Aisan Industry Czech, s.r.o. is a subsidiary within the Japanese Aisan Industry Group which manufactures various engine components – fuel-pump modules, throttle bodies, carburetors for independent car manufactures such as Renault and Toyota. According to the original transfer pricing documentation the Czech company was classified as a limited risk contract manufacturer within the group, but yet it had suffered operating losses for several years. Following a tax audit an assessment was issued resulting in additional corporate income tax for FY 2011 in the amount of CZK 11 897 090, and on top of that a penalty in the amount of CZK 2 379 418. The assessment resulted from application of arm’s length provisions where the profitability of Aisan Industry Czech, s.r.o. had been determined on the basis of the profitability of comparable companies – TNMM method. An appeal was filed by Aisan Industry Czech, s.r.o. with the Regional Court which – by judgment of 30 October 2019 – dismissed the appeal and confirmed the additional payment order issued by the tax authorities. In its decision the Regional Court concluded that Aisan Industry Czech, s.r.o. should have been compensated for carrying out manufacturing services to the benefit of the multinational Aisan Industry group. The court also concluded that Aisan Industry Czech, s.r.o. was in fact a contract manufacturer – as stated in the original transfer pricing documentation – and not a full-fledged manufacturer as stated in the later “updated” transfer pricing report in which the FAR profile of the company had been significantly altered after receiving the initial assessment. According to the Regional Court, it had been established that the price of the service negotiated between the Aisan Industry Czech, s.r.o. and its parent company Aisan Industry Co., Ltd. was different from the price that would have been negotiated between independent parties under the same commercial conditions. By selling products to related and unrelated parties at prices determined by the group, Aisan Industry Czech, s.r.o. did not even achieve a minimum level of operating profitability. In FY 2011 Aisan Industry Czech, s.r.o. had a negative profit margin of 3,27 %. According to the court Aisan Industry Czech, s.r.o. should have received a remuneration of CZK 61 080 700 from the Aisan group for the manufacturing services, i.e. the difference between the operating margin it would have achieved at at arm’s length, 1,26 % (the minimum of the profit margin of comparable entities), and the profits it had actually achieved -3.27 %. According to the Regional Court, it was not the pricing of the individual products that was relevant, but rather the overall set-up of Aisan Industry Czech, s.r.o.’s operation within the Aisan group as a contract manufacturer bearing disproportionate risks which were not compensated. Therefore it was not appropriate to set a reference price and analyse the individual transactions since the involvement in the group distorted both transactions with related and unrelated parties, as all the prices had been determined by other group entities. An appeal was then filed against the decision of the Regional Court with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The court fully agreed with the decision and conclusions of the Regional Court, which it considered to be correct and well reasoned. Excerpts “In the course of the tax audit, the tax administrator found, on the basis of an analysis of the transfer prices, that the complainant bore risks that were beyond its control and that this fact was not reflected in the pricing policy, which was influenced by the connected persons. The influence of related parties resulted in the complainant selling its products below its operating costs and not being compensated for those losses. ” “Given that the complainant could not influence from whom and for how much it would purchase inputs, nor to whom and for how much it would sell its products (output price), the tax authorities considered the transactions carried out to be controlled, since it was the parent company Aisan JP together with its sister companies ACE and ACA that influenced this, although the risks involved were borne by the complainant.” “As regards the plea that the defendant and the Regional Court erred in law in failing to distinguish between transactions with related parties and those with unrelated parties, that plea is also unfounded. In that regard, it should be noted that the complainant was represented by the companies of the Aisan group, which concluded the transactions to which the complainant was bound. It is clear from the commission agreements that the sister companies ACA and ACE did so in relation to all customers, irrespective of whether they were related or unrelated. The e-mail communications also show the influence of the parent company Aisan JP regarding the final approval of the sale. It is clear from the summary of the functions of the original transfer pricing report that the selection and final approval of material suppliers, setting of delivery terms, price negotiations and negotiation of delivery terms with end customers is without the influence of the complainant. These decisions are made by the parent company Aisan JP and its sister companies ACA and ACE, which also determine the final prices and quantities of products. Although the complainant sells production and purchases materials from unrelated parties, all sales plans are provided by related parties of the Aisan group…..Therefore, in the present case, all transactions carried out by the complainant are considered to be controlled transactions on the basis of a function and risk analysis. The conclusion of both the defendant and the Regional Court that it was not appropriate to analyse individual transactions, since related parties influenced all transactions, is therefore correct.” “The Regional Court and the defendant also correctly stated that the reasons given by the complainant for the negative operating profitability cannot be accepted, also because the complainant did not show negative profitability only in 2011, but it was a long-term trend from 2009 to 2012. For these reasons, the administrative authorities were justified in concluding that the ...

In jurisdictions where the burden of proof is on the taxpayer, tax administrations are generally not at liberty to raise assessments against taxpayers which are not soundly based in law. A tax administration in an OECD member country that applies the arm’s length principle, for example, could not raise an assessment based on a taxable income calculated as a fixed percentage of turnover and simply ignore the arm’s length principle. In the context of litigation in countries where the burden of proof is on the taxpayer, the burden of proof is often seen as a shifting burden. Where the taxpayer presents to a court a reasonable argument and evidence to suggest that its transfer pricing was arm’s length, the burden of proof may legally or de facto shift to the tax administration to counter the taxpayer’s position and to present argument and evidence as to why the taxpayer’s transfer pricing was not arm’s length and why the assessment is correct. On the other hand, where a taxpayer makes little effort to show that its transfer pricing was arm’s length, the burden imposed on the taxpayer would not be satisfied where a tax administration raised an assessment which was soundly based in law ...

In 2009, 2010 and 2011 BSA Finances received a total of five loans granted by the Luxembourg company Nethuns, which belongs to the same group (the “Lactalis group”). Depending on the date on which the loans were granted, they carried interest rates of respectively 6.196%, 3.98% and 4.52%. Following an audit covering the FY 2009 to 2011, the tax authorities considered that BSA Finances did not justify that the interest rates thus charged should exceed the average effective rates charged by credit institutions for variable-rate loans to companies with an initial term of more than two years. Hence, the portion of interest exceeding these rates was considered non-deductible pursuant to the provisions of Article 212(I) of the General Tax Code. In 2017, the  Administrative Court ruled in favor of BSA Finances and discharged the additional corporate tax. But this decision was appealed by the authorities to the Administrative Court of Appeal which in  June 2019 overturned the decision of the lower court. The Judgement from the Administrative court of Appels was then appealed by BSA Finances to the French Supreme Administrative Court. The Supreme Administrative Court overturned the decision from the Court of Appeal and remanded the case to the Court of Appeal. “In considering that the company had not established that the margin rates applied were in line with market rates for loans made under the same conditions, whereas the Riskcalc application, which it was not disputed was fed from the company’s balance sheets and profit and loss accounts over several years, had classified its level of risk as “BBB/BBB-” on the basis of comparative ratios established by Moody’s, that the refinancing contracts produced, which made it possible to determine the actual margin rate of the loans taken out by the applicant company itself, were accompanied by details making it possible to compare the main specific conditions with the clauses of the loans in dispute and that, lastly, the combination of these elements was such as to justify, in the absence of any element to the contrary, that the credit margins applied by Nethuns were in line with market practices, the Court distorted the documents in the file submitted for its assessment.” Judgement of the Court of Appeal The court ruled in favor of BSA stating that a scoring obtained by using automated tools such as RiskCalc is inherently less accurate than the actual rating a proper rating agency the fact such a scoring is less accurate does not mean that it can be disregarded systematically. in the absence of any valid criticism of the scoring by the tax authorities, it was an acceptable proof “10. After the Conseil d’Etat, in its decision of 11 December 2020, annulled the judgment of the Court of Appeal of 25 June 2019 on the grounds that the combination of elements attesting to a rating of the company’s risk by means of a publicly accessible financial tool, namely the RiskCalc software developed by the rating agency Moody’s, which it was not disputed was fed from the company’s balance sheets and profit and loss accounts over several years, and the syndicated contracts entered into with the company, which were not the subject of a complaint, was not sufficient to justify the decision, and the syndicated contracts concluded with financial organisations in 2010 and 2011 were such as to justify, in the absence of any evidence to the contrary, that the credit margins applied by Nethuns were in line with market practices, the Minister for Economic Affairs, The Minister of the Economy, Finance and Recovery reiterated his criticism of the RiskCalc software, arguing that it covers only a small fraction of the methodology used by the rating agencies, so that it provides only a measure of the probability of default that is meaningful only in relation to the scale of default probabilities created by the software itself. It questions the relevance of the model for entities such as SNC BSA Finances insofar as it is based on data from companies with gross assets of less than EUR 10 million, and is therefore not relevant to global groups. It also stresses the inadequacy of the information provided by the methodologies published by Moody’s regarding the adjustments allowed by the software and their potential impact on the rating, even though these adjustments may be significant, particularly in terms of taking into account the support of the parent company or the special treatment of shareholder loans. 11. However, on the one hand, SA BSA argues, without being challenged, that the ‘BBB/BBB-‘ ratings used correspond to a ‘conservative’ analysis based on ratings that are less downgraded than those of SNC BSA Finances with regard to the rating of its main partner, known as a corroborative economic analysis, so that, having itself made the necessary adjustments, the argument based on the failure to take account of the group’s support in determining the rating is, in any event, lacking in fact. The Minister does not mention, in detail, any other form of data restatement, in particular as regards a possible ‘special treatment of shareholder loans’, which would have been necessary in this case. On the other hand, SA BSA argues, again without being challenged, that if the model is established with regard to a sample drawn up by Moody’s showing the balance between small and large companies, it does not lead to an under-representation of the latter given their economic weight. Finally, in a more general way, it is certainly constant that the ratings obtained from tools of the trade make it possible to attribute a rating to a specific loan that is more approximate than a credit rating that could be carried out by a rating agency for a given borrower. Nevertheless, while SA BSA argues without being challenged that the use of a rating agency is not intended to apply, given its cost, in an intra-group transaction, the rating provided in this case by RiskCalc can be considered sufficiently reliable to justify the profile of SNC BSA Finances and ...

Aisan Industry Czech, s.r.o. is a subsidiary within the Japanese Aisan Industry Group which manufactures various engine components – fuel-pump modules, throttle bodies, carburetors for independent car manufactures such as Renault and Toyota. According to the original transfer pricing documentation the Czech company was classified as a limited risk contract manufacturer within the group, but yet it had suffered operating losses for several years. Following a tax audit an assessment was issued resulting in additional corporate income tax for FY 2011 in the amount of CZK 11 897 090, and on top of that a penalty in the amount of CZK 2 379 418. The assessment resulted from application of arm’s length provisions where the profitability of Aisan Industry Czech, s.r.o. had been determined on the basis of the profitability of comparable companies – TNMM method. An appeal was filed by Aisan Industry Czech, s.r.o. with the Regional Court. Judgement of the Regional Court The court dismissed the appeal and upheld the assessment of the tax authorities. In its decision the Regional Court concluded that Aisan Industry Czech, s.r.o. should have been compensated for carrying out manufacturing services to the benefit of the multinational Aisan Industry group. The court also concluded that Aisan Industry Czech, s.r.o. was in fact a contract manufacturer – as stated in the original transfer pricing documentation – and not a full-fledged manufacturer as stated in the later “updated” transfer pricing report in which the FAR profile of the company had been significantly altered after receiving the initial assessment. According to the Regional Court, it had been established that the price of the service negotiated between the Aisan Industry Czech, s.r.o. and its parent company Aisan Industry Co., Ltd. was different from the price that would have been negotiated between independent parties under the same commercial conditions. By selling products to related and unrelated parties at prices determined by the group, Aisan Industry Czech, s.r.o. did not even achieve a minimum level of operating profitability. In FY 2011 Aisan Industry Czech, s.r.o. had a negative profit margin of 3,27 %. According to the court Aisan Industry Czech, s.r.o. should have received a remuneration of CZK 61 080 700 from the Aisan group for the manufacturing services, i.e. the difference between the operating margin it would have achieved at at arm’s length, 1,26 % (the minimum of the profit margin of comparable entities), and the profits it had actually achieved -3.27 %. According to the Regional Court, it was not the pricing of the individual products that was relevant, but rather the overall set-up of Aisan Industry Czech, s.r.o.’s operation within the Aisan group as a contract manufacturer bearing disproportionate risks which were not compensated. Therefore it was not appropriate to set a reference price and analyse the individual transactions since the involvement in the group distorted both transactions with related and unrelated parties, as all the prices had been determined by other group entities. Click here for English Translation Click here for other translation ...

In jurisdictions where the burden of proof is on the taxpayer, tax administrations are generally not at liberty to raise assessments against taxpayers which are not soundly based in law. A tax administration in an OECD member country that applies the arm’s length principle, for example, could not raise an assessment based on a taxable income calculated as a fixed percentage of turnover and simply ignore the arm’s length principle. In the context of litigation in countries where the burden of proof is on the taxpayer, the burden of proof is often seen as a shifting burden. Where the taxpayer presents to a court a reasonable argument and evidence to suggest that its transfer pricing was arm’s length, the burden of proof may legally or de facto shift to the tax administration to counter the taxpayer’s position and to present argument and evidence as to why the taxpayer’s transfer pricing was not arm’s length and why the assessment is correct. On the other hand, where a taxpayer makes little effort to show that its transfer pricing was arm’s length, the burden imposed on the taxpayer would not be satisfied where a tax administration raised an assessment which was soundly based in law ...