A Danish parent in the Maersk group’s oil and gas segment, Maersk Oil and Gas A/S (Mogas), had operating losses for FY 1986 to 2010, although the combined segment was highly profitable. The reoccurring losses was explained by the tax authorities as being a result of the group’s transfer pricing setup.
“Mogas and its subsidiaries and branches are covered by the definition of persons in Article 2(1) of the Tax Act, which concerns group companies and permanent establishments abroad, it being irrelevant whether the subsidiaries and branches form part of local joint ventures.
Mogas bears the costs of exploration and studies into the possibility of obtaining mining licences. The expenditure is incurred in the course of the company’s business of exploring for oil and gas deposits. The company is entitled to deduct the costs in accordance with Section 8B(2) of the Danish Income Tax Act. Mogas is responsible for negotiating licences and the terms thereof and for bearing the costs incurred in this connection. If a licence is obtained, subsequent expenditure is borne by a subsidiary or branch thereof, and this company or branch receives all revenue from extraction. Mogas shall ensure that the obligations under the licence right towards the State concerned (or a company established by the State for this purpose) and the contract with the independent joint venture participants are fulfilled by the local Mogas subsidiary or permanent establishment. Mogas has revenues from services provided to the subsidiaries, etc. These services are remunerated at cost.
This business model means that Mogas will never make a profit from its operations. It must be assumed that the company would not enter into such a business model with independent parties. It should be noted that dividend income is not considered to be business income.”
According to the tax authorities Mogas had provided know-how etc. to the subsidiaries in Algeria and Qatar and had also incurred expenses in years prior to the establishment of these subsidiaries. This constituted controlled transactions covered by the danish arm’s length provisions. Hence an estimated assessment was issued in which the additional income corresponded to a royalty rate of approximately 1,7 % of the turnover in the two subsidiaries.
In 2018, the Tax Court upheld the decisions and Mogas subsequently appealed to the regional courts.
Judgment of the Regional Court
The Regional Court held that the subsidiaries in Algeria and Qatar owned the licences for oil extraction, both formally and in fact. In this regard, there was therefore no transaction. Furthermore the explorations studies in question were not completed until the 1990s and Mogas had not incurred any costs for the subsequent phases of the oil extraction. These studies therefore did not constitute controlled transactions. The Court therefore found no basis for an annual remuneration in the form of royalties or profit shares from the subsidiaries in Algeria and Qatar.
On the other hand, the Regional Court found that Mogas’s so-called performance guarantees for the subsidiaries in Algeria and Qatar were controlled transactions and should therefore be priced at arm’s length. In addition, the Court found that technical and administrative assistance (so-called time writing) to the subsidiaries in Algeria and Qatar at cost was not in line with what could have been obtained if the transactions had been concluded between independent parties. These transactions should therefore also be priced at arm’s length.
As a result, the Court referred the cases back to the tax authorities for reconsideration.
Excerpts
“It can be assumed that MOGAS’s profit before financial items and tax in the period 1986-2010 has essentially been negative, including in the income years in question 2006-2008, whereas MOGAS’s profit including financial items, including dividends, in the same period has been positive, and the Regional Court accepts that income from dividends cannot be regarded as business income in the sense that dividends received by MOGAS as owner do not constitute payment for transactions covered by section 2 of the Tax Act.
However, the Regional Court considers that the fact that MOGAS’s profit before financial items and tax for the period 1986-2010 has been essentially negative cannot in itself justify allowing the tax authorities to make a discretionary assessment.”
“As stated above, the performance guarantees provided by MOGAS and the technical and administrative assistance (timewriting) provided by MOGAS constitute controlled transactions covered by Article 2 of the Tax Code.
The performance guarantees, which are provided free of charge to the benefit of the subsidiaries, are not mentioned in the transfer pricing documentation, and the Regional Court considers that this provides grounds for MOGAS’s income relating to the performance guarantees to be assessed on a discretionary basis pursuant to Section 3 B(8) of the Tax Control Act currently in force, cf. Section 5(3).”
“Already because MOGAS neither participates in a joint venture nor acts as an operator in relation to oil extraction in Algeria and Qatar, the Court considers that MOGAS’ provision of technical and administrative assistance to the subsidiaries is not comparable to the stated industry practice or MOGAS’ provision of services to DUC, where MOGAS acts as an operator.
Against this background, the Regional Court considers that the Ministry of Taxation has established that MOGAS’ provision of technical and administrative assistance (timewriting) to the subsidiaries at cost price is outside the scope of what could have been obtained if the agreement had been concluded between independent parties, cf. tax act Section 2 (1).”
UPDATE 5 May 2022: According to the Danish newspaper “Berlingske” an appeal has been filed by the tax authorities with the Supreme Court.