LAKUM KTL, a. s. had deducted from its taxable income costs for the purchase of advertising and promotional services from PRESSTEX MEDIA and PAMBROKE Media. Following an audit, the tax authorities concluded that LAKUM had entered into a legal relationship with PRESSTEX and PAMBROKE for the purpose of reducing the tax base. The tax authorities established reference prices on the basis that LAKUM could have entered into the contract for advertising and promotional services directly with the club concerned and, from the price range thus established, determined the arm’s length price for the services and increased the tax base accordingly. Decision of the Regional Court The Regional Court ruled in favour of the tax authorities on the pricing issue. Excerpts “37. The applicant first argued that the conditions for the application of the first sentence of Article 23(7) of the Income Tax Act were not met. According to that provision, if the prices agreed between related parties differ from the prices which would have been agreed between unrelated parties in normal commercial relations under the same or similar conditions, and if that difference is not satisfactorily substantiated, the taxpayer’s tax base is adjusted by the difference found. The concept of connected persons is defined in paragraph (b)(5) of the same provision as meaning that, for the purposes of this Act, connected persons are otherwise connected persons who have formed a legal relationship principally for the purpose of reducing the tax base or reducing a tax loss. 38. The applicant argued that a finding that the price obtained differs from the normal price is not sufficient to conclude that there are connected persons, otherwise the question of otherwise connected persons would be superfluous. At the same time, the applicant’s knowledge of that unreasonable increase must be established. He also argued that there was no profit on the part of the applicant, since he had actually spent the sums on advertising and the savings in the form of a reduced tax base were much smaller in relation to the costs incurred. 39. The Regional Court did not find any merit in this objection in its previous judgment. It has reached the same conclusion now. It did not consider it necessary to await the decision of the Extended Chamber in Case No 2 Afs 132/2020-56 of 22 December 2021 on the question whether ‘the finding of a significantly increased price of the subject-matter of the contract compared to the normal price without a satisfactory explanation of the difference is a sufficient condition for concluding that there is a combination of persons for the purpose of reducing the tax base or increasing the tax loss, or whether other facts in the conduct of the taxpayer indicating the unusual nature of the commercial transaction must be proved by the administration’. The reason for this is that the tax authorities based their conclusion that the parties were connected not only on the finding of an exorbitant price but also on other circumstances which suggest that the transaction was unusual. In its previous judgment, the Regional Court did not deal with them in detail, as it relied on the view, held by case law at the time, that the finding of an exorbitant price without a satisfactory reason was sufficient for the conclusion of connected persons within the meaning of Section 23(7)(b)(5) of the Income Tax Act (e.g. Supreme Administrative Court judgments of 13 June 2013, no. 7 Afs 47/2013-30, 28 January 2021, no. 3 Afs 393/2019-43 or 20 August 2021, no. 2 Afs 313/2019-43). The Court therefore found the applicant’s objection with regard to them irrelevant. In view of the question submitted to the Extended Chamber, its irrelevance is no longer apparent and the Regional Court will comment on them below, but there is no reason to wait for the decision of the Extended Chamber; even if it were to prevail that the definition of connected persons includes, in addition to the exorbitant price, the presence of such facts in the conduct of the tax entity as to indicate the unusual nature of the transaction, that could not have a favourable effect on the applicant’s procedural success in the case now under consideration. 40. In the case at hand, the tax authority raised doubts about the claimed costs, finding that the total costs incurred by the applicant’s suppliers PRESSTEX and PAMBROKE for advertising and promotional services for the year 2013 for the applicant amounted to CZK 56 104, while the applicant booked costs of CZK 6 000 000, representing 107 times the price paid by the suppliers PRESSTEX and PAMBROKE. The tax administrator’s doubts were also raised by other “non-standard circumstances” mentioned in the Tax Audit Report on pages 23-25, which are: – a change in the contractual terms, as the documents on the performance of the subject matter of the contract were delivered to the applicant after the end of the contractual relationship – discrepancies between the contract and the invoice and between the photographic documentation and the invoice (different size of the banner, failure to indicate advertising in the Golf Arena Ostrava, invoicing for advertising services even for months when no matches were played) – the applicant’s failure to comply with the payment terms – failure to verify the effectiveness of advertising costs – non-standardisation of the applicant’s suppliers PRESSTEX and PAMBROKE (non-contactability of PRESSTEX, virtual headquarters, cash withdrawals of large sums, company without a statutory body) – the failure to verify the price quotation, since the applicant accepted the price proposed by PRESSTEX without further investigation of the more advantageous quotation, even though the applicant could have recognised the overestimation of the price because it has long been active in the sports and business environment. 41. On the basis of the foregoing, the tax administration found that there was a relationship between the applicant and PRESSTEX and PAMBROKE corresponding to Article 23(7)(b)(5) of the Income Tax Act, and the defendant agreed with its assessment (see paragraph 90 of the contested decision). 42. The ...

C. spółka z o.o. is part of a larger group and mainly (95%) sells products (boxes, metal enclosures, etc.) and related services to related parties. According to its transfer pricing documentation the “cost-plus” method had been used to determine the prices of products sold to related parties. The company was audited for FY 2016. According to the tax authorities, the company did not provide enough evidence to support the cost-plus method. The tax authority instead used the transactional net profit method to estimate the company’s income for the year 2016, taking into account factors such as characteristics of goods or services, functional analysis, contractual conditions, economic conditions, and economic strategy by comparing the company’s performance with similar companies over a 3 year period by using EBIT margin. As a result, the authority adjusted the company’s loss and established income based on a EBIT margin of 3.66%, resulting in additional taxable income of PLN 1,803,592.08. C. spółka filed an appeal with the Administrative Court. The Administrative Court predominantly dismissed the appeal and found in favor of the tax authorities. However, the tax authorities have wrongly determined the income of the complainant, by referencing to its entire activity, despite the fact that 5% of the transactions are not subject to regulation under the arm’s length provision. Because of this, the court repealed the decision of the first-instance authority and stated that when re-examining the case, the authority should take into account the position expressed. An appeal was then filed by C. spółka with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Court dismissed the appeal and upheld the decision of the Administrative Court. Excerpts “The company completely ignores in the cassation complaint that the tax documentation of the transaction submitted by it did not confirm its use of the “cost-plus” method of calculating the sales price to related parties with a mark-up of 30% on the direct costs constituting the cost base (depreciation, value of materials and energy used, third-party services, salaries and wages with mark-ups). The submitted tax documentation shows that in the Company, the valuation of the value of the products sold to related customers should follow the reasonable margin “cost-plus” method. In addition, the Company, in describing the method and manner of calculating income and determining the price of the subject of the transaction, explained, among other things, that in 2016, in transactions to related parties (i.e. to: C. GmbH,. P.GmbH, R. mbH), the price was the sales value of individual finished products, determined each time on invoices issued by the Applicant. The price for the individual products was determined on the basis of pre-agreed price lists or on the basis of ongoing arrangements and negotiations, taking into account changing market conditions. This was to be the method provided for in Article 11(2) of the A.p.d.o.p., consisting in setting the price for the sale of goods and rights and the provision of services in transactions with a related party at the level of the sum of the cost base and profit mark-up, comparable to the cost base and profit mark-up established between independent parties, which take into account comparable functions, risks incurred and assets involved. In the explanations submitted during the tax proceedings, the Company additionally stated that it calculated the selling prices of finished goods taking into account the following elements: – material costs; – third-party service costs; – labour costs; – a mark-up of 30%. It further explained that the 30% mark-up applied by it was established in 2005 and was not updated, and was applied in transactions carried out for related parties and independent parties under individual orders and orders. At the same time, it did not submit any documents related to the calculation of the sales prices of finished goods applied to related parties. It should also be emphasised that the Appellant, when preparing the profit and loss account in the comparative variant, did not separate in it such an item as management costs within the meaning of the Accounting Act, the determination of which is necessary in the event of a reliable application of the “cost-plus” method to transfer pricing settlements. The tax authority was therefore correct in concluding that the sales prices to related parties were not correctly calculated based on market standards. At the same time, it must be emphasised that the Company did not have any long-term contracts with customers, and production and sales were based on current orders from customers, including related and independent entities. In the business relationship concerning the production and sale of products to the related party C. GmbH (as parent company), the Applicant acted as a subcontractor, and these processes were planned on the basis of long-term contracts concluded by C. GmbH with its customers. The company did not in any way contractually secure its own turnover volume or even the planning of the supply of its products and services in the medium term. Most importantly, however, it is apparent from the evidence gathered, including the documentation obtained from the Applicant, that sales were made at amounts that did not take into account all costs incurred and that there was no rational reason for such sales prices. According to the tax authority’s calculations, the revenues obtained by the Company according to the reasonable “cost-plus” margin method indicated by itself should have been higher by approximately PLN 4.5 million. Meanwhile, the margin realised by the Applicant was negative and actually amounted to -6.80%. This indicates that the Company’s method of pricing to related parties, contrary to its position, did not assume the achievement of an adequate profit, and the tax documentation submitted for the Complainant’s transactions with related parties did not assume a mark-up of 30%, which would have translated into a profit for 2016 rather than a loss. Therefore, it is not possible to agree with the Company’s position that only objective factors influenced the negative financial result and were the only reason for the application of Article 11(1) of the A.T.C. Properly ...

C. spółka z o.o. is part of a larger group and mainly (95%) sells products (metal containers) and related services to related parties. According to its transfer pricing documentation the “cost-plus” method had been used to determine the prices of products sold to related parties. The company was audited for FY 2016. According to the tax authorities, the company did not provide enough evidence to support the cost-plus method. The tax authority instead used the transactional net profit method to estimate the company’s income for the year 2016, taking into account factors such as characteristics of goods or services, functional analysis, contractual conditions, economic conditions, and economic strategy by comparing the company’s performance with similar companies over a 3 year period by using EBIT margin. As a result, the authority adjusted the company’s loss and established income based on a EBIT margin of 3.66%, resulting in additional taxable income of PLN 1,803,592.08. Judgement of the Administrative Court The Court found that the TNMM was the most appropriate method to determine the company’s income in 2016, and that the comparability analysis was carried out in accordance with the regulations and data available to the authority. However, the tax authorities have wrongly determined the income of the complainant, by referencing to its entire activity, despite the fact that 5% of the transactions are not subject to regulation under Article 11(1)-(3) of the A.p.d.o.p. Because of this, the court repealed the decision of the first-instance authority and stated that when re-examining the case, the authority should take into account the position expressed in the court’s decision. Excerpt from the judgement regarding adjustments where the result is within the inter quartile range “It is also necessary to share the Applicant’s position regarding the use of the median average, well, the authority of first instance, which was accepted by the Appellate Body, stressed on page 151 of the issued decision that the statistical analysis conducted by it used positional measures, as the comparative analysis is an approximation of the prices used in transactions between unrelated parties. In order to determine the range of prices, statistical tools in the form of quartiles (…) were used to analyse the results, the analysis carried out assuming that the appropriate range of results is the interquartile area (first quartile, median, third quartile). Hence, according to the authority, in practice, the most common assumption is that the market values are those that fall between the value of the lower quartile and the upper quartile of the sample population. The inter-quartile range is used to define the rules generally applicable in the market. It should be noted here that the inter-quartile area for 2016, ranges from 1.61% to 3.89%, so since the market value of the EBIT(2) operating margin is already the value of the bottom quartile of 1.61%, and the estimation made is to determine the margin obtained in comparable transactions by independent entities – §18 of the MF Regulation (and such market transactions are already at the level of the bottom quartile), there is no legal basis for determining the market values of EBIT(2) using the arithmetic average of the median operating margin.” Click here for English Translation Click here for other translation ...

Furniture S.A is engaged in the production and sale of furniture and had established a US subsidiary to market and sell furniture overseas. The pricing of the controlled transactions with the US subsidiary had been based on a resale price method, which resulted in prices amounting to 70% of the list price for the products. The Portuguese tax authority issued an assessment for FY 2015 and 2016, where the pricing of the controlled transaction had been adjusted in accordance with the price list resulting in additional taxable profits. Result reached in the arbitration tribunal. The Tribunal set aside the additional assessment of income in respect of the transfer pricing adjustment. Excerpts “…In the contract concluded with E… the Claimant safeguarded direct sales to large customers (with volume to fill a given number of containers). In practice, despite this safeguard, it is apparent from the evidence produced that the only major customer in the US since then has been E… and, in particular, no business was conducted with any major US customer in the years 2015 and 2016. Therefore, it is not possible to identify, as there is no internal comparable in the transactions carried out by the Claimant with unrelated entities in the US market. In fact, the comparable used by the Tax and Customs Authority are the list prices of direct (end) customers of the Claimant, in relation to which the comparability factors required for the application of the transfer pricing regime are not demonstrated, namely the comparable market price method used by the Tax and Customs Authority. In fact, to compare commercial transactions carried out with wholesalers (on the one hand) with transactions carried out with retailers and direct addressees (on the other hand), is to compare substantially different realities, since the intervention of wholesalers in the marketing circuit necessarily implies that prices are charged that ensure them a profit margin, which does not occur in sales made directly to retailers. Indeed, it is unsustainable, from an economic point of view, that, in purchases from the Plaintiff for subsequent resale to retailers, an independent wholesale intermediary would accept a price that would not allow it to remunerate itself with a margin (aimed at covering its costs plus a remuneration). Therefore, it cannot be considered proven that the price that would be charged between the Claimant and E…, if the latter were an independent wholesaler, would be the price charged by the Claimant with retailers. On the other hand, the quantities sold by the Claimant to E… are different (much higher) than those sold to other direct customers of the Claimant in the US market and the quantity of goods sold is one of the factors “likely to influence the price of the transactions” expressly provided for in paragraph a) of no. 5 of Ordinance no. 1446-C/2001. Furthermore, the conditions under which marketing is carried out are also different, as none of the operations carried out with direct retail customers were subject to the conditions agreed in the contract entered into between the Claimant and E… and “the contractual terms and conditions that define, explicitly or implicitly, the manner in which responsibilities, risks and profits are shared between the parties involved in the operation”, are comparability factors that sub-paragraph b) of article 5 of Ordinance 1446-C/2001 requires to be weighed. In this context, it must be taken into account that the deferral of payment allowed to a wholly owned entity does not imply bearing an economic risk similar to that inherent to transactions with independent entities. In this context, as there are unique characteristics in the transactions of the Claimant with E…, the lack of adequacy of the comparable market price method is evident, as it “requires the highest degree of comparability with incidence both on the object and other terms and conditions of the transaction and on the functional analysis of the intervening entities” (article 6, no. 1, of Ministerial Order no. 1446-C/2001). This lack of appropriateness of the comparable market price method is confirmed by paragraph a) of no. 2 of the same article 6 of Ministerial Order 1446-C/2001, from which it follows that, as regards the use of internal comparables, this method cannot be used when there is no “transaction of the same nature having as its object an identical or similar service or product, in like quantity or value, and under substantially identical terms and conditions, with an independent entity in the same or similar markets”. Lastly, it should be emphasised that, as tax arbitration proceedings are an alternative to judicial review proceedings (Article 124(2) of Law 3-B/2010 of 28 April 2010), they are, like the latter, a procedural means of mere legality which aims to eliminate the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [Articles 2 of the RJAT and 99 of the RJAT]. Therefore, the acts must be assessed as they were performed. Therefore, it is not in question to assess whether the application by the Claimant of the transfer pricing regime (for example, in relation to the use of the Minimum Resale Price Method provided for in article 7 of Ministerial Order no. 1446-C/2001) was correct or not, but to determine whether the corrections made by the Tax and Customs Authority have legal support. In the case at issue, the corrections are illegal due to an error in the choice of the comparable market price method and its application to a situation in which the legal requirements for its application are not met. Therefore, it must be concluded that the corrections made by the Portuguese Tax and Customs Authority based on the transfer pricing system are vitiated by error on the assumptions of law. This error justifies the annulment of the corrections, under the terms of article 163, no. 1, of the Administrative Procedure Code, applicable subsidiarily under the terms of article 2, paragraph c), of the LGT. The request for arbitral award regarding these corrections being granted, the knowledge of the remaining defects imputed to ...

Furniture S.A is engaged in the production and sale of furniture and had established a US subsidiary to market and sell furniture overseas. The pricing of the controlled transactions with the US subsidiary had been based on a resale price method, which resulted in prices amounting to 70% of the list price for the products. The Portuguese tax authority issued an assessment, where the pricing of the controlled transaction had been adjusted in accordance with the price list resulting in additional taxable profits. Result reached in the arbitration tribunal. The Tribunal set aside the additional assessment of income in respect of the transfer pricing adjustment. Excerpts “… The application of the principle of comparability must be based on an individual analysis of the transactions, with a view to comparing the conditions practiced in a transaction between related entities and those practiced between independent entities. As it results from the matter of fact given as settled, the creation by the Claimant of a subsidiary based in the United States of America was determined by the bankruptcy of its main US customer and had the purpose of maintaining and boosting the commercial relationship with that market and minimizing the costs of local transportation, storage and packaging of the products sold to retailers and the agency of local intermediaries. The contract for the supply of products and goods entered into between the Claimant and the subsidiary sets out precise rules regarding the commercial relationship established between the parties and the charges that each of the contracting parties assumes in relation to the marketing of the furniture manufactured by the Claimant (clauses five and six). The same contract expressly contemplates the possibility of the direct sale of the products and goods to other customers residing in the United States of America without prior authorisation of the subsidiary (clause four). In this context, the invoicing of the supplies made to the subsidiary for 70% of the price list practiced in the sales directly made by the Applicant in the North American market constitutes a reasonable profit margin, which is intended not only to remunerate the activity of reselling the products, but also to compensate the marketing costs incurred by the counterparty and to which it is contractually bound. It is not possible to consider, under this condition, that the Claimant violates the arm’s length by stipulating, in relation to its subsidiary, a lower price than that practiced in direct sales, when it is certain that the comparison established by the Tax Authority is made with the direct clients of the Claimant without considering the comparability factors between the tied and the non-tied operations, namely with regard to the contractual terms and conditions that define how responsibilities, risks, and profits are shared between the parties involved in any of those operations. Therefore, regardless of the most appropriate method for determining transfer prices, the tax correction, in this regard, proves to be illegal due to the incorrect interpretation and application of the transfer pricing regime by the Claimant.” Click here for English translation. Click here for other translation ...

A Polish Subsidiary A SP. z o.o. had incurred a loss in 2012 in the amount of PLN 1,357,333.66 and following an audit the tax authorities issued an assessment whereby the loss was reduced by an amount of PLN 234,019.90. The disputable issue was whether, in the circumstances of the case under consideration, the tax authorities correctly determined the amount of the applicant’s loss for 2012 in an amount other than that resulting from the correction of the declaration due to the finding that the Company undervalued income from transactions concluded with related entities for a total amount of PLN 234,019.90. The Administrative Court dismissed the complaint of A SP z o.o. According the the provided transfer pricing documentation the company had applied a TNMM and determined remuneration based on cost added a fixed percentage of 4% for the parent company, 8% for other companies. Meanwhile, the mark-ups actually applied by the applicant company in transactions concluded with related entities: B K- S.RA. and K-LLC – (booked on accounts 70101 and 70301) showed that they differ significantly from the above-mentioned mark-ups resulting from the transfer price documentation submitted by the Company, corresponding to market conditions. The applicant did not even try to explain this discrepancy. Therefore, the tax authority correctly calculated the amount of understatement / overstatement of revenues from sales made by the Company to related entities, referring the value of the mark-up resulting from transfer pricing documentation (4% for the parent company, 8% for other companies) to the value of costs related to individual transactions. In the opinion of the Court, the tax authorities showed without doubt that the transactions concluded by the Company with related entities set conditions different from those that would be determined by independent entities and that, as a result, in the audited tax year the Company reduced sales revenues by PLN 234,019.90, which was a premise to apply on the provisions of art. 11 paragraph 1 updop and annual settlement of the Company for 2012. without considering existing relationships. Click here for translation ...

The Italien tax authorities had issued an assessment against Fashion box s.p.a., adjusting revenues for FY 2004 with the sum of EUR 988,888.27, related to transfer pricing transactions between the taxpayer and foreign subsidiaries of Fashion Box Group s.p.a. located in various European countries. In particular, the tax authorities pointed out that sales to the European subsidiaries accounted for 95 % of total sales and that the discounts applied to subsidiaries were 31 % while those offered to Italian shops were between 2 and 2,5 %. The products were sold in Italy for slightly lower prices than those applied to European subsidiaries. Therefore, the subsidiaries could enjoy a much higher profits. An Italian shop had a theoretical mark-up of 138% while the foreign distributor had a mark-up of 233 %. Hence, profits had been transferred to the foreign entities of the group. The Regional Tax Tribunal rejected the assessment. In its judgement the Tribunal stated that it was necessary to compare the prices of the products ‘at the same marketing stage’. In the present case, prices charged ‘at retail’ on the domestic market, had been compared with the ‘wholesale’ prices charged to foreign subsidiaries. The tax authorities appealed against this judgment. Judgement of the Supreme Court The Court dismissed the appeal of the tax authorities and ruled in favor of Fashion Box s.p.a. Excerpt “On this point, the Regional Commission provided adequate and appropriate reasons for its decision, pointing out that the higher discounts applied to European subsidiaries (31 %), compared to those applied to Italian companies (2,5 %), were justified by the different stage of marketing of the products. In fact, it is clearly stated in the grounds that the tax recovery made by the Office is based solely on the greater amount of the discount in favour of the European subsidiaries, but no account is taken of the fact that, while sales to the European subsidiaries are wholesale, those to Italian customers are ‘retail’, so that the comparison relates to products which are not at the same stage of marketing, with the consequent impracticability of the ‘price comparison’ method. Nor can that reasoning be regarded as insufficient, merely because it did not take account of the ‘counter-evidence’ offered by the Revenue Agency, which, noting the different marketing stage of the products, in the case of a comparison of prices between sales to European subsidiaries (wholesale) and sales to Italian companies (retail), also compared the prices charged to the independent Danish customer, to whom discounts of 25 % were applied. Indeed, quite apart from the fact that the level of discount in that situation is very close to that applied to the foreign subsidiaries (25 % and 31 % respectively) and that the Danish customer De Lorenzo had not signed up to the obligation to increase the level of sales every year and was a ‘multi-brand’ retailer, with a larger volume of sales – so that even in that case there were absolutely significant differences – it should be noted that the trial judge does not have to take into consideration all the evidence in the file, when he provides an adequate and analytical statement of reasons for his conviction, based on a solid basis of argument” Click here for English translation Click here for other translation ...