertaking’ as a feature of associated persons and ‘a commercial or financial relationship’, or ‘a business relationship’, as the case may be. “In such a case, it is usually based on a decision by the controlling (parent) entity on the commercial management of the dependent (subsidiary) entity (this will typically be, for example, a decision on with whom and under what conditions a contractual relationship is to be entered into in the future, as in the case of the Seventh Chamber cited in paragraph [37]). A decision on the commercial management of a company does not, as a rule, in itself have the effect of creating, modifying or terminating a contractual obligation (transaction) without more. Simply put, it is an expression of the ‘internal will’ of the entity concerned, which may not, however, be fulfilled (e.g. the intended contractual transaction fails to be concluded for various reasons). The decisive transaction in this case is not, then, also seen by the tax authorities as any transaction (contractual obligations) relating to the implementation of the cessation of production or the disposal of materials (stocks). [28] The SAC observes that the tax authorities saw the parent company’s order against the subsidiary (the applicant) as something of a hypothetical service. However, it was not an obligation within the meaning of section 23(7) of the Income Tax Act, but the normal business management of the company (the applicant). It is certainly a feature of a related party relationship between a parent company and a subsidiary that the parent company decides on the production direction of its subsidiary. [29] However, as the Regional Court pointed out in paragraph [30], it should be emphasised that section 23(7) of the Income Tax Act could be applied, for example, to the assessment of the prices of inventories (materials) purchased from the parent company (and subsequently in conjunction with the parent company’s decision in question). However, this is a different transaction from the conduct now at issue, where the price of the stock transferred or other circumstances were not called into question by the tax authorities. [30] In the present case, it is also relevant to the assessment of the economic rationality of the case that the applicant, as a subsidiary, purchased stock (material) for the production of knitting machines from the parent company in 2011 and disposed of that stock in 2014 on the basis of the parent company’s decision (order), as the production of the knitting machines in question was loss-making. [31] In that connection, the SAC observes, in relation to the applicant’s cassation objections, that it is not true that the Regional Court disregarded the relationship between the parent company and the applicant and the functions and risks which they bore. The Regional Court dealt with that issue, for example, in paragraphs [29] et seq. of the judgment under appeal. [32] Furthermore, the SAC observes that throughout the proceedings no one questioned the rationality of the decisions taken by the parent company in the context of the applicant’s business management. Only in the applicant’s view was the parent company obliged to compensate the applicant for the damage suffered. The complainant also considers that the parent company made a profit by its actions. [33] It is always necessary to weigh carefully and objectively the circumstances of a particular case. In the present case, its circumstances suggest that, as a result of its decision (the order), the parent company merely avoided the negative consequences that would have been associated with the continuation of unprofitable production. Those negative consequences (increasing losses) would have been suffered by the applicant in the first place. The parent company did not receive any direct profit as a result of that decision alone. Nor is there any indication to date that the conduct of the parent company now under review constitutes conduct which would have caused the applicant damage without further delay. Furthermore, in the present case, it cannot yet be concluded that the parent company, and hence the applicant, for example, sought (unjustifiably) to reduce its tax base. Three years elapsed between the purchase of the material, the cessation of production ...

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 IX paragraph 9.128

Take the example of an enterprise that designs, manufactures and sells brand name clothes. Assume that the manufacturing process is basic and that the brand name is famous and represents a highly valuable intangible. Assume that the enterprise is established in Country A where the labour costs are high and that it decides to close down its manufacturing activities in Country A and to relocate them in an affiliate company in Country B where labour costs are significantly lower. The enterprise in Country A retains the rights on the brand name and continues designing the clothes. Further to this restructuring, the clothes will be manufactured by the affiliate in Country B under a contract manufacturing arrangement. The arrangement does not involve the use of any significant intangible owned by or licensed to the affiliate or the assumption of any significant risks by the affiliate in Country B. Once manufactured by the affiliate in Country B, the clothes will be sold to the enterprise in Country A which will on-sell them to third party customers. Assume that this restructuring makes it possible for the group formed by the enterprise in Country A and its affiliate in Country B to derive significant location savings. The question arises whether the location savings should be attributed to the enterprise in Country A, or its affiliate in Country B, or both (and if so in what proportions) ...

TPG2022 Chapter IX paragraph 9.126

Location savings can be derived by an MNE group that relocates some of its activities to a place where costs (such as labour costs, real estate costs, etc.) are lower than in the location where the activities were initially performed, account being taken of the possible costs involved in the relocation (such as termination costs for the existing operation, possibly higher infrastructure costs in the new location, possibly higher transportation costs if the new operation is more distant from the market, training costs of local employees, etc.). Where a business strategy aimed at deriving location savings is put forward as a business reason for restructuring, the discussion in Section D. 1.5 of Chapter I is relevant ...

TPG2022 Chapter I paragraph 1.102

In the circumstances of Example 2 in paragraph 1.84, the significant risks associated with generating a return from the manufacturing activities are controlled by Company A, and the upside and downside consequences of those risks should therefore be allocated to Company A. Company B controls the risk that it fails to competently deliver services, and its remuneration should take into account that risk, as well as its funding costs for the acquisition of the manufacturing plant. Since the risks in relation to the capacity utilisation of the asset are controlled by Company A, Company A should be allocated the risk of under-utilisation. This means that the financial consequences related to the materialisation of that risk including failure to cover fixed costs, write-downs, or closure costs should be allocated to Company A ...

France vs SAS Microchip Technology Rousset, December 2021, CAA of MARSEILLE, Case No. 19MA04336

SAS Microchip Technology Rousset (former SAS Atmel Rousset) is a French subsidiary of the American Atmel group, which designs, manufactures, develops and sells a wide range of semiconductor integrated circuits. It was subject to an audit covering the FY 2010 and 2011 and as a result of this audit, the tax authorities imposed additional corporate income tax and an additional assessments for VAT. The administration also subjected SAS Atmel Rousset to withholding tax due to income deemed to be distributed to one of the Atmel group companies. The authorities invoked the provisions of Article 57 of the General Tax Code as the new legal basis for the additional corporate tax contributions and the social contribution on corporate tax, resulting from the reintegration of the capital loss arising from the sale of SAS Fabco shares and the assumption of responsibility for SAS Fabco’s social plan, instead of the provisions of Article 38(1) and Article 39(1) of the same code. The tax administration, which relies on the guidelines recommended in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Public Administrations, argued that the transfer of the production activity, materialised by the sale of the Rousset plant, is part of a global strategy. The parent company of the group will benefit from the gains made through the outsourcing of the production activity, and moreover initiated and conducted the negotiations, as demonstrated by the letter of intent to purchase dated 12 May 2009 from LFoundry GmbH, addressed to the group’s parent company. Similarly, the administration notes that the “Stock Purchase Agreement” and “Wafer Purchase Agreement” relating respectively to the transfer of shares in SAS Fabco, and to the terms of purchase of semiconductors sold by this same company, were signed by Mr A…, Atmel Corporation’s Director of Operations. It follows from all of these elements that the tax authorities must be considered as providing evidence of a practice falling within the scope of Article 57 of the General Tax Code, which establishes a presumption of indirect profit transfer. SAS Microchip Technology Rousset applied to the Marseille administrative court for a discharge of duties and penalties for the taxes to which it was thus subject for the years 2010 and 2011, and in a judgment of 21 June 2019, the administrative court decided in favor of SAS Microchip Technology Rousset and set aside the assessment. The Authorities filed an appeal to the Court of Appeal. Judgement of the Court of Appeal The court dismissed the appeal of the authorities and upheld the decision of the administrative court in favor of SAS Microchip Technology Rousset. Excerpts “…although the administration argues that this operation was entirely led by the group’s parent company’s operations manager, this circumstance, particularly because of the international scope of the project, is not such as to demonstrate that the interests of SAS Microchip Technology Rousset were not taken into account and that the transaction in question was concluded to the exclusive benefit of the American company. It follows from the above that the court was right to consider that the sum in dispute could not be considered as an indirect transfer of profits to the American company Atmel Corporation within the meaning of Article 57 of the General Tax Code. As a result, the tax authorities were not justified in increasing the profit subject to corporate income tax for the financial year ending in 2010 by EUR 72,062,567. “…Furthermore, it is also clear from the information provided by the respondent company that the cost of the additional costs generated by the Manufacturing Services Agreement was much lower than the costs that SAS Microchip Technology Rousset would have had to bear in the event of the restructuring of the Rousset manufacturing unit or its closure. It is clear from the documents in the file that the Flichy firm estimated that the redundancy costs alone would have amounted to EUR 176 800 000, while the community of the Pays d’Aix estimated at EUR 60 million the amount of business tax that would have had to be paid in the event of cessation of the activity. Finally, the fact that the director of operations of the parent company Atmel Corporation took the decisions relating to the transfer of the manufacturing activity of SAS Microchip Technology Rousset is not sufficient to establish that, by accepting the terms of the Manufacturing Services Agreement and by bearing the resulting additional costs, the respondent company did not act in the interest of the company. Consequently, the latter provided proof that the costs in dispute, which it had borne, had been justified by obtaining favourable considerations for its own operations and did not constitute an indirect transfer of profits. The administration was therefore not justified, as the administrative court ruled, in reintegrating the corresponding sum into the taxable profits of SAS Microchip Technology Rousset for the financial year ending in 2011.” Unless it establishes the existence of an abnormal act of management, the tax administration does not have to interfere in the management of companies. Under the combined provisions of Articles 38 and 209 of the General Tax Code, the profit subject to corporation tax is that which derives from operations of any kind carried out by the company, with the exception of those which, because of their purpose or their methods, are alien to normal commercial management. The assumption by an enterprise of costs for which it has no direct consideration or which are not directly incumbent on it is only normal commercial management if it appears that, in granting such advantages, the enterprise has acted in its own interest. It follows from the reasons set out in points 10 and 12, recalling the interest of SAS Microchip Technology Rousset in bearing the additional costs linked to the invoicing conditions provided for in the “Manufacturing Services Agreement” and “Wafer Purchase Agreement” relating to the purchase of wafers from LFoundry, that the administration does not establish an abnormal management act. Click here for English translation Click here for other translation ...

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 IX paragraph 9.128

Take the example of an enterprise that designs, manufactures and sells brand name clothes. Assume that the manufacturing process is basic and that the brand name is famous and represents a highly valuable intangible. Assume that the enterprise is established in Country A where the labour costs are high and that it decides to close down its manufacturing activities in Country A and to relocate them in an affiliate company in Country B where labour costs are significantly lower. The enterprise in Country A retains the rights on the brand name and continues designing the clothes. Further to this restructuring, the clothes will be manufactured by the affiliate in Country B under a contract manufacturing arrangement. The arrangement does not involve the use of any significant intangible owned by or licensed to the affiliate or the assumption of any significant risks by the affiliate in Country B. Once manufactured by the affiliate in Country B, the clothes will be sold to the enterprise in Country A which will on-sell them to third party customers. Assume that this restructuring makes it possible for the group formed by the enterprise in Country A and its affiliate in Country B to derive significant location savings. The question arises whether the location savings should be attributed to the enterprise in Country A, or its affiliate in Country B, or both (and if so in what proportions) ...

TPG2017 Chapter IX paragraph 9.126

Location savings can be derived by an MNE group that relocates some of its activities to a place where costs (such as labour costs, real estate costs, etc.) are lower than in the location where the activities were initially performed, account being taken of the possible costs involved in the relocation (such as termination costs for the existing operation, possibly higher infrastructure costs in the new location, possibly higher transportation costs if the new operation is more distant from the market, training costs of local employees, etc.). Where a business strategy aimed at deriving location savings is put forward as a business reason for restructuring, the discussion in Section D. 1.5 of Chapter I is relevant ...

TPG2017 Chapter I paragraph 1.102

In the circumstances of Example 2 in paragraph 1.84, the significant risks associated with generating a return from the manufacturing activities are controlled by Company A, and the upside and downside consequences of those risks should therefore be allocated to Company A. Company B controls the risk that it fails to competently deliver services, and its remuneration should take into account that risk, as well as its funding costs for the acquisition of the manufacturing plant. Since the risks in relation to the capacity utilisation of the asset are controlled by Company A, Company A should be allocated the risk of under-utilisation. This means that the financial consequences related to the materialisation of that risk including failure to cover fixed costs, write-downs, or closure costs should be allocated to Company A ...