“B-Production” is a subsidiary in a US multinational group and engaged in production and sales. “B-Production” pays services fees and royalties to its US parent. Following an audit, the tax authorities issued an assessment where deductions for these costs had been reduced which in turn resulted in additional taxabel income.
An appeal was filed by “B-Production” with the Administrative court which in a judgement of June 2015 was rejected.
An appeal was then filed by “B-Production” with the Supreme Administrative Court. In the appeal “B-Production” contested the findings of the Administrative Court that there was a hidden distribution of profits by means of the payment of management fees and duplication (overlapping) of the services at issue under the management contract and the other two agreements between the B-Production and the parent company. B-Production further argued that the evidence in the case refutes the conclusions in the tax assessment and the contested decision that the services rendered did not confer an economic benefit and in addition argues that the costs of royalties and the costs of engineering and control services under the other two contracts are not a formative element of the invoices for management services, a fact which was not considered by the court.
Judgement of the Supreme Administrative Court
The Supreme Administrative Court decided in favour of the tax authorities and dismissed the appeal of B-Production as unfounded.
“The dispute in the case concerned the recognition of expenses for intra-group services. The NRA Transfer Pricing Manual (Fact Sheet 12) states that intra-group services in practice refers to the centralisation of a number of administrative and management services in a single company (often the parent company), which serves the activities of all or a number of enterprises of a group of related parties selected on a regional or functional basis. The provision of such services is common in multinational companies. The concept of intra-group services covers services provided between members of the same group, in particular technical, administrative, financial, logistical, human resource management (HRM) and any other services.
In the present case, the costs in question relate to a contract for the provision of management services dated 26.11.2002, paid by the subsidiary [company], registered in the Republic of Bulgaria, to the parent company, [company], registered in the USA. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘the OECD Guidelines’) should therefore be taken into account in the analysis of those costs and, accordingly, in the interpretation and application of the substantive law. According to paragraph 7.5 of the OECD Guidelines, the analysis of intra-group services involves the examination of two key questions: 1/ whether the intra-group services are actually performed and 2/ what the remuneration within the group for those services should be for tax purposes.
In the present case, the dispute in the case relates to the answer to the first question, since it is apparent from the reasoning of the audit report, the revenue authorities and the ultimate conclusion of the court of first instance that the services did not confer an economic benefit on the domestic company and constituted a disguised distribution of profits within the meaning of section 1(5)(b) of the Act. “a” of the Tax Code.
Therefore, the arguments in the cassation appeal for material breaches of the rules of court procedure – lack of instructions concerning the collection of evidence related to the amount of the price of the intra-group service and the allocation of the burden of proof to establish this fact – are irrelevant to the subject matter of the dispute.
Paragraph 7.6 of the OECD Guidelines states that, according to the arm’s length principle, whether an intra-group service is actually performed when an activity is carried out for one or more group members by another group member will depend on whether the activity provides the group member concerned with an economic or commercial advantage to improve its commercial position. This can be determined by analysing whether an independent undertaking would, on comparable terms, be willing to pay for the activity if it were carried out for it by an independent undertaking or whether it would only have carried it out with its own funds.
It is correct in principle, as stated in the appeal in cassation, that the analysis of intra-group services and their recognition for tax purposes is based on the facts and circumstances of each particular case. For example, the OECD Guidelines lists activities which, according to the criterion in point 7.6, constitute shareholding activities. According to paragraph 7.10, b. “b” of the OECD Guidance, expenses related to the accounting requirements of the parent company, including consolidation for financial statements, are defined as such. The evidence in this case established beyond a reasonable doubt that the management services covered by the contract at issue in this case included the compensation of a responsible financial and accounting manager, including cash flow planning and reporting, preparation of monthly, quarterly and annual reports (American Accounting Standards accounting. These activities, which there is no dispute that they were performed, fall within the definition of Section 7.10 for “shareholder activities.” The remaining activities included in management services, including the costs associated with the use of the software programs referred to in the expert report, are imposed by the parent company’s requirements for control and accountability of the subsidiary under the three sets of activities – managing director, production and finance. There is no merit in the objection in the cassation appeal that the management contract services do not duplicate the costs of the other two contracts. It is established from the conclusion of the FTSE that the costs of engineering and control services and royalties (know-how and patent) are not a formative element of the invoices for management services. The conclusion of the experts was based only on the fact that separate contracts had been concluded for the individual costs and not on an analysis of the elements that formed the fees. According to Annex 6 to the expert report, the costs of the management services contract for the vice-president of production and the corporate production engineer accounted for 50 % (half) of the management contract costs.
It follows from the foregoing that the costs of the management services contract arise primarily from the capacity of a member of the group and do not confer an economic and commercial benefit on the subsidiary which bears them within the meaning of paragraph 7.6 of the OECD Guidelines. Therefore, these expenses were lawfully determined to be unrelated to the business, constituting a hidden profit allocation within the meaning of §1.5(b). “a” of the General Tax Law. Pursuant to Article 26(11) of the Income Tax Act, in this case the accounting expenses are not recognised for tax purposes. Pursuant to §1, item 4, b. “c” of Art. 194(1) of the CCCT, the undisclosed distribution of profits constitutes a dividend which is subject to withholding tax.”