The Administrative Court had annulled an income assessment issued by the tax authorities to Yazaki Bulgaria in FY 2014, 2015 and 2016.
An appeal was filed by the tax authorities with the Supreme Administrative Court for annulment of the judgment.
In the assessment, the tax authorities had accepted the comparability analysis carried out by Yazaki Bulgaria in respect of transactions relating to the manufacture of automotive products, including the calculated interquartile range of market values established on the basis of data for 25 comparable companies.
According to the benchmark study the Net Cost Plus margins of the comparable companies for the three-year period were as follows:
2014 weighted average Net Cost Plus – lower quartile 2.27%, median 4.16% and upper quartile 7.02%;
2015 weighted average Net Cost plus 2015 – lower quartile 1.68%, median 4.31% and top quartile 6.80%;
2016 weighted average Net Cost plus for 2016 – lower quartile – 2.22%, median 3.95% and top quartile 7.66%;
The actual Net Cost Plus margins realized by Yazaki Bulgaria for the periods were outside of the established range (-1.02% for 2014, 1.43% for 2015 and 0.46% for 2016) but by “adjusting” the cost basis, Yazaki Bulgaria’s net profit margin were within the interquartile range: 2.34% for 2014, 4.3% for 2015 and 2.56% for 2016.
The tax authorities considered that there were no basis for the adjustments made by Yazaki Bulgaria to the actual net profit margins and since the actual results had been outside of the interquartile range, the profit was set to the lower quartile for each year.
Judgment of the Supreme Administrative Court
The Supreme administrative court allowed the appeal of the tax authorities and set aside the decision of the Administrative Court.
Excerpts in English
“In the present case, the audited company alleges the existence of losses from new projects during the audited periods that are specific only to the controlled transactions in the manufacture of automotive products, which were not found in the comparator companies. The impact of group-specific events on the profitability of the examined and compared businesses and the reliability of the comparability analysis is identified as a feature of TNMM in the OECD Handbook, 2010 (paragraph 2.72) and in the NRA Handbook on Transfer Pricing, Fact Sheet 10 (paragraph 6.2). These interpretative sources should be taken into account in the interpretation and application of the substantive law – Article 15 of the Tax Code and Article 46 of Regulation N-9/14.08.2006.”
“According to paragraph 1.70 of the OECD Guidelines, 2010, related enterprises may incur real losses due to large initial costs, including inefficiencies or other legitimate business reasons, but under market conditions the losses would be temporary. Paragraph 1.72 states that losses such as those in the trial from unforeseen start-up labour costs can be expected for a limited period of time in order to increase profits in the long term. Such circumstances are also reflected in the transfer documentation prepared by the company, where the comparability analysis on the 2014, 2015 and 2016 automotive transactions indicates that YBE’s long-term projections are that for future periods the Renault Edison and Ford Transit projects, respectively the Renault Edison and Mercedes MFA2 projects will be more efficient and better revenue generating, but the case has not established that such results have been achieved. The valuation of the Renault Edison project in 2017 as a loss-maker and its discontinuation in 2017 is aimed at overcoming losses in accordance with paragraph 1.72 and the arm’s length principle. For the remaining projects, the case does not establish, including from the conclusion of the forensic economic expert, that the losses from the difference between the reported low productivity and the budgeted productivity during the periods at issue, resulting from higher labour costs at start-up, have been overcome in the long term in view of the life cycle effects of the products and that the profitability of the net profit indicator used, net cost plus, has been achieved in accordance with the arm’s length principle. Therefore, it cannot be assumed that the company’s elimination of the impact of labour cost losses for additional staff employed in 2014, 2015 and 2016 in connection with new production projects, when comparing the net profit indicators within the meaning of Articles 43 and 44(2) of Regulation N-9/2006, is in line with the objectives set out in Articles 4, 12 and 14 of the Regulation and with the arm’s length principle.”
“Reasonably in this respect in the audit act it is accepted that the losses assumed by the audited company do not correspond to the functions, responsibilities and risks of the controlled transactions, which it has assumed according to the data in documentation for transfer pricing. According to the documentation, market and price risk is borne by the related party in the group (CSC) and not by the manufacturer.
In view of the above, it is to be held that the increase in the financial results of a company for the year 2014-16 made by the revision order on the basis of section 15 of the Income-tax Act to the lower quartile of the range of market values found in comparable independent companies is lawful.
In holding to the contrary, the court rendered a judgment contrary to the evidence in the case and in violation of substantive law, which should be set aside and another judgment entered dismissing the appeal in its place.”
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The tax authorities adjusted the income based on the shortfall of Yazaki Bulgaria’s net cost plus margin from the lower interquartile range (lower interquartile range minus achieved net cost plus margin). Is this consistent with Bulgarian law, or should it have been adjusted with respect to the median of net cost plus margin earned in the comparator set?