Following an audit of “Raw Materials Ltd” an assessment was issued by the tax authority regarding pricing of intra-group transactions in FY 2018 and 2019. At issue was the pricing of intra group sales and purschases. A complaint was filed by “Raw Materials Ltd” with the Dispute Resolution Board claming that the tax authority had misapplied the chosen transfer pricing method. Decision of the Board The Board upheld the assessment of the tax authorities and rejected the appeal of “Raw Materials Ltd”. Excerpt in English “Because the tax authority, taking into account the activity, the organisation and the specific characteristics of the audited company itself, chose as more reliable the internal comparables relating to sales to third independent companies, because the internal comparables are more reliable due to their internal nature. In addition, it is ensured that identical accounting practices are followed in relation to the cost structure (….). Moreover, internal comparables have a more direct and closer relationship with intra-group transactions, in line with the OECD Guidelines (last updated version – July 2010), which in para. 3.27: “Step 4 of the formal process described in paragraph 3.4 is to review internal comparables that may exist. Internal comparables may have a more direct and closer relationship to the controlled transaction than external comparables. The financial analysis may be easier and more reliable as it will be based on identical accounting standards and practices between the internally comparable transaction and the controlled transaction. In addition, access to information on internally comparable transactions may be more comprehensive and less costly.” As stated in the relevant audit report, the applicant company did not sufficiently justify in the documentation file the rejection of the internal comparative sales data to third independent undertakings, and no further evidence was submitted at the appeal stage to substantiate that claim. As regards the applicant company’s claim that it sold products with a loss due to defects, as is apparent from the relevant report, the audit showed that the result of that transaction was profitable. Because the applicant’s claim that the audit has unjustifiably changed the treatment of the same tax subject matter in relation to previous audits of the financial years 2010-2011 and 2015-2017 is unfounded as, on the one hand, according to the principles of accounting there is independence of the financial years and, on the other hand, the table relied on by the applicant itself shows that the circumstances in the years under audit are different as the percentage of its turnover relating to sales to affiliated undertakings has varied significantly. Because according to Article 28 of the Code of Taxation: “1. The Tax Administration shall notify the taxpayer in writing of a note of findings containing the results of the tax audit and the provisional corrective tax assessment, which must be fully reasoned. The taxpayer may request to receive copies of the documents on which the corrective tax assessment is based. The taxpayer shall have the opportunity to express its views in writing on the provisional corrective tax assessment within twenty (20) days of the written notification. 2. The Tax Administration shall issue the final act of corrective determination of the tax, within one (1) month from the date of receipt of the taxpayer’s views or, in case the taxpayer does not submit his views, from the expiry of the deadline specified in par. 1. The final act of corrective tax assessment shall be issued on the basis of an audit report prepared by the Tax Administration. The audit report shall contain a detailed and reasoned account of the facts, data and provisions taken into account by the Tax Administration in determining the tax. The final tax assessment notice together with the audit report shall be communicated to the taxpayer.” Because Article 65 of the Tax Code states that: “In the event of a challenge to an act of assessment of tax in an appeal, the taxpayer or any other person making such a challenge shall bear the burden of proving that the act of assessment of tax is defective.” Since the audit complied with the provisions of Article 28 of the Tax Code and prepared the audit report no…… which it delivered to the applicant company with the provisional determination acts attached. The applicant responded to the abovementioned Memorandum of Acknowledgments by means of the letter No……Replying Memorandum. The audit examined the allegations set out in that memorandum, the positions of which are set out on pages 122 to 129 of the relevant audit report, and then proceeded to adopt the contested definitive acts. Consequently, the allegation of infringement of the right to a prior hearing. Since, in the present appeal, the applicant puts forward allegations essentially similar to those made during the audit, on which the audit has taken a position in the relevant report (see pages 122 to 129 of the relevant audit report), and does not submit any new evidence to alter the findings. Because the findings of the audit, as recorded in the tax division for large tax payers’s audit report, on which the contested acts are based, are considered to be well-founded, acceptable and fully reasoned.” Click here for English translation Click here for other translation ...

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 ...