1 Afs 101/2012 - 38

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CZECH REPUBLIC

R O S U D E K

J M E N E M E R E P U B L I C S

The Supreme Administrative Court (SACC), sitting as a panel composed of the President, JUDr. Lenka Kaniová, and the Judges, JUDr. Marie Žišková and JUDr. Zdeněk Kühn, decided in the legal case of the applicant: FISH MARKET a.s., with registered office at Rybářská 801, Třeboň, represented by JUDr. Martin Hájek, lawyer, with registered office at Revoluční 1003/3, Prague 1, against the defendant: Appellate Financial Directorate, with registered office at Masarykova 31, Brno, on an action against the decision of the Financial Directorate in České Budějovice, with registered office at Mánesova 3a, České Budějovice, of 16 August 2011, No 2564/11-1200, in proceedings against the applicant's cassation complaint against the judgment of the Regional Court in České Budějovice of 24 October 2012, No 10 Af 104/2011 - 61,

t a k t o :

I. The appeal is dismissed.

II. The applicant is not entitled to the costs of the appeal proceedings.

III. Orders the defendant to pay the costs of the appeal.

C o n c l u s i o n s :

I.

Definition of the case and legal assessment of the case by the Regional Court

[1] The Tax Office in Třeboň ('the tax administrator') assessed the applicant for corporate income tax for the period from 1 January 2006 to 30 September 2008 in the amount of CZK 956 340 and also ordered him to pay a penalty of CZK 191 268. During the tax audit, the tax administrator found that the applicant was engaged, among other things, in the sale of live freshwater fish and that the margin on sales to a related party (KOLTER, a.s.) was much lower than on sales to other independent persons. He therefore began to examine the reasonableness of the difference in the agreed selling prices of the fish between the applicant, on the one hand, and the independent persons and the economically linked person, on the other. In assessing the tax on the applicant, the tax administrator applied Article 23(7) of Act No 586/1992 Coll. on Income Taxes.

[2] The applicant appealed against the additional payment assessment, but the Financial Directorate in České Budějovice rejected the appeal.

[3] The applicant subsequently challenged the defendant's decision by bringing an action before the Regional Court in České Budějovice. The court dismissed the action by the judgment set out in the header. It held that in the present case it is disputed whether the purchase price agreed between the applicant and KOLTER a.s. for the sale of fish was agreed at the normal price as between independent persons. In the present case, there was no dispute that they were economically related persons in terms of Section 23(7) of the Income Tax Act, since the applicant had a 39% share in the share capital of KOLTER a.s.

[4] The Court emphasised that the most appropriate method for determining the normal price is a comparative method consisting in selecting a suitable sample of entities carrying on business under the same or at least similar conditions; the tax administrator chose for the calculation entities carrying on the same distribution activity at the same time, selecting a sufficient number of entities. Only after the tax authority had collected a sufficient sample of prices did it proceed to determine the normal price. By comparison, it found that the prices negotiated with the related party differed from those negotiated with independent parties. The Court agreed with the defendant that if it considered it essential to establish the price at which the applicant traded the fish, it was superfluous to establish the price at which those persons resold the goods. It is therefore irrelevant whether those persons further processed the fish or merely supplied it to the trade. What is relevant, however, is the denominator that in all the cases compared they were distributors of fish in substantially the same volume.

[5] During the audit, the tax administrator found that the quantity of fish purchased from the selected distributors did not affect the price of the goods (e.g. the customer Human purchased 4.8 tonnes of live scaled carp at CZK 45.23 per 1 kg, the trading company Schultheiss GmbH purchased 27 tonnes in the period in question at CZK 46.1 per 1 kg. The claim that KOLTER had taken surplus fish and was therefore charged a lower price was not substantiated by the applicant and no evidence of discounted sales was produced or appears in the administrative file. The Regional Court agreed with that assessment.

[6] The Court also agreed with the conclusion that the tax authorities had focused on price comparisons in relation to distributors whose activities were focused on the wholesale of fish, namely distributors from Germany, Poland, Hungary and France. Even from this sample, it is clear that there is a divergence between the prices agreed and the arm's length prices. The applicant has not refuted the doubts raised by the tax authorities concerning the price difference.

[7] With regard to the documentary evidence submitted by the applicant to the court only during the proceedings, the court stated that it could not take it into account, since it had to be based on the situation that existed at the time of the administrative authority's decision.

II.

Brief summary of the main arguments put forward in the appeal

[8] The applicant lodged a cassation complaint against the judgment of the Regional Court on the grounds laid down in Article 103(1)(a), (b) and (c) of the Civil Procedure Code. Thus, the differences between regions should have been taken into account; the similarity of economic conditions within the European Union must be taken into account. The applicant referred to the judgment of the Supreme Administrative Court, Case No 6 A 75/2002-68, and pointed out that the Regional Court had erred in refusing to apply the views set out therein to the present case.

[9] The company KOLTER a.s. takes from the applicant all the residual fish which it has not been able to sell elsewhere; that company takes 50% of the residual production of scaly carp. The tax authorities did not take into account the structure of the purchases of the individual purchasers.

[10] If the court is arguing on the basis of Human and Schultheiss, GmbH's sampling of purchases that the quantity of goods taken does not affect the price, that reasoning is flawed. The quantity of the goods purchased does have an impact on the price of the goods, in particular also taking into account the composition of the structure of the products purchased. The purchaser Human purchases goods other than scaled carp from the applicant (e.g. also a large proportion of semi-finished products and fish products), whereas Schultheiss, GmbH purchases exclusively live fish.

[11] By failing to carry out a comparative analysis of the prices applied in the supplies to the organisations of the Slovak Fishermen's Association as evidence in the tax proceedings, the tax administrator infringed Article 92(2) of the Tax Code.

[12] Thus, it was not properly established throughout the proceedings that the price agreed between the applicant and KOLTER a.s. was not normal and was thus in breach of section 23(7) of the Income Tax Act.

[13] In conclusion, the applicant criticised the Regional Court for refusing to take the proposed evidence and referred to the case-law of the Supreme Administrative Court. In that case, the Court has repeatedly held that administrative court proceedings are governed by the principle of full jurisdiction. It is therefore not necessary for the proposed evidence to have been adduced in the administrative proceedings and it is sufficient if it is offered to prove the allegations before the court. The applicant therefore requests that the Supreme Administrative Court set aside the judgment of the Regional Court under appeal and refer the case back to that court for further proceedings.

[14] The defendant, in its observations on the appeal, referred to its observations on the application; it maintained the conclusions expressed therein.

III.

Legal opinion of the Supreme Administrative Court

[15] On the basis of the appeal, the Supreme Administrative Court examined the judgment under appeal in accordance with Article 109(3) and (4) of the Code of Civil Procedure, bound by the scope and the grounds put forward by the applicant in his appeal, without itself finding any of the defects referred to in paragraph 4 to which it would be obliged to have regard of its own motion.

[16] The appeal is unfounded.

[17] The essence of the appeal is to answer the dispute as to whether the purchase price agreed between the applicant and its economically linked trading company KOLTER a.s. for the sale of fish was agreed at the normal price as between other independent persons and, if not, whether the applicant has satisfactorily substantiated that difference in price.

[18] In tax proceedings, the principle applies that it is the taxpayer who bears the burden of allegations in relation to its tax liability and the burden of proof in relation to those allegations. This issue has already been comprehensively dealt with by the Supreme Administrative Court in its judgment of 30 January 2008, No. 2 Afs 24/2007 - 119, published under No. 1572/2008 Coll. of the Supreme Administrative Court and at www.nssoud.cz. In some cases, however, this general rule does not apply and the burden of proof and the burden of allegation lies with the tax administrator. This is the case in the application of the first sentence of Section 23(7) of the Income Tax Act. However, the tax administrator may only adjust the tax base if the legal conditions for such a procedure exist.

[19] The aforementioned provision states that "if the prices negotiated between related persons differ from the prices that would have been negotiated between independent persons in normal business relations under the same or similar conditions, and if this difference is not satisfactorily documented, the tax administrator shall adjust the taxpayer's tax base by the established difference...".

[20] First of all, therefore, it must be proved that the persons are related within the meaning of the above-mentioned provision, i.e. that they are related economically, personally or in another way functionally equivalent to an economic or personal connection. However, that fact is not at issue in the present case.

[21] In order to assess whether the tax administrator, when adjusting the tax base, respected the fulfilment of the conditions set out in Section 23(7) of the Income Tax Act, the Court proceeded on the basis of the following theses and premises.

[22] Where it is established that the parties are related persons within the meaning of the cited provision, it is incumbent on the tax administrator to prove that the prices negotiated between those persons differ from the prices that would have been negotiated between independent persons in normal commercial relations under the same or similar conditions. This means that, in order to make a comparison, the tax authority must establish both the price agreed between the related parties and the normal price (compared with the average of prices, the so-called reference price) at which independent persons trade in a comparable commodity.

[23] A necessary (but not sufficient) condition for the adjustment of the tax base is the existence of a price difference. The tax authority therefore bears both the burden of allegation and the burden of proof in relation to that difference. As a rule, it will not be difficult to establish the actual price, since it is a fact which is decisive for the determination of the tax base and is usually recorded in the accounts or other compulsory records of the persons examined or of the taxable person himself.

[24] In order to establish the 'normal' price, the administrator must be able to bear both the burden of allegation and the burden of proof in relation to all relevant aspects. The tax authority can, and usually will, determine the normal price by comparing the prices actually obtained for the same or similar commodity between genuine independent operators. However, it may determine it, in particular because of the absence or unavailability of data on such prices, only as a hypothetical estimate based on logical and rational reasoning and economic experience. As already stated by the Supreme Administrative Court in its judgment of 27 January 2011, Case No 7 Afs 74/2010 - 81) - the reference (usual) price is essentially a simulation of a price created on the basis of a consideration of what price these persons would have negotiated in a situation identical to that of related persons if they were not related and if they had normal business relations with each other.

[25] Where the tax authority establishes a reference price on the basis of data on the actual prices actually achieved for an identical or similar commodity between genuinely existing independent operators, it must carefully examine the extent to which those prices were achieved under the same or similar conditions as those under which the price was negotiated by the connected persons and, if those conditions differ, make an appropriate adjustment to the reference price. The burden of proof on the tax authorities also relates to establishing the circumstances in which the price was negotiated by the connected persons. Also, where the tax authority establishes the reference price on the basis of data on the prices actually achieved for an identical or similar commodity between actually existing independent entities, this will normally lead to the establishment of a range of specific prices so achieved (e.g. For the purposes of determining the difference between prices, the price must be based on the range of prices within the evidentially fixed interval (see the judgment of the Supreme Administrative Court of 31 March 2009, No. 8 Afs 80/2007 - 105, published under No. 1852/2009 Coll. of the Supreme Administrative Court).

[26] Even if the tax administrator considers that it has been proven that the parties to the legal transaction in question are related persons and that they have agreed on a price different from the reference price, i.e. if it bears the burden of proof and the burden of allegation in respect of all these decisive facts, this does not mean that it can adjust the tax base without further delay. The person to whom the tax base is to be adjusted still has to be given the space (both in time and in fact) to explain and substantiate the difference between the prices found to his satisfaction (see also the judgment of the Supreme Administrative Court (SAC) No 7 Afs 74/2010-85).

[27] At this stage, the burden of allegation and the burden of proof, in contrast to the other conditions for adjusting the tax base pursuant to the first sentence of Section 23(7) of the Income Tax Act, is again borne by the taxpayer. The taxpayer has to allege and prove special and normal market conditions, yet economically rational reasons why the price between it and the related party was negotiated differently from the reference price. It is therefore now up to the taxable person to prove the price difference which has arisen and which has been established and justified by the tax authorities. If the taxpayer has discharged that burden, the tax authority's adjustment of the tax base is not an option.

[28] From the administrative file, the Supreme Administrative Court found that the defendant had selected a sample of traders who also traded with the applicant, but were not economically related to each other, to compare prices and to establish the normal level of prices on the relevant market (the market for distributors of fish - specifically, live class I carp). The tax authority proceeded on the basis that the applicant was the exclusive dealer of live fish in the group, acting as the exclusive distributor. Approximately 75 % of the fish production is exported to European countries (Slovakia, Austria, Germany, France, Italy, Hungary, Poland), while the remaining production is sold on the domestic market.

[29] The principle of the market distance test was introduced into Czech legislation in 1996 by the aforementioned Section 23(7) of the Income Tax Act. The subject of the examination under the OECD Transfer Pricing Guidelines (1995) are controlled transactions, their valuation and the allocation of profits arising therefrom between associated enterprises. The basis for the application of the arm's length principle is to carry out a so-called benchmarking analysis, whereby comparable arm's length transactions must be found to the controlled transactions.

[30] Traditional transaction methods are further divided into direct and indirect methods. Direct methods include the comparable independent price method. This method can be applied when an independent transaction comparable to the controlled transaction under study can be found. As there is no comparable arm's length transaction for many of the related party transactions under review, this direct method cannot always be applied and one of the indirect methods must be used.

[31] In the present case, the tax administrator used the 'comparable uncontrolled price method' (CUP) to determine price comparability. This is the preferred method of comparison, which is used in transactions where there is a fully comparable (identical) product - a commonly traded commodity sold by the undertaking under examination to both related and independent undertakings. The identity of the product or commodity sold is thus an essential element.

[32] The tax authority analysed the structure of the applicant's customers - distributors who purchased the same goods during the period under review; it found that Schultheiss GmbH (Germany), Bihl Raymond + Cie (France), TEHAG (Hungary), Human Inh. Paulus - Fischgrosshandlung (Germany), GYORI 'ELORE' HALÁSZATI TZS (Hungary). It found that Schultheiss GmbH (Germany) came closest to the volume of business carried out between the applicant and KOLTER a.s. The tax authorities thus selected six independent entities purchasing exactly the same product from the applicant during the periods under consideration. The result was to find the price range within which the agreed prices per kg of the identical product purchased during the period under consideration by the independent customers varied and to compare it with the price agreed with the dependent party-KOLTER a.s.

[33] With regard to the applicant's claim that the price agreed with KOLTER a.s. is influenced by the low price level in Slovakia, the defendant argued that the price level in Hungary, for example, from where the three distributors in the comparative sample were selected, is entirely comparable. Moreover, the price level in the individual countries is not relevant; what is relevant is the level of the price arrangement between various independent persons at which those customers purchased the product from the applicant (it is therefore irrelevant at what price they then resold it on the market). The Supreme Administrative Court agreed with that conclusion. Moreover, by comparing the cost and revenue accounts of these persons, the tax administrator found that, in the period under review, the applicant's margin on sales of fish to the related person, KOLTER, a.s., was significantly lower (1,71 %) than on sales to another independent customer, Schultheiss, GmbHP (11,62 %); the margin of KOLTER a.s. (these findings also support the defendant's conclusion that the person associated with the applicant enjoyed commercial advantages, although the tax authorities did not use this finding as evidence but it became the initial reason for investigating whether any differences in the agreed prices existed).

[34] In so far as the applicant reiterates, both in the application and in the appeal, that the comparison between KOTLER a.s. and Schultheiss, GmbHP and Human and Schultheiss, GmbHP cannot be made because of the different structure of the purchases and that therefore an inappropriate sample of traders was chosen, the Court does not accept that argument. On the contrary, both the defendant and the Regional Court made it clear that Schultheiss, GmbHP and KOLTER a.s. had purchased almost identical quantities of fish from the applicant, were comparable in that respect and it was therefore no longer relevant what other products (now not compared) the companies additionally traded.

[35] The Court also agreed with the denial of the need to compare economic market conditions, since the defendant considered that it was precisely the determination of the selling price of the goods vis-à-vis the customers that was relevant. The prices at which those customers sold the goods, if any, are no longer relevant from the point of view under examination. It is certainly conceivable that, in a weaker market, these customers (independent persons) would not make the same profits from their downstream business as they would in a stronger market. However, the subsequent economic behaviour of those persons does not affect the sample of distributors selected who purchased a comparable volume of goods from the applicant, nor does it affect the reasoning and findings made by the tax authorities in determining the comparability of the selling price. Nor does the tax authority's chosen method of comparison (CUP) take that information into account.

[36] At this point, the Supreme Administrative Court also recalls that the choice of criteria for assessing the 'normalcy' of prices is an administrative discretion; in its decision of 11 February 2004, No 7 A 72/2001 - 53, published at www.nssoud. cz, whose legal conclusions expressed there are applicable to the case under review, the Supreme Administrative Court concluded that "if the mechanism for determining the usual price is not determined by a legal norm and the administrative authority is called upon to determine it, the determination of the usual price must be approached with special consideration and its amount must be determined on the basis of objective criteria and in such a way that the conclusions of the administrative authority lead to a reliable judgment and the method of its determination and the amount of the usual price itself can be reviewed. [...] It is not for the Supreme Administrative Court to interfere in the selection of the criteria or to determine which of the criteria the administrative authority should take into account in determining the normal price, and it leaves the selection of the criteria to the administrative authority [...]." If the administrative reasoning does not depart from the above rules, the court respects it and does not substitute its own reasoning for it.

[37] The Supreme Administrative Court considers that the first question, whether the tax administrator bore the burden of proof in establishing the difference between the prices negotiated with independent persons and an economically connected person, was logically answered by the administrative authorities. It is clear from the recapitulation described above (and from the contents of the administrative file) that the tax administration established by an appropriate comparative method (the requirements of which it fulfilled) on a selected sample of traders the range of prices which were negotiated with independent persons in normal business relations under identical or similar conditions, quantified the difference between the prices negotiated between the connected person and other independent traders on the relevant market, and informed the applicant of the difference in prices thus established with the dependent person.

[38] It therefore remains to answer the second question, which is whether the reasonableness of the observed difference in the prices negotiated between those persons is reliably established. If the claimant could explain and also reliably prove why he had agreed to the difference in prices, the tax authorities would have no room to increase the difference in the tax base compared to the tax base claimed by the claimant in its tax return.

[39] Indeed, the tax administration gave the applicant the opportunity to explain or reliably prove the difference (notice of 8 December 2010, no. 278527/10/077540301189).

[40] The applicant responded to the invitation by a submission of 21 December 2010, but did not reliably document the difference in the prices found; indeed, the applicant does not even claim to have reliably documented the difference in prices found by the tax administration.

[41] In so far as the applicant argues that the price of the products sold to KOLTER a.s. was lower than that of other customers because that company also bought fish which would otherwise have been unsellable on other markets, the applicant has failed to prove that claim (as the defendant and the court have also stated). There was no evidence in the administrative file that inferior fish were sold to that company or that goods were sold at any discount. On that point, the Court concludes that the reasonableness of the difference in prices established by the tax authorities between the various distributors on the one hand and KOLTER on the other has not been established by the applicant.

[42] The Court also rejects the merits of the applicant's claim that the tax authorities and the court should have taken into account the conclusions of the judgment of the Supreme Administrative Court of 13 October 2004, No 6 A 75/2002 68, since, in the applicant's view, the case was identical. However, the Court of Cassation does not share that view. In the judgment cited above, the Court held that the tax authorities could not use the 'comparable price method' (CUP) in examining the transaction in question, since they did not find an identical product in the relevant market, but used the 'cost plus' comparative method (COST+). Under this method, the total costs associated with the creation and sale of the output are adjusted by a reasonable gross margin (profit margin). The total cost thus represents the costs incurred by the supplier in relation to the product it supplies to the related buyer (another undertaking), including the addition of an adequate mark-up to cover a reasonable profit in relation to the functions performed and market conditions. Thus, this method must analyse the differences between controlled and arm's length transactions that affect the amount of the mark-up to determine which adjustments need to be made to the relevant arm's length transaction mark-up. The conclusions on the non-comparability of the margin achieved in the different foreign markets reflected the results obtained by the chosen comparative method. It is precisely because of the use of a different method for determining the manageability of the transaction (in the present case, the level of the margin in the various markets was not examined at all) that the conclusions of that judgment cannot be applied to the present case.

[43] The applicant's final complaint is that the Court of First Instance erred in refusing to take into account the documentary evidence adduced at trial. By means of those documents, the applicant sought to demonstrate the different price levels in the various markets at which the complainant's goods could be sold to customers in those markets. The applicant submits that, in view of the principle of plenary jurisdiction laid down by law, the court could not refuse to take the evidence on the ground that the applicant should have submitted it earlier to the administrative authorities.

[44] The case-law of the Supreme Administrative Court has already commented on the issue. In its judgment of 21 June 2006, Case No 1 As 42/2005-62, the Court stated that 'the legal conclusion of the court that it cannot take the evidence proposed by the applicant in the application unless the applicant had already proposed it during the administrative proceedings is contrary to the principle of full jurisdiction'. Those conclusions apply without exception in all types of proceedings where the principle of inquiry is applied, that is to say, where it is for the administrative authority itself to establish and establish the facts on which it will then base its conclusions.

[45] However, the situation may be different in proceedings where, on the contrary, the burden of proof is on the party to such proceedings and the administrative authority assesses whether the party has carried it, and it is on that basis that the administrative authority then draws its conclusions. A typical proceeding that substantially shifts the burden of proof to the parties is a tax proceeding, which in many respects is not based on the principle of investigation (see, for example, the judgment of the Supreme Administrative Court of 9 February 2005, No. 1 Afs 54/2004-125, or of 31 May 2011, No. 5 Afs 70/2010-93). This situation was also taken into account by the Court of Cassation in its judgment of 21 June 2006, Case No 1 As 42/2005 - 62, where it stated that 'when reviewing a tax decision by an administrative court, a reasonable balance must be struck in each case, taking into account both the principle of full jurisdiction of the administrative court's decision-making on the one hand, and avoiding obvious obstruction by the taxpayer on the other. Therefore, the implementation of evidence newly proposed only in the proceedings before the regional court should be insisted upon, usually, if (1) the court does not convincingly justify the redundancy of their implementation and (2) such evidence could not have been proposed already in the appeal proceedings, e.g. because the appeal decision (or the reasons on which it is based) was objectively surprising for the tax entity or because the proceedings were burdened with fundamental defects (e.g. the tax authority was not allowed to submit evidence, refused to accept it, etc.).

[46] The Regional Court's conclusion in the present case is therefore incorrect only in so far as it expressly stated in its judgment that it could not take into account the evidence proposed by the applicant, since it was based, in principle, on the state of affairs which existed at the time when the administrative authority made its decision; it is the only way in which it can assess the correctness or incorrectness of its procedure and its decision. On the other hand, however, the applicant only offered evidence intended to demonstrate the different price levels on the various markets at which goods can be sold on those markets. However, as regards this line of argument, the Court clearly explained and described (pp. 7, 8 and 9 of the judgment) that it was not decisive at what price the goods supplied by the applicant to the various distributors were resold on the various markets, but only at what price the applicant sold identical goods to its customers, who were a group of persons economically independent of the applicant on the one hand and a dependent person (KOLTER a.s.) on the other. That means that the court explained in the text of the judgment why it considered the situation to be sufficiently proven; in that situation, the court's erroneous reasoning on the impossibility of taking evidence does not therefore affect the legality of the judgment.

[47] For the reasons set out above, the Supreme Administrative Court therefore fully agrees with the conclusions of both the defendant and the court that the complainant did not bear the burden of proof in relation to proving the reason for the difference in prices, and that the tax liability for the tax periods in question was therefore assessed against him in full accordance with the law. Both the defendant and the court described why and on what evidence they relied and why they considered that the complainant had failed to prove its allegations concerning the proof of the tax base and corporation tax for the 2007 tax year.

IV.

Conclusion and decision on costs

[48] In the light of the foregoing, the Supreme Administrative Court concludes that the appeal is not well-founded and therefore dismisses it (Article 110(1) of the Civil Procedure Code). The Court of First Instance did not find any defect which it was obliged to take into account, even without an application (Article 109(4) of the Civil Procedure Code).

[49] The costs of the proceedings were decided in accordance with Article 60(1) in conjunction with Article 120 of the Civil Procedure Code. The defendant did not incur any costs in excess of normal administrative costs and was therefore not awarded costs.

C o n c l u s i o n : No appeal is allowed against this judgment.

Done at Brno, 23 January 2013.

Lenka Kaniová, JUDGE

President of the Chamber