The case concerned a Danish company that provided legal services regarding tax deductions for improvements to real estate, etc.
In 2006, the owner of the Danish company moved to Y2 city and in the process established a company in Y2 city, which would then provide services to the Danish sister company, including legal advice.
The tax authorities had increased the Danish company’s taxable income by an estimated total of approximately DKK 58.4 million, as the tax authorities considered that the company’s transfer pricing documentation was sufficiently deficient, in accordance with Section 3 B(8) of the Tax Control Act, cf. Section 5(3), and that the service agreements were not concluded at arm’s length in breach Danish arm’s length provisions.
Judgement of the High Court
The tax authorities were entitled to exercise discretion over pricing of the controlled transactions as the transactions had not been priced at arm’s length and the transfer pricing documentation was deficient.
“The case shows that SKAT’s estimate of H2 ApS’s payment (management fee) for the services provided by G1 is based on the TNM method as a pricing method, which is justified in particular by the fact that G1 was a simple service/service provider.
Furthermore, the case shows that in calculating G1’s transfer prices for the provision of services to H2 ApS, SKAT carried out a benchmark analysis of 25 comparable law firms and audit firms using Return on Total Cost (hereinafter RoTC) as a profit level indicator. It is stated that RoTC is calculated by dividing the companies’ profits (earnings before interest and tax) by their costs (total costs). The benchmark analysis showed a market RoTC median of 6,72 %, which implied that the tax authorities considered G1 eligible to earn a profit of 6,72 % in relation to G1’s expenses and that G1’s expenses with the said mark-up could be approved as the amount of H2 ApS’s expenses to G1 for tax purposes for the period 2006-2010 (approximately DKK 20 million).
The High Court accepts, after an overall assessment, that the services provided by G1 to H2 ApS are comparable to the services provided by law firms and auditing companies and that the applicants have not demonstrated that the TNM method was not applicable as a pricing method, also referring to the above-mentioned reason why, in the High Court’s view, the profit-split method was not the appropriate pricing method to apply in relation to the controlled transactions.
The High Court considers that, on the basis of the evidence submitted – in particular in the light of the calculation of the profit rate in the legal sector contained in the Competition Council’s analysis report of 14 December 2005 – the applicants have not established that the profit-split method was applied. In the light of the evidence, including the evidence of the profitability analysis carried out by the tax authorities, as set out in the Competition Authority’s report of 14 January 2021 on ‘Competition in the legal sector’, the applicant submits that the tax authorities’ estimate in the present case is based on an incorrect or inadequate basis capable of influencing the estimate, having regard also to the fact that the Y2 company mainly provided legal services and that approximately half of the companies included in the SKAT benchmark analysis are law firms. In this respect, the Court of Appeal has emphasised in particular that it follows from the above-mentioned analysis report that a partner in a law firm receives a salary for work performed as well as a remuneration for ownership in the form of a share of the law firm’s profits, that if the partners’ income is calculated on the basis of their personal income – which includes both a salary for work performed as well as a remuneration for ownership – the profit rate in the legal sector was between 30 and 35 %. in the years 2012 to 2018, and that the profit rate was around 20 per cent in those years if the remuneration for the partners’ work is adjusted.
The High Court thus considers that the calculation method used by SKAT does not take proper account of the remuneration structure of law firms and that SKAT’s benchmark analysis thus arrived at a profit rate which is not accurate. In doing so, the High Court also took into account that it follows from TPG 2010, points 2.90-2.91, 2.92 and 2.97, that profit level indicator may be, inter alia, net profit in relation to turnover (sales), costs (costs) or assets (assets), see also section C.D.188.8.131.52 of the Legal Guide 2021-1.
On the basis of the above, the High Court remands the tax assessment for Rafn & Søn ApS and, consequently, the determination of the joint taxable income for PB Holding ApS for the income years 2006-2010, as regards the amount of DKK 33,699,860, to be reviewed by the Tax Agency in order for the Tax Agency to take due account of the remuneration structure of the law firms in the discretionary assessment.”