New transfer pricing and value-added tax developments

Within international company groups, a large number of goods and services are supplied on a daily basis. The focus is usually on transfer prices for income tax purposes. These are used to price intra-group cross-border transactions as if they were between unrelated third parties. Price adjustments are often made retrospectively, either by the groups themselves or enforced as a result of tax audits. Now, due to current highest-level jurisdiction, the consequences of these transactions on value-added tax (“VAT”) are also coming into focus. We will examine these now in more detail. The complex relationship between VAT and transfer pricing is evident from their differing objectives. While VAT taxation centres on the utilisation of goods and services, transfer prices serve as the benchmark for allocating profits between related entities for income tax purposes.

From a VAT perspective, the question is whether the balancing payments are based on a service, how the adjustment of the transfer prices affects the VAT considerations and to what extent the minimum tax base or restrictions on VAT deduction apply.

Transfer pricing and VAT

In its most recent decision, the European Court of Justice (“ECJ”) in the ‘Högkullen’ case dealt with whether services provided by a management holding company in the areas of management, financing, real estate, IT and personnel administration are to be regarded as services as a uniform supply or whether they constitute individual services. In case of a uniform supply, the minimum tax base would be calculated not on the basis of the market price, but on the costs incurred at the holding company level (including overheads).

The tax authorities' classification of the services as a uniform supply was based on the fact that a total price was charged for the broad range of services. However, according to the ECJ, this fact alone is not determinative. The services were independent and autonomous and were not so closely linked that they complemented each other. They were therefore not to be regarded as services as a uniform supply. The ECJ has now created a basis for further VAT assessment with this individual service-by-service treatment of the usual activities of a group parent company vis-à-vis its subsidiaries.

The reason for the court proceedings was whether a purchase price on the market for this particular combination of individual services could be determined at all for the purpose of examining the minimum tax base. As a measure against tax avoidance, this is intended to ensure that sales are taxed as if between unrelated third parties – treatment that, in the case at hand, would have had an effect due to the subsidiaries’ lack of VAT deduction. However, this was no longer relevant due to the individual service-by-service treatment.

Previously, the ECJ had ruled in the ‘Weatherford case’ that a VAT deduction from general administrative services such as IT, human resources, marketing, accounting and consulting of a group parent company is also permissible if these are purchased from other group companies and are also provided to other group members in a similar manner (as is usual in the case of group cost allocations). For the ECJ, the decisive factor was that there was a sufficient connection between the remuneration paid and the services actually performed. It is not necessary to assess whether the procurement of services by the parent company for the subsidiary made economic sense from a profitability perspective. However, it must be ensured that the apportionment standards used in the group for internal billing also reflect the actual scope of the services purchased and that specific services were actually provided that are included in the subsidiary’s own services.

VAT consequences following a transfer pricing adjustment

The ECJ has not yet clarified the legal situation regarding adjustments as a result of transfer prices for income tax purposes. Some consider these to be irrelevant for VAT purposes. The ECJ currently has the opportunity to comment on this in two proceedings.

In the ‘Acromet Towercranes’ case, cranes were leased and sold, with the parent company taking care of purchasing and administration. It also bore the economic risk, while the subsidiary took over local marketing activities. If the subsidiary’s surplus, as determined using the ‘Transactional net margin method’ (TNMM), fell outside the arm’s-length range, the parent company made a balancing cash payment. The local tax administration and the Advocate General at the ECJ assume an independent taxable supply in the VAT sense, whereby the administration also denied the VAT deduction.

Similarly, in the ‘Stellantis Portugal’ case, the referring court also considered the entirety of the price adjustments made for the cars supplied to the subsidiary to be an independent performance for VAT purpose. The reduction in the price is aimed at ensuring a minimum profit from the sale of the cars for the subsidiary. The margin fell below a calculated minimum profit, primarily due to warranty services to be provided, with the effect that the profit was indirectly corrected by adjusting the group’s internal vehicle purchase prices.

From a VAT perspective, there is, at any rate, no compelling reason to regard the cash payment or price reduction as a consumption of a supply of goods or services in the VAT sense. In the ‘Acromet Towercranes’ case in particular, the non-taxability of the remuneration as a payment based purely on the company relationship for VAT purposes also appears to be justifiable. In the case of the price adjustment for cars in the ‘Stellantis Portugal’ case, however, there are several possible solutions. The outcome of the practice-relevant proceedings is awaited. 

Conclusion

The ECJ rulings that have already been issued and are still to be expected can be associated with the expectation that domestic and cross-border corporate transfer pricing will be more clearly defined in terms of VAT - but will also take centre stage. Entrepreneurs should therefore be well prepared for the fact that processes relating to invoice pricing will increasingly be scrutinised from a VAT perspective.