ERT Automotive Bohemia s.r.o. is active in the automotive industry. From 1 January 2013 to 30 November 2013, it provided the manufacture and repair of upholstery products for the automotive industry for its ‘sister’ company, Reiner Lasertec GmbH, established in Germany (both companies were owned at the time by the parent company Notos Beteiligungen GmbH, also established in Germany). ERT Automotive Bohemia s.r.o. provided ‘wage labour’ for Reiner Lasertec at a price of EUR 0,15 per minute of work. In December 2013, ERT Automotive Bohemia s.r.o. changed this business model. It no longer simply processed materials for Reiner Lasertec, but instead took over its former role. It was thus responsible for the production of the entire specific automotive part, which it then supplied as an independent manufacturer and final supplier.
The Tax Office suspected that ERT Automotive Bohemia s.r.o. had supplied services to a related party from January to November 2013 at a lower price than would have been agreed between independent parties pursuant to section 23(7) of the Income Tax Act. Following a tax audit, it therefore assessed ERT Automotive Bohemia s.r.o. by way of an additional assessment for corporate income tax for FY 2013.
ERT Automotive Bohemia s.r.o. criticised the tax authorities for ‘comparing incomparables’ – that is to say, for comparing the activities and costs as a subcontractor and of Reiner Lasertec as the final supplier. However, Reiner Lasertec, as the final supplier, was, unlike ERT Automotive Bohemia s.r.o., in charge of, for example, negotiations with customers. ERT Automotive Bohemia s.r.o. also pointed out that, according to the tax authorities’ calculations, as a mere manufacturer, it should be making unprecedented profits (for that position in the production chain) in terms of wages.
ERT Automotive Bohemia s.r.o. succeeded in an appeal to the Regional Court, which referred the case back for further proceedings. According to the Regional Court, the tax authorities did not bear the burden of proof or the burden of proof as regards the determination of the reference price and the difference between the agreed price and the reference price. Nor did they deal with the argument that the agreed price for the services provided to Reiner Lasertec covered all its costs as well as a reasonable profit. They did not take sufficient account of the fact that ERT Automotive Bohemia s.r.o. acted as a subcontractor in the controlled transaction, whereas in the independent transaction it was already acting as an independent manufacturer.
Judgment of the Supreme Administrative Court
The Supreme Administrative Court upheld the decision of the Regional Court and ruled in favour of ERT Automotive Bohemia s.r.o.
Excerpts
“[15] However, the tax authorities suspected that until November 2013 the applicant had provided its services ‘below cost’. The tax authorities first intended to adjust the applicant’s tax base by approximately CZK 7,5 million, based on the reference price determined by the TNMM (net margin method). However, he subsequently (also following the applicant’s objections) proceeded to establish a new reference price using the CUP (comparable independent prices) method. In determining the second reference price, the administrator compared the original transaction between the applicant and Rainer Lasertec (or the provision of services by the applicant from January to November 2013) with the subsequent transaction between the applicant and Boshoku Automotive. He then attempted to ‘clean up’ the independent transaction with Boshoku Automotive so as to compare only comparable activities, i.e. the part of the production that the applicant was also providing before December 2013 (the essential part of the dispute being whether the complainant succeeded in doing so). And it concluded that the applicant had indeed provided its services to Reiner Lasertec until November 2013 ‘below cost’, i.e. at a lower price than would have been agreed under similar conditions between independent persons…”
“[21] First of all, the selection of the independent transactions with which the tax authority wants to compare the controlled transaction is already under scrutiny: ‘the selection of independent transactions and, if they are not fully comparable, the appropriate method of their adjustment must be made on the basis of objective, fair and reviewable criteria’ (8 Afs 80/2007). When determining the reference price, the tax authorities must primarily base themselves on existing independent transactions which are at least at their core comparable to the controlled transaction.”
“[29] At the most general level, the SAC recognises that a transaction which is broader in scope than the controlled transaction and which incorporates the subject matter of the controlled transaction (i.e., for example, the present independent transaction) may also serve as an independent transaction in determining the reference price. As the SAC has already stated above, the range of transactions that can be used for comparison is wide (cf. paragraph [21]). After all, the SAC has even gone so far in the past as to allow the tax authorities to use a transaction between related parties as an independent transaction, but with a price determined by an expert opinion (cf. cases 1 Afs 143/2017, cited above, paragraph 26, and 3 Afs 105/2017, paragraph 22).
[30] However, even such an independent transaction must be comparable, at least in substance, to a controlled transaction. It must at least be eligible for subsequent correction. What comparability means, at least at its core, is of course to be determined on a case-by-case basis. In general, however, the subject matter of the controlled transaction must form an essential part of the wider arm’s length transaction – so that the arm’s length price is agreed with respect to it. If the subject matter of the controlled transaction were only a marginal, insignificant part of the wider arm’s length transaction, it would become unworkable. Similarly, it is important that the position of the parties to the broader arm’s length transaction, in particular that corresponding to the position of the taxpayer in the controlled transaction, should not differ substantially. It is only if these conditions are met that the adjustment of the arm’s length transaction will make any sense – otherwise the tax authorities would effectively be determining the reference price by a hypothetical estimate, which is not envisaged by Article 23(7) of the Income Tax Act (cf. again paragraph [21] above and judgment 9 Afs 232/2018, Automotoklub Masaryk Circle).
[31] In the present case, however, it is not clear whether the arm’s length transaction used is at all comparable in substance to the controlled transaction and whether an adjustment to the arm’s length transaction can even be meaningfully made.”
Excerpts
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