On 28 February, the Supreme Administrative Court issued a decision 7 Afs 31/2024, by which it dismissed the appeal of the Financial Directorate of Appeal against the decision of the Regional Court in the case of an additional corporate income tax assessment based on the results of a tax audit focused on transfer prices.
We consider the decision to be important because the Supreme Administrative Court stated that if the tax administrator is to make an additional adjustment to the tax base due to an adjustment of transfer prices, " ... in no case can it be an adjustment of the price of a controlled transaction according to the conditions of an artificially created, hypothetical market."
The subject of the dispute, which the Regional Court decided in favour of the taxpayer, was the method of determining the remuneration for contract manufacturing. The dispute concerned a situation in which the manufacturer - contrary to the originally agreed contractual terms, according to which it was not the owner of the material necessary for the production of the products supplied to the associated person - purchased part of the material from its own funds.
Based on the audit findings, the tax authorities concluded that the manufacturer was entitled to a remuneration for capital tied up in inventories in addition to the profit mark-up applied to the production costs incurred to date as specified in the Contract. This remuneration was quantified by the tax authorities using the 12-month average USD LIBOR rate, without, however, carrying out a comparative analysis. In so doing, it did not verify whether the profit margin on all production costs (including the cost of purchased materials) realised by the taxpayer was within the range of profit margins achieved by comparable independent producers who also held capital tied up in inventories of materials needed for production.
The Appellate Tax Directorate concluded that the tax administrator had acted correctly in assessing the remuneration for tying up the funds in the purchased stock as if were a separate transaction. According to the Appellate Tax Directorate, the purchase of the stock on the instructions of the parent company could be regarded as the taxpayer de facto granting a loan to the related party. The Appellate Tax Directorate justified its acceptance of the use of the USD LIBOR interbank rate by comparing the investment in stocks needed for production with a hypothetical transaction involving a short-term lending of funds by the taxable person in a risk-free market, where the remuneration could be set as interest. The representative of the taxpayer brought an action against the decision of the Financial Directorate of Appeal before the Regional Court, which ruled in favour of the taxpayer.
The Supreme Administrative Court agreed with the Regional Court's opinion, which pointed out that USD LIBOR is the rate that determines the reference interest rate for short-term international interbank loans, and neither the taxpayer nor the parent company that ordered the purchase of the stock were banking institutions. According to the Regional Court, the use of the risk-free interest rate to increase the contractor's profit margin was not sufficiently justified, as it was not supported by the range of prices realised under comparable conditions.
Autror: Lenka Lopatová
We consider the decision to be important because the Supreme Administrative Court stated that if the tax administrator is to make an additional adjustment to the tax base due to an adjustment of transfer prices, " ... in no case can it be an adjustment of the price of a controlled transaction according to the conditions of an artificially created, hypothetical market."
The subject of the dispute, which the Regional Court decided in favour of the taxpayer, was the method of determining the remuneration for contract manufacturing. The dispute concerned a situation in which the manufacturer - contrary to the originally agreed contractual terms, according to which it was not the owner of the material necessary for the production of the products supplied to the associated person - purchased part of the material from its own funds.
Based on the audit findings, the tax authorities concluded that the manufacturer was entitled to a remuneration for capital tied up in inventories in addition to the profit mark-up applied to the production costs incurred to date as specified in the Contract. This remuneration was quantified by the tax authorities using the 12-month average USD LIBOR rate, without, however, carrying out a comparative analysis. In so doing, it did not verify whether the profit margin on all production costs (including the cost of purchased materials) realised by the taxpayer was within the range of profit margins achieved by comparable independent producers who also held capital tied up in inventories of materials needed for production.
The Appellate Tax Directorate concluded that the tax administrator had acted correctly in assessing the remuneration for tying up the funds in the purchased stock as if were a separate transaction. According to the Appellate Tax Directorate, the purchase of the stock on the instructions of the parent company could be regarded as the taxpayer de facto granting a loan to the related party. The Appellate Tax Directorate justified its acceptance of the use of the USD LIBOR interbank rate by comparing the investment in stocks needed for production with a hypothetical transaction involving a short-term lending of funds by the taxable person in a risk-free market, where the remuneration could be set as interest. The representative of the taxpayer brought an action against the decision of the Financial Directorate of Appeal before the Regional Court, which ruled in favour of the taxpayer.
The Supreme Administrative Court agreed with the Regional Court's opinion, which pointed out that USD LIBOR is the rate that determines the reference interest rate for short-term international interbank loans, and neither the taxpayer nor the parent company that ordered the purchase of the stock were banking institutions. According to the Regional Court, the use of the risk-free interest rate to increase the contractor's profit margin was not sufficiently justified, as it was not supported by the range of prices realised under comparable conditions.
Autror: Lenka Lopatová